First of all I would like to clarify that, I never advised the retired people to invest their entire hard earned money in share market. Everybody knows that, direct investment in equity market is a very risky and there is every possibility of incurring loss in the short term especially for speculation business. Investment in selected blue chip company shares/ good performing mutual fund schemes always provided handsome returns to its investors and increased their wealth multiple times over a period of time. In this connection, please read the last sentence of my article "Do consult your Financial Planner for a proper allocation of your retirement assets". In case you wish to get a reasonable, tax efficient and inflation adjusted returns, investments in equity instruments are inevitable and that will from an important component in your retirement portfolio. But the percentages of exposure in equity and related instruments will vary according to the financial situation, tax liabilities and risk appetite of each investor. If you are not expert enough to determine the correct asset allocation, you can take the help of an expert in this field. Equity here means not only direct investment in company shares but also selected good performing equity and balanced mutual fund schemes.
Investing in equity is important for creating a retirement corpus as it gives good returns. However, as you approach close to retirement, reduce the equity portion and increase debt in your portfolio. This is essential because preservation of your corpus becomes more important than its appreciation. So, if you start investing at the age of 30 years, 60-70% of your portfolio could be in equity, but at least five-seven years before you retire, equity should not comprise over 30-40% of the portfolio (again this depends on your personal financial situation - the commonly accepted thump rules will not work here- eg if your age is 40 your equity exposure should be 100-40= 60 and if your age is 70 the equity exposure should be 100-70 =30 etc). You can either use systematic withdrawal plans to shift the money from equity to good debt instruments, or move a sizeable part of corpus to bank deposits or guaranteed fixed income generating securities. However, just because you are retiring does not mean that you have to give up on equity entirely; invest 25-30% of your portfolio in good performing selected equity funds/Balanced Funds. Also try to include alternative assets class like Gold/Silver and other commodities in your portfolio either in physical or electronic form. It's recommended to use ETF/E-gold/ Reliance Gold Plan instead of buying these assets in physical form.
Over a period of time good Diversified Equity Mutual Funds and selected equity shares delivered unimaginable level of returns.
Eg. HDFC Equity Fund – if somebody invested Rs. 10,000.00 in this fund during 1994 (December) @ Rs. 10.00 per units now the value of investment would have appreciated to Rs. 302,820.00, this fund is a constant performer and delivered an annual return of 21.29%. You have to accept one more fact that, the entire return generated form this fund is tax free (if you hold the investment for minimum one year). Suppose you invested the same money in Bank Fixed Deposit @ 8% quarterly compounding you would have received Rs. 38,442.00 for these 17 years, more over the income generated from this class of asset is taxable. If you consider the inflation and tax effect, you can imagine how much you would have earned from this FD investment. See the differences. This is just only one example, like this I can produce so many live examples.
Regarding equity share investment one classic example is Axis Bank, initial issue price during 2001 was Rs. 19.00 today this share is trading at a price of around Rs. 1,407.00. Another example is Yes Bank, today this share is trading around Rs. 521.00. This capital appreciation is in addition to the dividends paid every year. If you invest selected shares like this, you will be benefited in two ways one is yearly dividend (not guaranteed – varies every year based on the performance) and second one is capital appreciation (again dependence on various internal, external and international factors)
Please note that this is not my recommendation to invest in these shares/mutual fund schemes today, I just sited this for example purpose to show the returns generated by these equity instruments. You also need to identify good shares/mutual fund schemes with the help of experts in this filed.
The RBI targets an inflation rate of 5 -7 % per cent based on the Wholesale Price Index (WPI) if this tendency continue the purchasing power of the rupee will halve in 14-15 years. That is, you will need Rs 200 in 2026 to buy the same goods and services that Rs 100 can buy today. But in practice the actual inflation should be around 7-10%, in this case the situation will be even more verse.
See this example, suppose you keep Rs 100 note in your locker in 2013, where it earns no interest. By 2043, it would buy no more than Rs 12-13 does in 2012. If you invested that money over in a fixed deposit at 5 per cent compounded, it would be worth no more than Rs 43- Rs 44 in terms of 2012 purchasing power.
Suppose you invest Rs. 100 @ 8% for 10 years, if you consider the inflation @7% the inflation adjusted maturity value would be Rs. 109.78, the actual returns in this case should be less than 1%. In case you are a tax payer, again you need to pay tax on this. So finally you are going to earn negative returns for your investments.
In October 1972, petrol cost was Rs 0.60 per litre. If you'd predicted then that it would cost Rs 70-plus in 2013, the average person would not believe this and they may sometimes have called you a mad. But this is reality, you must accept.
Another simple example – during 1995 a good vegetarian lunch meal was costing Rs 3.00 but if you wanted to eat the same food from the same hotel now you need to pay around Rs. 40.00 – 50.00. There is more than 1250% increase in prices.
Even if price goes up or come down your interest from Bank FD (locked) will remain same. So you are forced to use your capital amount to pay off your daily needs and one day your capital also becomes zero.
To beat inflation, your savings must generate a long-term return that beats inflation, or at the minimum, keeps pace with it. This is to ensure that you can at least maintain your current lifestyle decades later. If you want to improve your living standards, you must target a higher rate of compounded return. This requires taking on some risk of capital loss. Safe instruments that preserve capital will not beat inflation in the long run. FDs and other forms of debt have a historical record of offering yields lower than prevailing inflation rates. Banks always keep an interest margin in their favour. They hike deposit rates with a lag when inflation rises, and cut rates quickly when inflation falls. The banks will cut their deposit rates the moment inflation goes down. Please note that there is an inverse relation between interest rates and bond prices, so the debt mutual funds will bring capital gains when interest rates fall. All present Government securities funds and other debts funds are going to provide a very good appreciation once RBI reduces the bank rates that will happen in a very short period of time.
Now the life expectancy of the people have increased lot due to the advancement in medical facilities and standard of living , so you need to target minimum 30-35 years of life after the retirement. In case you do not plan well most of your investments will become zero within few years after your retirement. So a careful planning is very much needed. But by the time you are in 70 and 80s, the cost of living will rise massively, even if the annual rate of inflation is not very high. Over very long periods, things get much more expensive. Since financial planning involves creating assets across years, any successful strategy must take compounded inflation into account. You should decide on the lifestyle you want and allow for reasonable rates of inflation in calculating the income you will need 30-40 years down the line.
Before you can begin planning your retirement portfolio, the first step is to determine just how much money you'll need to retire on. While this amount differs for everybody, a good goal is to figure on replacing 100% of your pre-retirement annual income during the first year of retirement—less whatever you were saving for retirement, of course. For example, if you're making Rs. 75,000 and saving 20% (Rs.15,000), then you should figure on needing Rs. 60,000 to maintain your lifestyle (some expenses may go away, such as commuting costs, but others could take their place, such as increased travel and health care etc like that when you grow older your medical bill also shoot up). While appropriate for younger investors still in the early stages of retirement saving, taking on more risk could have a diminishing impact later on the ability of the portfolio to sustain cash flows past a certain point, because the expectations for higher volatility tend to undermine the benefits of higher potential return. General guidelines are all well and good. But if you're truly concerned about your ability to achieve the retirement of your dreams (and you should be), you should analyze your particular situation in more detail to figure out what makes the most sense for you with the help of an expert Financial Planner.
Another important point is reassessing your willingness to withstand volatility. One characteristic of successful investors is their ability to strive for higher returns while tempering that pursuit with considerations of risk. A best practice is to assess your willingness to tolerate risk during a "neutral" market (in other words, one that is not swinging too high or too low). This is because studies show the risk tolerance of individuals is influenced by recent market activity. When the market goes up, people want to take risk. When the market goes down, people want to avoid risk. Having said that, there's no better teacher than the real world to help you gauge your true risk tolerance. If your portfolio is calibrated to a level of risk that makes it hard for you to sleep, then consider selecting a portfolio with a risk level more appropriate for you.
Keep tax-efficient investments like equity shares, equity mutual funds held longer than one year, tax-managed funds, index funds, regular-dividend-paying stocks and mutual funds, as well as good quality bonds (if they make sense for your tax bracket).
The combination of stocks and bonds, along with an appropriate allocation to cash investments, can help protect you against market volatility while keeping you invested for long-term needs. Bonds/Bank FDs provide a cushion that's generally less volatile than stocks and provide a regular source of income. Stocks provide potential for growth, as well as dividends that may increase over time.
Once you retire, you will be formed to fight a continuous battle against inflation and presently the only financial instrument capable of overriding this battle is a small amount of investment in equity and equity related instruments. Again I am not recommending the retirees to become day trading speculators, but sometimes including 25 to 35 per cent of one's hard earned money in equities through balanced funds or high rated diversified equity funds is the safe decision. Over the long time periods retirees invest for, the ups and downs of equities balance out but low returns of fixed income investing eventually eat away one's savings in a guaranteed manner.
Hope, I clarified my stand. This is my view of retirement planning and I normally advise people to follow this (again the equity exposure will very base on personal financial situations and individual's risk appetite and tax conditions)
Best Regards
Prakash Nair
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