Sunday, April 17, 2011

Planning for Retirement

Amruta is keen to save for the long term. She still has over 15 years of service in her job with a bank, and will be eligible for pension when she retires. Should her savings consider her retirement needs? Or is too far for her to worry? It is never too early to plan for retirement. We all go through a stage in life, when we hold a regular income yielding job or profession, and reach the stage when we no longer work. To plan for retirement is to set aside today’s funds for tomorrow. And to ensure that we receive a comfortable level of income from our investments, even if our regular income ceases to flow in.

There are two components to planning for retirement. The first is the building of a corpus by saving from our regular income. The deployment of this corpus should have the single objective of accumulation into a large value by the time we are ready to retire. The second is the deployment of the corpus to fund our retirement. How much we save, how we invest the saving, and how we modify the investment pattern based on our needs, is the gist of planning for retirement.

Amruta, like so many of us, contributes to her provident fund and plans to invest the proceeds after retirement into an annuity scheme which will pay her a regular fixed pension in her retirement years. She thinks it is good to invest in safe avenues and to deploy the corpus such that the capital is not put to risk. Is she doing the right thing?

Not really, Amruta needs to worry about a few things. If the need is growth, her investments need to focus on assets such as equity funds. Her pre-retirement saving needs to be growth-oriented to become a larger corpus. If the need is income, investments needs to focus on assets such as debt funds. Her post-retirement investment needs to be income-oriented to provide for her regularly. Amruta needs to harness the power of asset allocation. If she chooses to stick to one type of income-yielding asset when she accumulates her corpus as well as draws from it, she exposes herself to risk. She needs an equity-oriented strategy when she accumulates, and a debt-oriented strategy after her retirement when she draws upon her investments. Retirement planning is a deft and dynamic exercise in asset allocation that rebalances equity and debt, or growth and income, based on the changing need of the investor.

Amruta’s asset allocation in the pre-retirement stage should leverage the time available before her retirement. Amruta will be able to invest in growth assets like equity, which may be volatile in the short term, but earn a higher return in the long term. She should target building a larger corpus for the same level of saving. To invest at a fixed rate for the long term could be a low risk strategy, but it would also mean taking the slow train to corpus-building. Amruta should choose long term growth investments such as diversified large cap equity funds, which invest in large, more liquid blue-chip companies that are leaders in their sectors. Such an investment is likely to provide Amruta with a higher rate of return, so her corpus can grow at a faster rate. Since she is not investing in a lump sum, but in regular instalments over a long period, she will not be timing the markets either.

Amruta’s asset allocation in the post-retirement period should primarily generate a regular income while also shielding her from inflation during her retirement years. She needs to choose a hybrid allocation, with a high portion in income-oriented investments, and a small portion in growth-oriented investments. A fixed corpus invested into fixed income assets will lead to a lower income in her later years, after inflation. If she needs an increasing rate of income over the years into retirement, she can achieve that only by allocating at least a portion of her money into equity assets. She should periodically transfer the growth in her equity funds to debt funds that will generate her income. She can begin with an equity allocation of say 40% when she retires, and reduce it over time to about 20% by the time she is 80 years old.

Dr. Uma Shashikant,
Director, Centre for Investment
Education and Learning

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