Importance of Asset Allocation in Retirement Planning
After retirement, every individual seeks financial freedom from various financial liabilities; be it a home loan for your house, or a personal loan for education or marriage. In addition to debt-free golden years, one also wants a stable income in the absence of their primary source of income. The increased medical bills for yourself or your spouse as your age increases can weigh you down. To meet these urgent medical requirements, it may require you to dip into your hard-earned savings. Since no retired person wants to be a financial burden on their dependents, it is important to plan the finances for your retirement.
A retirement plan is a systematic approach to accumulating sufficient corpus that comes in handy to meet all your financial needs at the time of your retirement. These funds can be used to meet your retirement goals like travelling or even supporting medical expenditures that may be required with age. Early retirement planning helps to take risky bets to grow your corpus while gradually moving to safer investments as you near the retirement age. Retirement planning ensures that your future requirement can be met using all the money that you save during your earning years. Moreover, considering inflation in your retirement plan will give you an edge in accounting for the depleting value of your money. Hence, it is necessary to have a large corpus. With a robust retirement plan, you can have a substantial financial base for yourself and your spouse by the time you retire, to fulfil all your dreams.
Asset Allocation in Retirement Planning
Among the different considerations in your retirement plan, the right asset allocation is a critical one. The overall returns that your investments will generate are directly proportional to the type of assets you choose. These investments can generally be equity-linked, debt-linked or a mixture of equity and debt.
The equity-linked investments have the feature of ownership of stocks that are listed by different companies. For instance, you can invest in stocks that belong to the energy sector, telecom sector, or even the FMCG sector.
Debt-linked investments, on the other hand, do not seek ownership in the company. Instead, these investments are a loan for the company that offers a fixed interest in return.
Hybrid investments are a mixture of the equity instrument and the debt instrument. The ratio of equity and debt depends on the specific instrument that forms part of your retirement benefits.
Allocating the right proportion of investments in three of these categories spreads the risk of your overall retirement fund. Thus, stability along with growth can be sought when you diversify your portfolio. Here are three ways to diversify your retirement portfolio.
- Equity allocation
Equity allocation is where the investments are apportioned towards the high-risk investment in equity instruments. Retirement benefits of an equity allocation are that the returns are highest in the case of equity allocation, but with a higher risk attached to it. Financial experts recommend staying away from 100% equity allocation if you are planning for retirement late in life due to their volatile nature. However, for young investors, it can be an effective way to increase your overall corpus and plan for retirement.
- Debt allocation
Allocating the investment funds towards debt-linked instruments like corporate bonds, and government bonds is an effective way to lower the risk for stable returns. Some of the debt allocations are government-backed, making them the safest alternatives; however, investment in corporate bonds does carry its share of risk. But this risk is minuscule in comparison to equity investing. Debt investments are an overtly safe way to plan for retirement and may not be an ideal choice if you have a long time, say decades, to plan for your future. Instead, it is a smart way to mitigate risk and seek growth for individuals that are nearing their retirement age.
- Hybrid allocation
Hybrid allocation is a more balanced approach to investing your retirement savings in both equity and debt-linked instruments. Under this allocation, the risk and returns are far more balanced as compared to extremes in the case of complete equity or debt allocations. A hybrid portfolio allocation facilitates stable growth while mitigating risks.
A retirement calculator is a nifty tool that you can use to decide which allocation should be made in your retirement plan. Setting a corpus goal in the retirement calculator over the investment horizon helps to identify what kind of investments you need to seek to achieve your financial goal for retirement.