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Key Steps to De-Risk Your Retirement Plan

The process of retirement planning might appear exciting, but its success depends entirely on your landing. The outcome is determined by how effectively you are able to protect and preserve your accumulated wealth, without forgoing significant market opportunities. This process of loss containment is known as de-risking in the investment world. De-risking is a critical step in a retirement plan. It can help people avoid the big market plunge and safeguard their accumulated wealth for their after-work-life. The step is most essential for retirees or those nearing the drawdown mode with less than 10 years of preretirement life.

Ideally, the process of de-risk should be initiated at least 2 or 3 years in advance. Here are some effective steps that will help you de-risk your retirement plan:

Relate the risk to your age

The most significant risk comes from having too much exposure to equity and very little in fixed income assets. While this might work as a wonderful strategy for those who are in their early years of retirement planning, it certainly will be dangerously impactful for the ones set to retire soon. For a person at the age of 30, investing more in equity makes more sense, since they can garner significant returns given the risk capacity. But for a person at the age of 57, who is close to drawdown in another 10 years, risking asset allocation in equity might not be the ideal scenario, as the aim should be to have stabilized returns with capital preservation at this juncture of life. But remember to not completely transfer your money to debt holding too. Instead you can have a larger portion of it with a lesser part of equity, and actively managed asset allocation. Given the increasing life expectancy and the impact of inflation, a certain amount of equity exposure is always needed. Hence, one must effectively balance risk and employ more debt versus equity, and assign a defensive cast to equity holdings but not completely seclude the latter. It is important to note that zero-risk investments are usually a bad idea. These could be the equivalent of inviting inflation to eat your accumulated corpus if your portfolio is traditionally balanced to completely avoid equity holdings.

Opt for a smooth de-risk strategy

Taking a plunge and moving all your equity-based investments to bonds is a great way to de-risk the portfolio and subsequently your retirement plan. The strategy could completely bounce back, given the fact that equity needs time to generate substantial returns. Hence, it is always advisable to take measured baby steps forward in the journey from volatile to non-volatile investment. It is essential to spread the funds in such a way that the maximum of your investments is in bonds in the last 2 years of retirement. Adopt a disciplined approach and take monthly or quarterly installments, and shift them into non-volatile contributions. A wholesale de-risking plan will not provide the aimed advantages.

Cautiously choose the de-risk mode

De-risk strategy is a crucial step in the retirement planning process, one which can either break or stabilize the accumulated lot. Hence, the choice of de-risking mode is of an essential priority. There are typically two types of de-risking modes:
  • Active mode:In this mode, the investor-cum-retiree chooses to consistently and actively manage the portfolio and deep asset allocation on its own as per market volatility. There is no involvement of an experienced professional. As a result, the chances of failure are higher.
  • Passive mode: In another form of de-risking retirement plan, the investor chooses protection plans or other options which provide an automatic allocation of assets based on the age, goal, period, and overall risk ability of the investor. The approach is more insightful and based on first-hand knowledge, which minimizes the chances of falling prey to market volatility forces. Multiple funds such as target-date portfolios provide such advantageous automatic allocation benefits. Nowadays, some 401(K) accounts also offer automatic rebalancing features, where an appointed manager streamlines the equity risk, repositions the portfolio to match risk capability as per the age, and performs intra-class positioning.

    Focus on tax-sheltered accounts

    While it is a good idea to de-risk your retirement plan and safeguard investments, it may be unreasonable to go about it hastily without a devised plan. In many cases, the changes you propose to make in your retirement plans can attract significant tax consequences. Ideally, your priority should be to first head for the tax-sheltered accounts such as retirement instruments like an individual retirement account or IRA, which will allow you to make any number of changes, provided they are in confined limits. However, for other taxable investment accounts, if your changes result in more gains, you could end up with a higher capital gains tax liability. But one can always choose to redirect the contributions rather than sell the taxable account portfolio assets. In order to de-risk, you can choose to sincerely narrow down on your contributions to equity and redirect the money towards bonds and cash. That said, it is advisable to first max out on the tax-sheltered accounts and then revise your taxable ones.

    Redirect your capital gains

    Given the performance of mutual funds at this stage, it is likely that the distributions will come in large. Hence, it is ideal for a retirement planner to shift the distributions to another holding rather than withdrawing them and paying a hefty tax liability on capital gains. You could choose to invest the excess money in more bonds or fixed annuities which will mature in the same year of your retirement.

    Choose your retirement year carefully

    The year you choose to retire can greatly impact your retirement goals. For example, if you choose to retire in a year which has recorded recession, you might end up losing returns equivalent to the value of 15 years. In contrast, if you opt to delay your retirement to take off in an up-market year, your outcome can flip your expectations. Even though the future is unknown, it can certainly be analyzed and then predicted based on market growth and forces, and the overall economic well-being, etc. Hence, it is crucial to take the last leap with utmost thought and consideration.

    Opt for a variable withdrawal rate

    Investors that contribute more to portfolios or investment strategies with fixed withdrawal rates are more prone to suffer financially in the long run. Hence, the ideal way to de-risk is to opt for variable withdrawal rates. For instance, you can choose a portfolio which offers 6% withdrawals with 2% flexibility. That way, when the market fluctuates negatively, you will reduce your withdrawals by 2%. On the positive side, when it gains, you can increase your withdrawals by 2%. This will increase the longevity of your assets while providing a flexible allowance.

    To sum it up

    The main goal of a de-risk strategy is to minimize risk and maximize gains while keeping capital protection and preservation as the top priority. De-risking provides for a targeted approach to opportunistically defend the accumulated corpus, enabling you to essentially enjoy your golden retirement life.

    The process can seem daunting to some, but you can always choose to take professional support from Financial Advisor and make the journey easy and fruitful.

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