Here's why risk is vital for retirement plans

Diversification is not just about having more than one share—in fact having one well diversified fund is enough when your SIP amounts are small.

You are a young 35-year-old couple and are saving for multiple goals—being debt free, buying a bigger house, children’s education, being a reserve in case either parents run out of money, etc. You sit down as a couple and are reviewing your portfolio, what do you exactly do? Let me guess:

• you see how your portfolio is doing
• you even compare it to a big broad index
• you even go to a couple of websites and see whether your fund is rated well
• If you have an equity portfolio you are very happy that ALL your shares have gone up

Right? Well most people do this. But, what have you missed out? You have missed out the risks in your portfolio. If all your funds and all your equities have gone up at the same time, remember at some point in time, they could all be in the red! All your shares or funds moving in the same direction is a potential sign you have not paid enough attention to diversification.

Diversification is not just about having more than one share—in fact having one well diversified fund is enough when your SIP amounts are small. Diversification is about having many shares, across multiple sectors, management groups, geographies, countries, currencies, industries, etc.  In such a scenario if your full portfolio rises simultaneously, this suggests they are all responding to the same key factors and drivers. That is RISKY INVESTMENT STRATEGY. 

A well-diversified portfolio will spread out investments across categories that respond differently to different factors and drivers. For example, if you owned ONGC, Selan, HOEL, HPCL, and Indigo—see how each one will react to oil price hike (or fall).

Many investors think owning more than one share is diversification. This is only partially true. Owning HPCL and BPCL is hardly any diversification. Owning EID PARRY gives you a flavor of fertilisers because it is the holding company for Coromandel International, etc, etc... Owning 2 companies in the same industry diversifies only one type of uncertainty: company-specific risk. So, if you held Satyam, Infosys, and Wipro, you were saved from the risk of owning only Satyam! While it could help protect you from the risk of having all your money concentrated in a Satyam-like house of cards, it won’t protect you 
from higher-level concerns.

How much do you withdraw annually, and could you cut it if you had to?

This might seem like a too early to answer and far away question, because not many people think of withdrawals as a risk. Check out your parent’s portfolio if they are living off their savings. It is a real crucial consideration in retirement planning—particularly for investors early in retirement. Assuming that your parents are 65 years of age, they must be grappling with this.

The ONLY PURPOSE of a retirement portfolio is to fund the years when you aren’t working. The biggest risk you face during that time is depleting your assets while you still need them. And, annual withdrawals typically put the greatest strain on your portfolio during retirement. Obvious, is it not? Well not too many folks think like that! Start learning about it NOW. Not learning is high risk.

PV subramanyam writes at www.subramoney.com and has authored the best seller ‘Retire Rich - Invest C 40 a day’