- May 13, 2014
- Posted by: peakalpha2023
- Category: Times of India
As a financial planning professional servicing 3,000 customers, I have found a few things common in many of my customers’ wish lists: Almost everyone wants to be fabulously rich, clear of all debt and retire as early as possible.
Two situations that befuddle a financial planner are short working years and long retirements. On an average, our lifespan is increasing by one year every three years. The previous generation would work till 60 and live till 75, with only 15 years of retirement to fund. The present generation would like to retire at 40. No problem with such a desire, except that if they live till 90, then they have a 50-year retirement to fund on the basis of 15 years of earnings. Hence, it becomes critical to ensure that assets grow that much faster to sustain their current lifestyle for the rest of their lives.
How do we stretch the rupee so that people can maintain the same or better lifestyle after retirement? We have various instruments to choose from. Under the debt option, we have fixed deposits, debt mutual funds, corporate bonds, Public Provident Fund (PPF), National Savings Certificates (NSCs) and so on. Gold is another form of debt because of the similar tax treatment as to debt instruments as well as returns.
Real estate has the potential to offer returns that beat inflation, but the associated frictional costs and the hassles of managing investment properties can prove to be a deterrent for many. Under equities, we have direct stocks, equity mutual funds, and various structured products whose underlying assets are stocks.
In general, conventional debt investments such as fixed deposits have not offered returns that have beaten inflation. On an average, the real returns from these instruments are negative. We are living in an age where annual inflation rate is averaging 8-10%. Going by the historical inflation rate, a Rs 100 earned 30 years ago will buy you groceries worth Rs 14 today.
Some customers tell me that they are satisfied with the 9% interest on their fixed deposits. But have they considered that a 9% interest will yield only a little over 6% post-tax (assuming a 30% tax bracket)? In the same period, inflation in our country is hovering at 10%, reducing the real return on their fixed deposits to a negative 4%. This means that people are becoming poorer every year without realizing it.
As a general rule, your age is a good guideline for the proportion of bonds you should hold. If you are 30, then have 30% bonds and 70% in equity. Bonds bring safety to your portfolio. Equity is the growth engine of your portfolio, and — over a longer time horizon — should offer you real returns that fight inflation aggressively. You require equity in your portfolio even after retirement if you are to prevent inflation from gnawing into your portfolio returns.
There is no question that equity is a volatile instrument. But not taking the risk associated with investing in equity is one of the biggest risks to your financial independence. While investing in equity, mutual funds are a great way to enjoy the diversification of a well-managed portfolio while earning good returns. Gains from equity and equity mutual funds are exempt from tax after a year. Added to this, if you invest in equity mutual funds via SIPs and thereby not try to time the market, compounding will ensure that your dreams of early retirement, or becoming a millionaire may well come true!
