[This is second and concluding part of the post “Retirement Planning”. If you haven’t read already, the link to Part 1 goes here. This post is rather longer than I expected it to be. But I didn’t think it good to take the conclusion to yet another part after it was already delayed. My sincere apologies for the delay as I had to attend to a few matters of critical importance.]
Focus of any retirement plan should be on establishing financial stability and soundness at the time of retirement. A good retirement plan allows you to live a desired lifestyle. There are various financial products, methods and strategies that constitute a good retirement plan. And that is what this post is about. We will discuss ideas, tools and strategies that make up a good retirement plan.
So, let’s get there step by step.
As I said in the previous part, Retirement Planning(RP) is a part of your financial planning. So, you start it the moment you start planning for your personal finance. And the earlier you start, the more time your invested money will have to grow. You should start investing as soon as you start earning or even before that if your financial situation allows you to. Starting investments, say in your early twenties, will immensely benefit you in the long run. You don’t need to have a big amount to start investing. Even with 500-1000 rupees, you can start investing in financial products like mutual funds. But in any case, starting early is the key to accumulate greater retirement funds.
Think of Retirement Planning (RP) and the first thing that comes to mind is the amount of money that you will need to retire. This money is called Retirement Fund/Retirement Corpus (RC). And to calculate RC, there are retirement fund calculators that you can find on the web. These tools require you to provide details like number of years to retire, current investment, current income and desired future income, expected rate of return etc. And based on these details, you will get a retirement fund figure. Some of them might even suggest monthly investment that you will need to do in order to achieve the calculated RC. You will then have to plan your investments accordingly.
A good retirement life is the biggest goal of anyone’s financial planning. And to achieve that goal, you will need to utilise your savings and invest it in a proper way to earn healthy returns. There are different asset classes which you can invest into. These asset classes are kind of investment categories. Real Estate, Gold, Stocks, Mutual Funds, FDs etc, are all asset classes. They all represent and fulfil different kinds of investment objectives for an investor. Just remember that most of them carry certain amount of risk with them. So, it is quite necessary to invest in diverse ways and according to one’s risk taking abilities at various stages of life. This entire mix of diverse investments make up what is called as retirement portfolio.
For better understanding I have divided RP(Retirement Planning) investment in two phases. First is PRP or Pre-retirement Phase which is important as in this phase you will have to invest in such a way that you achieve your RC figure at the time of retirement. The second one, we will call as PSP or Post-retirement Phase which is even more important as in that phase you will have to use your RC in such a way that it provides you with regular income.
Now, Let’s see these asset classes as to where they fit in a particular retirement planning.
In the earlier stages of your life when you have just started working and have limited responsibilities, your risk taking ability will be high. At such time you can invest in assets which are a bit risky but help you earn good returns. Equities/Stocks are such an asset. If you have sizable amount to invest, you could buy some good scrips after a due research and hold them for a longer period. Periodic reviews are necessary as there may be market fluctuations. Here, you need to be careful as you would often be tempted to trading on stock exchanges for quicker gains. Trading is an activity in itself which is highly risky and requires constant monitoring, expertise, market understanding etc,. So, unless you possess requisite skills or you are engaged in some other full-time business/employment, trading is definitely not the thing for you. You might end up making very little gains or worst, suffer losses.
Anyhow, in later stages of your working life you should gradually shift to safer investment options. And considering the risk associated with equities as well uncertain nature of dividends, they may not be a part of your portfolio in PSP. Though they are definitely worth a shot in PRP. Just consider for an expert advice and a long term investment.
• Mutual Funds
Mutual Fund investments are gaining traction now a days and a lot of people are now considering it for their investment needs. In fact, among MFs, you would find so many types, subtypes and combinations that investors can often get confused as to which kind of MF scheme should they invest into. But, if carefully chosen MFs can make up your entire retirement portfolio. Yes, you can plan your retirement just with MFs if you so desire. There are mainly two types of them like equity and debt but there are variety of sub types and combinations like balanced, hybrid, money market, large cap, midcap, small cap, diversified, sector, ELSS, gilt etc . All these MF types have different investment objectives, invest in different kinds of avenues, provide varying returns and carry varying amounts of risk. Enough diversity to be beneficial both in PRP as well PSP.
In PRP, at early stage, you can invest in equity or equity oriented balanced funds to take advantage of long term capital appreciation and wealth building. As per your risk taking ability, you can invest in large cap, mid cap or small cap equity funds. Risk takers can invest in small and midcap funds to maximize on the returns. Experts have advised to invest in MFs based on goals. Based on short term, medium term and long term goals, there are MF schemes that suit those particular terms. But that could be another post altogether and considering our sole goal(for the sake of this post) is retirement, we would take only long term route in PRP to let your funds grow into your retirement corpus. The longer time frame you give to the MF investment, the better results you will get. Especially in later years (say during 15th-20th years of investment), when you will see the real magic. The interest and capital gains you would have earned on your investment, will in turn, fetch more interest and capital gains. That’s your money earning more money for you, which is called compounding.
In PSP, when you have a corpus to invest into, MF schemes such as MIPs (Monthly Income Plans) which are debt oriented, can be used. You can invest your desired corpus amount in such scheme and it will provide regular monthly income. Being debt oriented, they are safer than pure equity schemes. MIPs too may have equity exposure up to 25 percent to provide growth for the investment besides providing stability.
One thing, always consider taxation and inflation while planning your retirement. Because the actual rate of return on your investment will depend on them. While you can take same rate of inflation for calculation across your investment, same is not the case with taxation. Regarding taxation, different rules apply to different kinds of investment. For MFs, tax on LTCG ( Long Term Capital Gain) on equities was up until NIL. But in last budget (2018), LTCG tax has been proposed at 10%. Besides, there are even different rules regarding LTCG among equity and debt MF schemes. LTCG is the gain on the money invested for more than 1 year for equity schemes. While for debt schemes, investment period should be more than 3 years for it to be called a long term investment.
India is one of the largest importers of Gold. We import tonnes of it in order to satisfy the gold consumption back home. People buy it mostly in the form of ornaments mainly during festive and wedding season.
But other than fulfilling cultural obligations and desires, I do not see whether it fits as an investment for retirement. Gold prices are volatile and though it has given hefty returns at times, it has dipped heavily too and also sometimes, hasn’t moved a bit during prolonged periods. I am sure you don’t want such unpredictability with your retirement fund. If you need to have it, I would suggest minimal amount like 5-10 percent of your portfolio. Also if you buy coins or certificate gold instead of ornaments, it will be more value for money. In fact, I see it as a fraction of my emergency fund(again, 5-10 percent) which can come in handy because of it’s liquidity.
• Real Estate
Well, I may have gone a bit far with this one, but if you have enough spare money, why not buy a second property (first one being your own home) and rent it out? You can then use the rental Income for variety of purposes, even extending your investments.
About rentals, they are not that great in India yet. Consider this. Assume you have a property that you could sell at Rs. 30 lac. Instead, you rent it out and started earning rent which will not be more than Rs.10K per month. With that figure your annual rental Income amounts to Rs.120000. This is just 4 percent of the price of your property. Even a bank FD can give you more than that (around 6-7 percent at present). Mutual funds related pension and income plans can give you even more. But there is another side too. The amount you lose in the form of lower rental, can be compensated or even surpassed by the appreciation in the value of the property over time.
But remember, rental incomes are not permanent. So, it will not be a good idea to invest your entire RC in real estate and depend on rental income during PSP. Exercise this option only after you have established regular and steady income with other options. Also, your first priority during PRP, along with your retirement planning, should be to buy a decent home for you to stay. And that too as early as possible, because property prices are on the rise in India. And considering the rise in population as well as the ever increasing demand for dwellings, the prices may rise further. Also, being a owner of a house in India sprouts a sense of pride, safety and security.
• Bank FDs
Bank FDs(BFDs) provide a safer option as compared to the other options mentioned above. Investment is highly liquid. They can be invested into in both the PRP and PSP. Whether you want to park money for short term or you are planning for regular income after retirement, BFDs have suitable terms ranging from 7 days to 10 years. In PRP, you can invest into BFDs to balance out your portfolio against MF schemes. There are other options too like PPF, but BFDs have so far been more popular even if they hardly provide inflation beating returns now a days.
During PSP, you can invest lump sum amount in a BFD and earn interest as monthly/quarterly/yearly income. Here, take note of this. Current rates on BFDs (in the range of 5-7 percent) are already very low, and given the Interest Rate trend in India which is downward, expect the rates to go down further in coming years. Hence, if you are considering regular income from BFDs in PSP, make sure to opt for a longer term option as you wouldn’t lose on the interest rates during subsequent renewals. Interest on BFDs is taxable beyond Rs.10000 in a year, so, do take that into account while planning for a BFD.
PPF (Public Provident Fund) is one of the SSSs (Small Savings Schemes) by GoI. Although, the current interest rates on PPF are not that great especially after it was decided to revise the interest rates on SSSs on quarterly basis by GoI, it is still a very good balancing option for your portfolio during PRP. Moreover, you can claim the amount invested as tax exempt up to Rs. 1.5 lac in a year, and at maturity, will get the entire amount (investment + interest) exempted from tax. Its fully secure and there are loans available on it to make sure you don’t have to break it half way.
Although, you can extend the PPF account for a further 5 year block any number of times after the initial maturity of 15 years, in PSP, you would most likely use the maturity amount to invest into monthly income plans or pension plans to earn regular income. Link to a specific post about PPF goes here in case you want to read more about it.
NPS ( National Pension Scheme or New Pension Scheme) is yet another central government scheme which is managed by PFRDA ( Pension Fund Regulatory and Development Authority). It was designed specifically keeping in mind the retirement. Its a defined contribution based pension scheme meaning the more you invest per year, the higher the pension you will get after the age of 60 years, which is the pension starting age for this scheme. Your money is invested in equities/ debt MFs and govt bonds and securities, which again you would have the option to choose and change as per your requirement. One thing, there will be no definite pension amount mentioned at the time of opening of an account as the scheme is market based. Your pension will depend on the amount accumulated at the end of your investment period which will in turn, depend on the returns it would have gained from the market.
But the good thing is that your entire accumulated corpus won’t get blocked. At retirement, you can withdraw 40 percent of the corpus tax-free and another 20 percent with tax. You will have to invest Remaining 40 percent into one of the pension schemes mentioned therein which will provide you with regular income.
Scheme joining age is 18-60 years. So its evident that if you join early during PRP, then even with low contributions you can accumulate a healthy corpus.
So, that’s it for this post. Remember, all these investment and strategies will benefit you in the retirement only if you also add one more investment into the mix and that is the investment into your own health. Its simple, if you are not healthy enough, you won’t be able to enjoy your retirement, even if you are wealthy enough. And also, don’t forget to buy health insurance which will save you from breaking your investments and disrupting your Financial Planning in case of a medical emergency. Stay Healthy, Stay Wealthy.