Why you must draw up a Retirement Policy Statement

By Larissa Fernand |  29-07-19 | 
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About the Author
Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

Let me start with an utterance that is bound to give you a reality check, should you need one.

The responsibility of providing a comfortable income in retirement is placed squarely on the shoulders of individual savers.   

That's it. You are on your own. So if you take it lightly, you are in for a lot of hardship. Because your post-retirement pot is going to depend on your pre-retirement commitment and discipline.

Most individuals conceptualize how they want to spend retirement, not realizing that it takes some financial thinking and restraint. I get it, that retirement is now a much looser definition. It is not as cut and dried as “my 9-to-5 job is over, I no longer have to work, I now draw a pension”. But everyone requires some sort of a roadmap that creates accountability and instils discipline. The idea is to establish a set of guidelines so you are aware when you are steering off the road.

Christine Benz, Morningstar’s director of personal finance, has consistently been urging individuals to give this considerable thought. I have taken insights from her various interactions over the years, and put it down.  

  1. Why must you have a Retirement Policy Statement?

There is tremendous value in putting pen to paper and creating such a statement.

It helps you articulate your investment programme and your retirement de-cumulation programme. Once you decide to list your strategy, no longer are you embarking on retirement without a real plan in place. This helps you ensure that you have a plan, that you have a strategy, and you have taken time to document it.

Another key benefit is the discipline it entails. If you have spelled out in your retirement policy statement, for example, that you are sticking to a 4% withdrawal rate system--well, the fact that you've committed that to paper is probably going to keep you on track with that system a little more than would be the case if you hadn't laid out any documentation. The same would go for crafting an asset allocation framework and spelling it out in your investment policy statement. The fact that you've written down that you plan to stick with a 75% equity allocation, 25% debt allocation will tend to keep you on board with that asset allocation programme a little more.

The final benefit is simply to give your spouse or family members the ability to get a quick and easy glance at what it is you are doing in terms of how you are approaching your investment programme or how you are approaching your retirement plan. 

  1. Is a Retirement Policy Statement the same as an Investment Policy Statement?

I see the two as very much living side by side. Even when retired, you still are managing an investment portfolio and the same types of considerations that influence your decision-making when you are in savings mode will still be in play.

In the Investment Policy Statement, you are getting into the desired asset allocation; the investment criteria that you are looking for when you pick investments; how you decide when it's time to sell; and so on. They still matter even when you retire.

The Retirement Policy Statement also considers the nonportfolio assets such as a pension and your approach to it. Also, it's de-cumulation-focused and little less focused on the specifics of managing that investment portfolio on an ongoing basis.

If you start reasonably early, set aside adequate savings, and invest in a semi-sane manner, it's hard to go terribly off track with investments in the years leading up to retirement. But decumulation--the process of figuring out how to position your portfolio to deliver desired cash flows in retirement--is another ballgame.

In retirement, a separate set of variables comes into play. Issues like asset allocation and the quality of the investments you choose are still important (which is why you still need an Investment Policy Statement) but so are factors such as how--and how much--you'll spend from your portfolio on an ongoing basis.

With a Retirement Policy Statement, you're effectively committing yourself to abiding by a given system. That's not to say your system won't evolve as the years go by, but it makes it much less likely that you'll ratchet your planned 4% spending rate up to 10% in a given year.

  1. How must you formulate a statement?

It need not be a lengthy document. Simple and to the point is the name of the game here. It could be: To maintain a portfolio that consists 60% of high-quality, dividend-paying stocks and 40% high-quality bonds, along with a cash component consisting of two years’ worth of living expenses. Spend from cash bucket and periodically refill using rebalancing proceeds. Use 4% guideline for spending."

Here is a downloadable template . You can use it as a guide and work on customizing it.

  1. What sort of detail must go into making that statement a reality?

Start with the basic outlines and then move onto specifics where you spell out the nitty-gritty of your spending plan and how you are extracting that cash flow from the portfolio.

  • When do you plan on retiring? When does your spouse plan to retire?
  • What is your "anticipated retirement duration"? This requires you to break out a crystal ball and forecast your own life expectancy. Of course, it's impossible to know years or decades in advance just how long each of us will live, and most people would just as soon avoid the subject entirely. But estimating how long each of us will live is just as important as other key retirement-planning variables such as savings rate, rate of return on your investments, and withdrawal rate.
  • The assets (savings account, fixed deposit, provident fund, equity investments, any and every investment) that you and your spouse will bring into retirement.
  • Your anticipated income needs in retirement; how much of those income needs will be coming from certain sources of income like a pension, an annuity, or rental income.
  • What is your specific withdrawal plan? Not only how much you plan to take out of your portfolio but also how you plan to actually extract that cash flow. Will you focus strictly on whatever current income your portfolio kicks off, or will you reinvest all of your income back into the portfolio and use a pure total return approach where you are just withdrawing rebalancing proceeds?
  • Don’t forget to address inflation. You will still battle with rising prices all through your years of retirement. Drawing fixed amounts from your portfolio will ensure that your standard of living declines as the years go by. That's not what most retirees want. Thus, it's wise to factor your approach to inflation into your spending plan. The "4% guideline," for example, assumes that a retiree takes 4% of his portfolio in year one of retirement, then inflation-adjusts the rupee amount as the years go by.
  • Your cash-flow generating system is the meat of the statement: Where will you go for cash from your portfolio on an ongoing basis? Document your approach to withdrawals. These can have a big impact on the viability of your plan as well as the variability of your cash flows during retirement. Here you're documenting not just your withdrawal rate--though that's in the mix, too--but also your approach to withdrawals.
  • The key components of your retirement spending plan: your spending needs and the extent to which they'll be supplied by non-portfolio income sources (pensions, annuity) and from your portfolio. Armed with your planned annual portfolio withdrawal and the total value of your portfolio (total retirement assets), divide the former by the latter to arrive at current annual spending rate. (We've included the term "withdrawal rate" on our worksheet because it's more familiar to investors, but I prefer the term "spending rate" because it’s more encompassing.)

The information in the above four points is attributed to Christine Benz. However, I suggest that you purchase the book Retire Rich: Invest Rs 40 a day. In a simple and non-intimidating fashion, with actual examples and case studies very relevant to the Indian context, it will guide you on retirement planning.

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