BackHow debt can be risky and equity safe for your retirement
The traditional idea of investing in debt when one is about to retire can easily backfire
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A thumb rule in the world of investments is an individual’s asset allocation in debt should be equal to her age. Which means, if someone is 25, the appropriate debt allocation should be 25% and the equity allocation 75%. Similarly, if someone has just retired at 60, then her debt investments should be 60% and the remaining in equity. Also, many experts advise that you should move most of your assets to debt as you move closer to retirement. I don’t agree.
I may be rocking the boat but my take is a little different on this. Planning for retirement can be a very daunting task. The average life span of an individual is increasing; many people consider early retirement (voluntarily or otherwise); and there are very few joint families. But the most important factor is maintaining the standard of living.
Inflation, as we know, is the biggest monster when it comes to planning for retirement. It can make a serious dent in your plans if not properly accounted for. Most people I talk to are grappling with basic inflation, the one based on the Consumer Price Index, at 8%, forget lifestyle inflation, which is even more worrisome. Recently, there were news articles on former all-round cricketer from New Zealand, Chris Cairns, now washing and cleaning buses and earning $17 per hour to make ends meet. If it can happen to celebrities, it can happen to anybody. Once you are used to a certain lifestyle, it may be difficult to downplay it later.
The traditional idea of investing majorly in debt when one is about to retire or already in retirement can easily backfire. Just because the investments are safe will not ensure that they generate the kind of income that you need. Moreover, you may easily outlive your assets, considering that your retirement life may last for a good 20-25 years. Worse, you may be forced to take up another job, or depend on your children to support you.
So, what should be the right strategy? I believe that asset allocation should be done on the basis of the goals and risk profiling, and not depending on age. When it comes to retirement planning, which is the longest as well as the biggest financial goal, systematic withdrawal plan (SWP) could be an effective draw-down strategy as it is flexible and tax efficient compared with other options such as annuities or interest from other fixed-income options.
SWP is a withdrawal strategy wherein a fixed amount can be withdrawn from the portfolio every month; the remaining stays invested. SWP can be done through any kind of mutual fund.
Say, an individual has accumulated ₹ 1 crore at the time of retirement at age 60, and her annual expenses are ₹ 6 lakh growing at 8% inflation. If she wants to preserve the ₹ 1 crore, she can invest this and draw a monthly pension from it till the age of 80, instead of liquidating the full amount.
Assuming that there are no major capital expenses, the first five years of expenses should be stowed in relatively safer instruments such as fixed deposits or debt funds. Anything that is needed only after five years can be invested in a diversified large-cap equity fund, assuming that it gives 12% or more tax-free returns. The idea is to get better inflation-adjusted returns. Every year, the split has to be rebalanced from equity to debt to maintain the asset allocation.
Many may argue this to be a risky proposition. But one must remember that in the long term, equity offers stable returns and that it has the power to beat inflation. In the shorter term, the portfolio may exhibit higher volatility, but over a longer period, not only will the portfolio be equipped to meet the monthly draw-downs, it will also have the power to allow for any big capital expenses or leave a decent surplus as estate for the near and dear ones.
Having a major portion in debt investments may not be able to take you very far in your second innings.
Always remember, risk is not bad if managed properly. And sometimes being absolutely safe can be the riskiest bet. So, go ahead, and live your retirement with dignity.
Gajendra Kothari is managing director and chief executive officer, Etica Wealth Management Pvt. Ltd.
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