Right corpus eases retirement pangs

[ad_1]

Read More/Less


Varadhan, an NRI aged 55 and retiring in 2021, has been working in West Asia for the last 30 years. He wanted to return to India and live comfortably in his home state of Kerala. Prior to retirement, he wanted to find out how much he could spend – rather, the threshold that would ensure a balanced life after retirement. Varadhan’s family includes his mother aged 85 and wife Shyama aged 51.

His assets were as follows:

Requirements

He wanted to set aside ₹12 lakh as emergency fund towards one year expenses with high liquidity and safety. Next, he desired to create a retirement portfolio with minimal risk to get an income of ₹75,000 per month (current cost) from his age 56 till age 90.

Varadhan wanted to set aside funds for his travel needs at an estimated cost of ₹3 lakh a year for 10 years. He also wanted to maintain health corpus of ₹1 crore for all three family members. Besides, he desired to buy a car costing ₹15 lakh. Finally, he wanted to create a will with his wife and daughter as beneficiaries with equal rights (for which we advised him to seek guidance from an advocate).

 

Priority to safety

Based on our discussion, we could understand that Varadhan had limited knowledge of financial instruments, and he had a conservative risk profile and investing mindset. He was a prudent saver and had built his financial assets over a relatively longer period backed by sheer discipline. He was not sure of inflation and its impact on savings over a long period. . Like many aspiring retirees, he also had the need to make a balance between risk and safety a paramount factor. Prima facie, Varadhan wanted to find out whether he could retire immediately or he would have to work till age 60 to add to this corpus and avoid unnecessary risk with his investments.

A challenge in this case would be taxation post retirement. Varadhan had accumulated much of his assets through NRE deposits and the interest was not taxable till date. But post retirement, when he becomes a resident in India, his interest income will be taxable. We helped him understand the taxation associated with deposits and safe investment products.

Recommendations

Based on the above, our set of recommendations were as follows. We advised Varadhan to reserve his NRO fixed deposit towards his emergency fund and car purchase. Hence, he needed to reduce his budget for the car or reduce the emergency fund. Next, we recommended that he create a retirement portfolio using his NRE deposits and mutual funds fully, along with 60 per cent of his gold savings. This will help him get retirement income of ₹75,000 per month from his age 56 till his wife’s life expectancy of 90.

Varadhan needed a corpus of ₹2.8 crore. We advised him to use products such as RBI Taxable bond, RBI Sovereign Gold Bond, large-cap mutual funds and high-quality debt mutual funds. Once he turned 60, he could choose Senior Citizens Savings Scheme and other investment products suitable for regular income. With a corpus of ₹2.8 crore, he needed to generate post-tax return of 6.5 per cent per annum to get the required retirement income. His expected inflation would be 5 per cent in the long run. He may come across periods where inflation could be higher; Varadhan could then use reserve funds to maintain his lifestyle.

His travel requirements (₹30 lakh) could be met with the balance investment in gold. This could be moved to safe avenues periodically to manage the volatility in gold prices. We advised Varadhan to take health insurance for a sum insured of ₹10 lakh each for himself and spouse. Also, the remaining ₹10 lakh from his gold investment could be reserved as part of the health fund immediately.

We recommended that Varadhan sell his land in the next 2-3 years and convert it to financial assets. This will help him manage his health corpus and reserve fund needs. To protect his retirement income from changes in economic assumptions, it is desirable to have ₹80 lakh as reserve fund. This is arrived on the basis of same inflation rate and expected return post-retirement.

Varadhan could retain his rental property and we suggested that rental income, if any, be gifted to his daughter every year. The rental income and maintenance charges for the house were not included in the cash flow calculations.

Every retiree we meet has a fear of outliving the retirement corpus. Safety of capital and inflation adjusted returns form a strange combination. Arriving at the right corpus, which we sometimes call ‘a rubber band corpus for retirement’ is crucial to meeting such expectations. Like how a rubber band has limited elasticity, the corpus should stand the test of inflation and the test of safety of capital. If this is taken care of while working, the desired result could be achieved.

The writer is an investment adviser registered with SEBI, and Co-founder of Chamomile Investment Consultants, Chennai

[ad_2]

CLICK HERE TO APPLY

What’s better – Investing in equity mutual funds or investing directly in stocks?

[ad_1]

Read More/Less


Amit has been investing in mutual funds for the last seven years. He is not happy with the returns, as they have been much below his expectations. He invested in a few small-cap stocks in March 2020. Some of those stocks have given more than 100 per cent returns in the last three-four months.

However, Amit did not really invest big amounts in those stocks. Hence, those investments have not made a meaningful difference to his portfolio.

Now, he wants to revisit his entire equity strategy. There is a sense of disillusionment with mutual funds and he is unsure if the mutual funds are worth investing in.

He wonders whether investing directly in stocks is a better approach than investing in mutual funds.

Flavour of the season approach

Amit has not focussed on allocation within various equity categories and has gone with the flavour of the season approach. He invested a lot of money in small-cap funds in 2017 when small-cap stocks were doing well. But the small-cap stocks have been under pressure since the beginning of 2018. While the broader equity markets have done not too well over the last couple of years, Amit’s portfolio has struggled even more due to higher allocation to small-cap funds.

Whether he invests directly in stocks or through mutual funds, the underlying exposure is to a volatile asset. Both the approaches have merits and demerits. If he gets his direct equity picks right, he can earn above-normal returns. However, if his bets go wrong, there can be serious wealth destruction. Mutual fund schemes have diversified equity portfolios and help hedge bets. While this reduces return potential, this also reduces risk.

Amit’s stock picks did very well over the past few months, and he deserves credit for his choices. However, he must not mistake luck for skill. Stock research requires time and skill. Four or five months of investing or getting two or three stock calls right does not establish skill. If he is very keen on investing a significant portion of equity portfolio in direct stocks, he must test his stock-picking skill and market judgement for a few years. Only then, should he allocate greater capital to direct stocks.

By the way, over the past four-five months, even some small-cap funds have returned more than 50 per cent. A rising tide lifts all the boats. Amit must remember that something similar happened in 2017 and he has experienced the subsequent pain. While no one can say with certainty whether the performance of the past few months will sustain or there will be a reversal, he must remain cautious.

At the same time, this does not imply that direct equity investing must be shunned completely. There is a middle ground. If Amit wants to take exposure to direct stocks, he must first set up a threshold for the direct equity exposure. For instance, he can limit direct equity exposure to say 20 per cent of the equity portfolio. Therefore, if his equity portfolio is ₹10 lakh, not more than ₹2 lakh should be in direct equity. This way, he can strike a balance between the two modes of equity investments.

Amit can set aside money for stocks that he has researched well and thinks offer potential for good returns. Mutual fund investments, if selected well, will diversify equity exposure. Therefore, this internal limit helps him retain upside potential of his stock picks. In addition, this helps him maintain discipline and not get carried away and take unnecessary risks.

If he is satisfied with the results of direct equity investments, he can increase the threshold after a few years.

Within the mutual fund portfolio, Amit can split investments across two-three funds. He can invest in a large-cap and a mid-cap fund. Or he can pick up a multi-cap fund. Remember four small-cap funds do not build a diversified equity portfolio. If he does not trust active fund management, he can simply invest in index funds or exchange-traded funds (ETFs). There are now passive options across the market spectrum.

The word “diversify” has been used loosely when referring to equity mutual funds. Note that true diversification does not happen when you add different types of equity products to the portfolio. You diversify the portfolio by adding assets with low correlation. For instance, adding a fixed income product to an equity portfolio diversifies the portfolio.

Asset allocation is of vital importance. Sub-allocation within the equity portfolio is secondary.

(The writer is a SEBI-registered investment advisor at personalfinanceplan.in)

True diversification

Having assets with low correlation helps in true portfolio diversification

[ad_2]

CLICK HERE TO APPLY