Retirement planning shouldn’t just be about maintaining a stable corpus. It’s also about growing it every year. That’s because the cost of living inches up with inflation.
Most financial advisers suggest that mutual funds can be a way to achieve that goal.
Traditionally, people have been investing in fixed income instruments for generating income for retirement. Though such investment options offer regular income, it doesn’t grow year after year because of inflation, according to Amit Trivedi, author and mutual fund expert. Also, there are certain traditional investment options that don’t offer the option of premature withdrawal. But “[when] you switch over to mutual funds, both [options] are available.”
Agreed Gaurav Mashruwala, independent financial planner. “If a person needs money at any point, he/she can redeem their mutual fund units at any point offering the benefit of liquidity compared with a lock-in in case of post office monthly income schemes or senior citizen savings schemes,” Mashruwala said on BloombergQuint’s weekly series The Mutual Fund Show.
Watch the full show here...
Here are the edited excerpts from the interview...
We established at least as per the two of you that mutual funds were among the best ways to build a corpus for retirement. Now, let’s approach this from a perspective of somebody who is already retired. First, why and then how. Why is it that mutual funds will be a better option even for such a category?
Amit: If I look at the traditional options, there are a few limitations. Traditionally, people have been investing in fixed income instruments for generating income for retirement. The assumption is that the retired person needs regular income. In reality, the need is regular income but growing year after year because of inflation. Because while the debenture or fixed deposit will continue to pay me the same interest every year, my cost of living is likely to inch up because of inflation and medication. In two directions it becomes inadequate. Number two, if I need some money in between then some of the instruments don’t even offer liquidity at that time of point. That easy and convenient liquidity may not be available. (When) you switch over to mutual funds, both are available. You can change in the amount of withdrawal as and when you want. Here, the company issuing a debenture or fixed deposit decides what percentage of interest they will pay you, in case of mutual fund, you can decide how much you want to withdraw. It could be 2 percent or 3 percent. In the other case, the interest income will come and then (the) balance has to be invested back. In this case, if you don’t need don’t withdraw. (There is) immense amount of flexibility.
Gaurav: Because the moment you withdraw, all instruments have tax implications. Now, whether you are in that bracket or not which means whenever somebody comes in and says, let’s generate more income and then we will invest. I say, don’t make that mistake. Because if you are even in 20 percent of bracket, Rs 100 comes to you and Rs 20 you pay out to the Government of India and you are investing back only Rs 80. If you don’t need it, why are you doing that?
Gaurav, you mentioned about the three things two of which are enumerated as well. Describe it in the fashion that mutual funds in all the three parameters give you something that others don’t because others may have one or two parameters but not the third one. You want to elaborate on that?
Gaurav: Yes, so I normally compare it to cricket stumps and second innings. This is the second innings of your life and this is one day international, the team batting second has to protect all three stumps and the one stump is liquidity and second is regular income, third is growth. I need liquidity to meet contingency in emergencies. So, I either have a liquid fund or ultra-short bond fund or whatever it is. My regular income can be through systematic withdrawal plan, dividend payout, and I could also have a fund which is in equity. Either I have an asset allocation fund which will solve our problem but dedicated fund for each one of these is what mutual fund gives it to me. (It gives me) liquidity, regular income and growth.
Other options might have one or two of these things but not easy to do?
Gaurav: So, look at it from savings background will give you liquidity but then the regular income hardly anything.
Even growth would be a problem because it is a nominal growth, right?
Gaurav: Exactly, look at post office monthly income schemes, senior citizen savings scheme where section 80C benefit is available. There is regular income, but you are locked in. As Amit said if you need more, it will not give you growth. If were to put all your money in direct equity portfolio, there is growth but there is no regular income. You make a dividend once a year but look at the volatility that you are going to be facing. This is one instrument which is versatile and which we discussed in the first show and as you mentioned. It has a lot of variants and to that extend it should be considered.
Amit: So, the SWP that Gaurav talked about, look at the amount of flexibility that is available. I mean, how much interest you will get from the debenture or deposit is decided by the issuer but how much dividend you will get is decided by the company. In case of mutual fund SWP the investor can decide how much to withdraw on the regular basis. That flexibility, that power comes in the hands of the investor.
A couple of other points that were mentioned was the ease of passing on the investment to the future generation. Why is that that you guys are saying that mutual funds have the highest ease or among the highest ease of passing on to the future generation? Why not the other instruments?
Gaurav: One is nomination and will. Nomination and will are not interchangeable. You need to do both, as far as a mutual fund is concerned, simply filling up the form and submitting takes care of it. There also, I have an option of deciding different percentages for different nominees. So, I could say my wife 50 percent, my son 20 percent, daughter 30 percent. Different composition for different beneficiaries is possible.
Let’s assume that somebody has not made the will but in mutual fund nominations has put in the name of the nominees and the percentages as you said, is that enough for passing?
Amit: No. It is only enough for the purpose of receiving the money from the fund on the death of the unitholder or the investor but when the person receives, the nominee is liable to distribute to the legal aid. I can have a friend of mine as a nominee but then if he receives the money it is his duty to pass on that money to my family. So, it’s a potential dispute.
Gaurav: We are not doing show otherwise I would have said that the nomination is a right to receive as trustee.
For now, we will try and enumerate that how a person who has retired can plan this innings of his. Would you want to start with that, Amit? What is the idea and scenario? For our viewers, I would like to lay out that this is assuming that other things are taken care of, this is an ideal case scenario which may or may not fit you because your expenses and your income might be slightly different.
Amit: Just to lay background as you said certain things are taken care off. So, what are those certain things which are taken care off? Let’s say we have assumed in this calculation or table that the medical contingencies are taken care off. The short-term, mid-term liquidity is taken car off and there is no other income from any other source. It could be pension or rental income or whatever. so, we have assumed it that way and then worked the numbers.
So, given a certain corpus, an assumed rate of return and an assumed rate of inflation, if you look at the corpus and start withdrawing (and because we have assumed an inflation, the expenses are growing at the rate of inflation, the corpus is growing at the rate of return assumed in this case). The assumption in this case is that both are linear. Every year there is seven percent growth in portfolio value and there is five percent growth in expenses.Given that if you start with one crore portfolio and if you are withdrawing, let’s say Rs 30,000 a month, your expenses. So, one crore portfolio and 30,000 per month expenses which is like 3.6 percent withdrawal in the first year then the money can last for 40 years. So, 40 years in retirement which is a reasonably good situation. I am going to illustrate that.
However, if the monthly expenses move from Rs 30,000 to Rs 50,000 which is the third column in the table, then that 41 years get reduced to 20 years. Now, 20 years is not a bad situation. I mean 20 years in the retirement is not that bad a situation but just imagine if Rs 50,000 becomes Rs 55,000 then the number of years, I mean any increase in monthly expense and the number of years keep reducing.
So, the idea out here is, a lot of people estimate that one crore may be enough, or five crore may be enough. Check the math. Because a lot of times we don’t estimate the inflation, we don’t consider inflation in the calculation. So, what happens is because you are withdrawing the corpus grows up to a point and then start declining whereas expenses continue to grow and then you run out of corpus.
Is there a trick in assuming that your expenses will grow at a slightly faster pace than what you are assuming, and your income will be ideally slightly lower than what you are assuming? In that case you actually might be in a safer position?
Amit: So, there are three elements out here. Number one is the rate of return and number two is the inflation. If there is a reasonable gap and I assume 2 percent gap. The third element is how much are withdrawing, the withdrawal rate as a percentage of a corpus. So, if you start at 3.6 percent then the money lasts longer. They are the three basic assumptions.
In the second table, I had actually shown 5 percent inflation. So, there was 6 percent rate of return then 7 percent and then 8 percent. So, if I assume 1 percent gap, which is 6 percent rate of return and 5 percent inflation then the money last for 23 years but if the return is 8 percent and inflation is 5 percent then the money lasts for 33 years, with higher rate of withdrawal as well. Now, the caution.
The caution is you may have little bit of control over inflation, you have almost no control over the rate of return. A lot of people start assuming a higher rate of return and the moment you enter in the higher rate of return you are either taking the risk of credit, which means I have bought a fixed deposit or debenture and the money gets stuck that could be one of the risk.
Second risk is I allocate higher amount to, equity and I need regular income. So, if in the beginning years if the portfolio starts depleting and I am also withdrawing money and the market value is also going down, the recovery would not be as good as the markets recovery because I have already eaten out of the capital. So, these are the cautions and coming back to your question, yes, it is safer to assume that investment returns are not going to be significantly higher than inflation. That’s a safer assumption.
Gaurav, do you want to add to this? As we said the numbers could vary a little bit so on and so forth, but are these assumptions largely on ballpark and therefore, how would you plan, let’s work with the assumption that you are 60 right now and you know your expenses and your inflation rate. How would you plan your thing? Amit just laid out the tables and ideally this is how he would probably plan. What would your planning be?
Gaurav: What will happen in my case is, if it’s a client because I face client situation. In real life there is not only mutual fund, there could be somebody with pension. There is going to be somebody saying I am going to have second career. The moment your regular income gets augmented with something else then you are in different paradigm. So, those things happen.
Important thing for viewers is that the numbers which Amit has given I agree with them. I don’t want to differ because it’s not possible. Whether inflation is five or five and a half or whatever, but they need to realise the real-life situation of theirs. Don’t get into a trap. There could be husband, wife, both working—one having government pension, one not having it. There could be somebody where the husband is retired but wife still has three more years of regular income coming. So, unless you are not fracturing in those and straight away constructing a mutual fund portfolio. You will not explore the complete potential of this instrument to maximise the length of till when your money will survive.
I agree. Since we can’t tailor-make situation, let’s work with an assumption that both husband and wife are 60 and both don’t have any pension plan, not even the benefit of NPS because it is a recent thing. Let’s assume that there is no pension coming in. They have a corpus that they want to deploy to make sure that their lifestyle doesn’t get impacted. How would you use mutual funds to help them?
Gaurav: For their contingency, once they have retired and there is no other regular income, I would recommend keep aside about six months’ reserved for emergencies. Out of that, about a week or 10 days in form of cash in home because if there is a calamity, rest, which is about a month’s reserves in savings bank linked to fixed deposit. Balance all money in liquid fund. So, that’s mutual fund which is taken care of.
When it comes to regular income because we are looking at the 60s, there are many more years left and hence my need for a regular income is not only going to increase, but also going to go into lifestyle-related expenses. Because you may have a particular phone and now you want more and hence there is an option where there are asset allocation funds or the dynamic funds which will keep rebalancing and they would give you a regular outflow for your routine expenses. So, I would use that particular instrument. Typically, if there is sufficient corpus, then after having taken care of six months for contingency, out of which five months into contingency fund, I’ll ensure these funds; may it be asset allocation fund or dynamic kind of fund takes care of your regular income for next four-five years.
By this you mean the balance advantage fund category?
Gaurav: It could be that. See, in balance advantage fund kind of category, I really don’t have control. How much is the maneuver between debt and equity but let’s say I have asset allocation fund which says 20 percent equity, 80 percent debt, then I am much more comfortable because I know how much they will go. The fund will not go highly aggressive on equity. Otherwise, I am stuck because if there is no regular income coming, I am little bit stuck. While I may not have complete control, the allocation is what I want in control.
I think about a year ago, a lot of people were sold balanced advantage fund with a message that this will give you regular dividends and therefore as a regular income generating plan. Now, since you mentioned dynamic asset allocation and mentioned it will give you regular income. How would this work or I mean what’s the kind of returns that a dynamic asset allocation fund typically gives? What is this monthly or annual return or regular income that you are talking about and how does the overall plan work?
Gaurav: So, how much returns that is very difficult to predict, number one. Number two, no mutual fund is supposed to declare guaranteed dividend month on month. So, if that was sold or picked up, ideally it shouldn’t have happened. That should not have happened whether it was run by fund house or distributor or adviser.
Amit: First of all, the thing started before the balanced advantage funds became popular category and those dividends were sold in balanced funds and these balanced funds were equity heavy so roughly 70 percent equity and 30 percent fixed income. Now, let’s assume a scenario that there is a Rs 1,000 fund and it says that I will be able to pay you 0.75 percent per month which is 9 percent a year. 9 percent was the fixed deposit interest rate at that period of time.
Now, how long will it be able to pay? So, first of all, there is a concept of distributable surplus. So, assume that he keeps the surplus for two years so for Rs 1,000 portfolio, he needs to have Rs 180 worth of surplus that is 18 percent—9 percent multiplied by two years. The funds corpus so, Rs 180 and then because of that if they get additional Rs 1,000 in flow because of that dividend. Now, the fund is Rs 2,000 whereas the surplus is Rs 180 and from that Rs 2,000 if there is 10 percent fall in value then that Rs 180 is wiped out. Now, that’s a scary situation and that’s why it shouldn’t have been done, it happened, it survived but then coming back to the 80 percent debt and 20 percent equity category, which used to be MIP at one point in time, there have been enough instances in the past where monthly dividends have been skipped simply because for that period there was no surplus.
From a perspective of a person who is 60, what’s the kinds of fund the person should invest into, and again none of these are cast in stone, but the expected approximate returns that the person would get from that category.
Amit: At 60 you are planning for next 25-30 years of receiving income. So, I would break the corpus into three buckets. First could be a liquid fund bucket or an ultra-short-term fund bucket, which is extremely low on the risk side. I would also be very wary that the fund doesn’t have much credit risk because it’s a liquid portfolio essentially— that’s the first bucket.
And how much in that bucket?
Amit: I will come to that. The second bucket is an income fund bucket, which does take slightly higher risk and generate let’s say 0.5 or 1 percent extra than that ultra-short-term fund. Ultra- short term generates about 6 percent and the other one 7-7.5 percent and then the balance amount can go into an equity fund, a diversified equity fund or a large cap equity fund. We are talking about a retired person’s money, so I am not suggesting mid-cap though there are a lot of retired investors who are comfortable. So, they may take a call.
Now, how much? So, first 3-5 years’ worth of expenses in the liquid fund or in that ultra-short-term fund. And I am assuming zero appreciation in expenses in this case and I am also assuming zero inflation. So, first year’s expenses multiplied by five. The next 3-4 years is in the debt fund. My regular monthly withdrawal keeps happening from the liquid fund, the debt fund is not touched, and the equity fund is left to grow for a long period and periodically when I sit down to review whatever is in the appreciation in that equity portfolio I will take that and put it back in the liquid fund, which allows me to continually withdraw from the liquid fund for a very long period and in case if I start running out of that then the debt fund is very much there. So, I don’t have to do that regular withdrawal from the equity fund. That’s how, I typically look at it.
Gaurav, would you differ and maybe you want to add something to this, and it is completely fine to have a different strategy?
Gaurav: What he is saying is what I would do with my money. But as a planner, I am doing with a client, I may not create so many pockets because if I create and if in between if he drops out then he is left in mess. I mean, they don’t review it— leave aside whether they have capability in terms of time and skills. Even if they have time and skills, they don’t do it. So, I would just stick to three. One bucket for contingency fund, one for regular income may be do SWP, one when money is growing and just give it to them and say keep coming to me every three months. Just in case, they don’t come they are still fine. So, for contingency liquid fund, for growth equity-based fund may be an index or a large cap and for this it could be asset allocation. Maybe I will give two schemes or something. What he is saying is right and that’s what I will do for myself or my clients who are regular but in real life it’s too difficult.
For somebody who has got a sizeable corpus and let’s say based on the expenses, 80 percent of the corpus that he has takes care of the things that we are talking about. Would you be comfortable, since the corpus is slightly extra to tell the retired person to park 20 percent of that corpus in mid-cap and small-cap funds presuming that because that it is excess money, that money won’t be needed for 10-12 years and therefore the chances of that money growing is much higher in the mid-cap or small-cap category as compared to the large-cap category or non-equity category?
Gaurav: In real life situation, my clients have gone 40-50 percent. That happens, in the sense that if the person has enough money and appetite and he is comfortable and doesn’t lose night’s sleep then it is perfectly fine. I had a situation, I am talking about 2003, going way back where Sensex at bottom was 2,600. The gentleman who retired had daughter’s marriage coming in three months in time and I said keep this money in liquid funds and his wife said I want money to be safe and he was like, even if I have a drought in this country, Sensex wouldn’t fall and he went 40-50 percent equity and then entire market shot up. So, we do get such people and they do have options in case if things go bad. It is not watertight, if they are comfortable, we will be more than happy because then you are passing on more to the next generation if there is enough wealth. What I am going to do not allowing wealth to grow.
Amit: It depends on the client who is coming there. If the client is very knowledgeable, only then I will go to that risk level otherwise I would rather start it at low risk level and build it up.
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