How to plan for longevity risk in retirement

Zerodha Varsity
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Most people, when they plan for their retirement, they look at the average life expectancy and then assume that’s the age they will probably live to. However, averages can be misleading because they conceal the variation of people who do not live to the average life expectancy mark or live past it. When you are making your retirement assumptions, it’s always better to be overprepared and save more with the assumption that you might live to be 100 years old or more. It’s not really hypothetical because science is getting better all the time. In 1960, the average Indian life expectancy was 40 years, and in 2020 it was 70 years old. Not planning for a long life is called “longevity risk,” and most people don’t intuitively think about it.

So what does this mean in investing terms? You will have to have a higher equity exposure because equities in the long run have higher expected returns compared to all the other asset classes like debt, real estate, and gold. But this leads to questions like: what stocks, how to pick them, etc. But there’s a much simpler, tax-efficient, evidence-backed, and historically proven way of investing in equities for the long run. In this video, @Karthik explains how to think about longevity risk and how to invest to cover that risk.

Of course, retirement is just one broader topic under personal finance. In case you didn’t know, we have a dedicated module on personal finance on Varsity:

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I agree with the concept of Index Fund. Liked the video as well.

What bothers me is the following:-

Assuming I am retired and now dependent on income from investment. I am periodically withdrawing the money from the Index fund for expenses. I am now in Dec 2019 when the Index was at 12,168. The index fell to 8597 upto March 2020. My investment in SBI ETF Nifty 50 fell from 125 to 84 in the three months. This is the time to buy in, but I am retired and depend on this fund for my expenses. It took another six months for the nifty to come back to 125 i.e November.

Now how do I survive this period, If I had invested in Index fund and was doing a SWP from my corpus. Thank God, the fund came back to 125 in six months time, what happens if this got extended to many years? What then? Will we still believe Index fund is better off. This is my query.

One option I can think off is doing a Reverse Mortgage if I own a self residing property. This will give me adequate cushion to stop SWP when market falls as badly as it did. Once the market rises, I can then restart the same. Even if you own real estate, it is of no use as it would be very difficult to sell during these times.

Second option, the obvious one, FDs from bank and post office to sustain. A small portion in Index fund which will to a certain extent offset the inflation.

Third option - As and when market peaks like when the fund went upto to 192, take out a small portion and put it in FD as Interest rate is high as well.

Are their any other options to fall back when market falls so badly. Not worried about corrections, but something like what happened in March 2020.

Any suggestion for Plan B or C

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For that you have to explore derivative market for hedging the portfolio. What people usually do, they buy long term puts when markets seems over bought for a premium of around 5 to 10% pa. So ,its like insurance plan .When it fall like covid fall , you can square off the put and buy equivalent ETF.

Hedging is the tradeoff where you give away small profits for safety.Again , its not simple and linear so very though to follow

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This is sequence of returns risk.

This is real risk when someone retires, and multi-year recession starts.

What we are looking for index fund like returns and drawdown like fixed assets.

One way to do it, it is created multi-asset portfolio with un-correlated assets (ie which do not go up and down in sync). Diversify and reduce the risk

Its possible to get least risk ( which is called minimum variance point) and still earn better than what fixed asset only investment will give you.

Or

Get almost index like returns with lower drawdown (which is called efficient frontier)

Portfolio theory suggests that more un-correlated assets you add in portfolio more you reduce risk (ie variability measured in terms of standard deviation).

However for individual investor it becomes difficult to manage so many indexes.

currently in India there are few funds which do multi-asset allocations. However, they trust on fund managers smartness to decide on how much to allocate on each asset class.

NPS is only one (which I know of) which uses fixed allocation, but it doesn’t use indexes.

My own retirement portfolio is simplified version of dream retirement fund with US stock market index as one of the components. I believe (rather pray) that it will be less volatile and still will give me index like returns (when I need money).

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Can I hedge my SBI ETF Nifty 50 portfolio, if so how.

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Hedging is only possible for 》1 lot size of ETF .

Ie. If you have 8 lakh worth of Nifty 50 ETF

There are multiple ways all are non linear in nature.

Search on youtube there are ample ways even to hedge your portfolio (which contain stocks etc)

Simple way is if you feel you are sitting on good return than either short future or buy long dated put.

Eg . You feel some risk of severe fall at 18000 to hedge it either you can short future which requires margin ( you can get margin pledging your ETF)

Shorting future also generate 6% pa as its always in premium due to risk free interest calculation but downside is your return is capped at 18k .if nifty goes 21 k you won’t get the benefit.

You can buy 18k PE Dec 23 currently trading at 780 pts. So its like insurance policy 4.8% PA. Here your portfolio is 100% hedged at the cost of 4.8% PA+ you will get benifit of upside.

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For the sake of simplicity, I would leave the ETF as is. We are probably living in the century where India will grow to become a super power. Nifty will zoom to greater and greater highs and so will your ETF. Short terms blips are part of the market and it can be ignored if you are an investor as I assume you are.

Why try to time the market and cap your profits by hedging which by the way will also make things more of a hassle in portfolio management ?

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There are two sub-questions merged in the original question:-

  1. How to manage expenses if you outlive your life expectancy?

  2. How to survive when market goes into multi-year, or god forbid, multi- decadal recession phase?

I would like to highlight one important financial- product, which, somehow, gets battered by the people who love and believe in stock market:-“ANNUITY PLANS” .

Annuity plans are EXACTLY built for the same purpose!

For all the haters of annuity plans due to their non-lucrative returns, I would like to say, that in adverse times, we should first try to survive, and annuity returns provides the same. It pays for your BREAD- till your last breath!

If your others assets are doing well including stocks, put BUTTER and whatever on your bread with that return. But the lifelong supply of meagre money to buy at least bread will not let you die.

My current financial planning includes buying an annuity plan at an appropriate age-likely 60, with a part of my retirement corpus- with an intention to get 40-50% of my expected expenses with annuity only.

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Great points I got - Hedging from @AlgoEye will defenetly read about it.
@t7support - simplicity - which I am doing right now.

@arvind1K - the points you raised is exactly what I am worried about.

As you rightly said, I never considered annuity as part of retirment planning product. Every second week I get a message from one of my Bank RM about Bajaj Allianz annity plan. I discard it even without reading for the following:-

  1. I am aware the returns mentioned are until the person dies, but the rate of return mentioned is lower than what a 10 year FD return gives out.
  2. Last month, I got similar one where the rates got revised upward, so I asked the RM what would have happened, if I had taken the older version, he says, sorry bad luck, take another one and do laddering. His reply was funny but there is no exit option unlike a FD.
  3. Somehow I only trust Government Organisation when it comes to Life Insurance (LIC my fav) and similary for annuity. Just dont feel like putting money in private company as these are life long and not sure what happens if they go bankrupt.

Fully agree with @arvind1K regarding “pays for the bread”. This is exactly what I was looking for apart from FD. I witnessed it first hand in march 2020 when I lost capital notionally on paper by almost 40%.
Gods luck was with me that I did not need the money from my equity at that time. My NPS investment fell by mere 1%. I then realised the importance of asset allocation.

I think investing in NPS which has asset allocation within itself and thereafter the option to move it to Annuity could be one of the product as 40% of NPS corpus will be moved mandatorily to annuity.

Thank you all.

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Equity investments should be planned such that you don’t ‘need’ to exit them for next 5-10 years. Asset allocation is imp, even more so if there is no income stream. So debt/FD/other must be able to cover these expenses + emergency expenses. In normal times, you can still take from equity if needed as per allocation target and meet your expenses.

Even after all of this, fear of multi decade bear markets will always be there. But hopefully wont happen for growing country like India for next few decades atleast. But also must be able to beat inflation and use only real returns for expenses. Only thing to do against this is maybe have some sort of external income going. Trading can help i hope, but its not for most people.

Yeah i feel same, also better look at fine print and also make sure that these plans will cover inflation. lakhpati used to mean something, now its nothing. crorepati will get there too.

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I learnt this the hard way.

Nothing beats stress free life. I am with you on this one.

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What if we reverse the scenario? For example, we take a loan from a private and the company goes bankrupt. Do we still have to repay the loan? :thinking:

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I’m sure! Retailers don’t get to escape debt :rofl:

That’s for Adani’s and Ambani’s.

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okay i like this thinking out of the box kind. You are smart.

we need to take enough debt to go to london and settle.

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I fully agree with you, but when do we ever exit? Most of the experts and people who write about finance say, invest only if you are the in long run. Now I am ok with that, but if I had invested in 2010 and the long run ended in March 2020. I will be crushed.

So the million dollar question which I am still asking and have not found the answer, when do I take the profits.

My own stategy is to keep a target price for each stock, once it reach, start selling in parts and bring down the average cost and thereafter leave it for perpetuity. At the same time if it falls accumulate. Overal result should be take out the capital invested and leave the rest.

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This is how I book full/partial profits in any stocks.But I hardly sell, if company is profitable.I will accummlate more during crash.

I guess Discount Cash Flow can solve this, in my case if intrinsic value of any share is greathe than 3x of current market price(cmp), it means stock is overpriced and partial profits can be booked.

Most imp, when to enter on basis of DCF Calculation:

When cmp is less than intrinsic value for any share, it’s value buy.

How to calculate DCF manually as well as using python code:
https://divyankm.github.io/Stock-Exchange-Data-Analysis/frontend_html_files/dcf_reverse_dcf.html

DCF can be calculated on 3000+ stocks automatically using python code, stated in above link.

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For index/MF investing only -

  1. Sell as per need, as per target allocation etc in normal markets. Allocation matters, if market is moving up, move some to debt etc. 10y gilt i think works well with Index, although 10Y gilt may not be the best for expenses due to duration risk.

  2. During income years, we don’t really need to sell ( but ideally still maintain debt allocation for tough times - may not have a job). As retirement nears, we have to face this risk. So manage risk accordingly ( say 5-10y earlier). But must still have equity investments to get something above inflation.

  3. Don’t sell if we are in bear phase, and if able add some without going overboard ( esp if need money for expenses). Can have adding on crashes as part of allocation plan. This is the reason for 5-10 year window obv.

Stocks are different. You need an edge and exit will be part of your rules.

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The problem is I will retire at 55-60 and need t remain cashflow which matches inflation till I am 100-105 years.

Which effectively means if I got job at 25… I have 30-35 years to accumulate money which will help me survive for next 45-50 years.

That means I need money for 50 years. If I exit equity at 45-50 then next 50 years debt should give me returns which increases with inflation.

This is slightly improbable if not impossible. I mean if my monthly outgo at the age of 60 is 1 L INR, with 6% inflation, keeping all other things constant I will need 10L INR at the age of 100.

This is 10 times more than what I started retirement life. With out accounting lifestyle inflation.

Also with annuity plans current structure, its difficult to meet these numbers.

To reduce sequence of returns risk which @neha1101 mentioned

This is real risk. Whatever said and done No one can predict future…at least for short term .

The ability to take risk or window does not exist when I am retired. Unless I have cashflow which beats inflation, I need to dip in principle amount or use plan B similar to

To beat inflation, we need equity like return,
To beat multiyear recession, we need drawdown similar to fixed income.
Since Decision making can be issue at old age, need portfolio management which requires zero prediction about future.

Personally, I am looking for fund similar to 7twelve. Which will effectively implements buy low and sell high across asset classes in balance way irrespective of economic situation.

When investor withdraws from it, money gets withdrawal in equal proportion of rise from last withdrawal… ensuring least possible withdrawal from every asset class.

Unfortunately there is none in India (to my knowledge), So implemented my own version of it.

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Please read again, i did not say exit equity. Your expenses for next 5-10 years should be in debt or similar. Or atleast some how you have to be able to manage without forcefully selling equity in bad times. That’s all.
Otherwise, sooner or later bad env will occur and then you will have to sell equity at bad times, Ideally we should be able to buy on crashes. I think you need to have equity or equivalent class of returns even in retirement, some way to have decent income over inflation.

Along with above, i think either we should have a large enough surplus beyond need or should have some sort of earnings after retirement as long as possible to reduce risk. Or support from family.

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When something is virtually guaranteed to trend upwards hedging and the complexity it brings is an overkill. Besides there is a real risk of capping the profit. E.g :- Hedge nifty at 18k and nifty zooms to 21k, the feeling is certainly not going to be elation.

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