In Part 1 of this post, we discussed how lower interest rates can be the new normal in the medium to long term. Low interest rates will necessitate a rethink in approach to post retirement planning for Senior Citizens. In the second part of the post, we will discuss how senior citizens can approach their post retirement investment planning, so that they are able to generate sufficient income, fight inflation and make sure that their savings outlast them.
The five most important considerations for post-retirement investment planning are:-
Investors should understand that risk is not binary – there are several grades of risk. Mutual funds are ideally suited for investors with different risk profiles, ranging from conservative to moderately conservative, to moderate, to moderately aggressive and aggressive. There is a misconception among many investors that mutual funds are risky because they invest in stock market. In addition to the stock market, mutual funds also invest in Government bonds, corporate bonds, money market and commodities. Different asset classes have different risk profiles. Debt mutual funds for example, invest only in Government bonds, corporate bonds and money market instruments – the risk in these funds is much lower than equity funds. Further, debt mutual funds tend to give higher returns than fixed deposits in the longer term because in debt funds you can get capital appreciation in addition to interest income. Also, if you invest in high credit quality corporate bond funds, you are likely to get higher income because yields of the highest quality NCDs (AAA, AA etc.) are higher than risk-free interest rate. Liquid funds give much higher returns than savings bank interest and are very safe investments. Incorrect notions / misconceptions and refusing to learn about products we lack knowledge in, are often counter-productive to our best interests.
You may like to read - Do you know how to select debt mutual funds: Modified duration and volatility
Regular income stream is an important requirement for senior citizens. FDs and Monthly Income Schemes paying monthly interest appeal to senior citizens. But there are other investment options available to retirees for regular income. Annuities, which pay fixed cash-flows every month for life, are very popular retirement products in the West - we have annuity products in India too, which investors may want to evaluate.
Mutual funds also offer regular income through monthly dividend options in many schemes. Apart from monthly dividends, investors can also benefit from capital appreciation in these schemes. Investors should note that, mutual funds being market linked investments, dividends are not assured, but several schemes have fantastic track record of paying regular monthly dividends.
Apart from monthly dividends, mutual funds also offer Systematic Withdrawal Plans (SWP), whereby investors can get fixed cash-flows from their investments. These cash-flows are generated by redemption of units, but the balance units remain invested and continue to earn returns. A well planned SWP not only generates monthly cash-flows, it can also give capital appreciation to investors. SWPs are also most tax efficient.
Read – SWP from balanced funds is a smart option to get regular returns
Retired lives are getting longer and if you want your savings to outlast you, then your savings needs to generate inflation beating returns. Asset allocation is as important in post-retirement years, as it is in pre-retirement. Equity is the best performing asset class in the long term and has historically been able to beat inflation by a wide margin over a sufficiently long investment horizon. Due to lengthening post retirement lives, senior citizens, especially those in the early years of retirement should not completely ignore equities. At the same time, investors should not be over-exposed to equities, because it also exposes you to high risk.
A judicious, relatively conservative approach to asset allocation is very important for senior citizens. Conservative hybrid funds, which have more than 75% exposure to debt, are well suited for senior citizens – you can get monthly income through dividends or SWP and at the same time, benefit from capital appreciation through the equity portion’s kicker returns. Depending on your risk capacity, you can also invest a portion of your savings in Aggressive hybrid funds. You need to have a long investment horizon for these funds and therefore, you should not depend on the income from these funds for your regular income needs.
Senior citizens enjoy special tax status in our country but if you fall in the taxable bracket, then you should try to plan your investments in such a way that tax on your income is as low as possible. Mutual funds are the most tax friendly investment options possible. While bank interest is taxable as per your income tax slab rate, debt mutual fund profits from investments held for more than 3 years are taxed at 20% after allowing for indexation benefits. Long term capital gains in equity mutual fund and equity oriented hybrid funds (investment held for more than 12 months) of up to Rs 1 lakh in a year is tax free; capital gains exceeding Rs 1 lakh in a year are taxed at 10%. Dividends paid by mutual funds are tax free in the hands of the investors, but fund house (AMC) has to pay 28.8% dividend distribution tax (DDT) for debt mutual funds and 10% DDT for equity mutual funds.
Finally, liquidity should be another important concern for senior citizens. Liquidity of investment is important for emergency purposes / short term needs and more so for senior citizen because they do not have other sources of income to inject liquidity in the short term. Apart from access to money, another important aspect of liquidity is that you should not have to pay a penalty to draw your money when you need. Mutual funds are among the most liquid investments available. You can redeem units of open ended mutual funds, partially or fully, any time without paying penalties after the exit load period (usually 12 months or so). Liquid funds have no exit loads and you can redeem units of liquid funds at any time, without paying any penalty. Usually, it takes 3 business days for your mutual fund redemption proceeds to get credited to your bank account. Liquid fund redemptions are credited to your bank account within 24 hours on business days.
As senior citizens, you should invest in low risk or moderately low risk mutual funds. SEBI has mandated all Asset Management Companies (AMCs) to risk-profile their mutual fund schemes. The risk profile of a scheme is indicated on a Riskometer. There are five risk grades on the Riskometer – low, moderately low, moderate, moderately high and high. All schemes indicate their risk grade. Majority of your investments should be in the low and moderately low risk grades. However, as discussed earlier, you should also have some investments in the moderate or even moderately aggressive grades, so that you are able to generate capital appreciation. If you have a large enough retirement corpus and want to leave an estate for your children and grand-children, you can also invest in equity funds for the purpose of wealth creation. Most debt mutual funds belong to the low or moderately low risk grade, while hybrid funds belong to moderate or moderately aggressive grade. You should consult with a financial advisor, if you need help in understanding risk grades and selecting mutual fund schemes that are right for you.
Why Smart asset allocation is crucial in retirement planning
How much to invest in mutual funds, will depend on your risk taking appetite and knowledge of mutual funds. I know retirees, some of them who took early retirements, who invested more than 80% of their savings in mutual funds. They have been investing in mutual funds for many years, 15 years or more. They understand mutual funds well, know where to invest, have got great long term returns and have confidence in mutual funds. On the other hand, if you are new to mutual funds, you can begin by allocating a portion of your savings to mutual funds, along with other savings options like FDs and PO schemes; annuities are also good investment options for retirees but they are not tax efficient. As you gain more experience and confidence in mutual fund investing, you can gradually increase your allocations to mutual funds.
You must read – Why you should get serious about retirement planning
In this two part post, we have discussed that Senior Citizens and future retirees must be prepared to accept the reality of low interest rates in the future. As such, a shift in mind-set is required towards post retirement investment planning. Mutual funds offer wonderful post retirement investment options, provided you understand the risk factors well. You should consult with your financial advisor about retirement planning with mutual funds.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.
Sundaram Asset Management Company is the investment manager to Sundaram Mutual Fund. Founded 1996, Sundaram Mutual is a fully owned subsidiary of one of India's oldest NBFCs - Sundaram Finance Limited.
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