Best Investment to lose your Capital while planning for retirement

The money we earn could be used to buy things that we need today. Nonetheless, we chose to invest, by reasoning that we would rather use this purchasing power some other time in the future. In this manner, the money that we saved will become our capital. Since that we exercised the option of saving for future, we should be earning enough on the saved capital, to consume more than what we intended to consume now.

Invested capital is essentially trying to protect not your currency notes or bank balance, but the ability of money to buy something for you. Basically, you are trying to protect the purchasing power of your money in the name of capital protection.

What is the biggest risk to capital?

It is the rise in prices, also referred to as inflation. When we say protection of capital, we presume our saving is growing at least in line with the inflation. If the rate of growth (investment returns) of the saved money (capital) is less than the increase in household expenses, then we are simply destroying the capital.

Which investment option surely and certainly destroys our capital?

Well, the first choice of Indian investors is a financial asset called fixed deposits (FDs).

Simple illustration- Suppose you have Rs 1 lakh and you want to spend this money on buying a TV or a refrigerator or on a holiday package. Instead of splurging on these items, you invest the money in fixed deposits for a period of three years.

After three years, your capital has grown from Rs 1 lakh to say Rs 1.21 lakh (annual growth of 7 %). But during the same time period, prices of these three products/services went up by 10 % per year and these now cost Rs 1.30 lakh.

In short, FDs have destroyed your capital. This illustration is from a short-term perspective.

How safe is your Bank FD as a retirement corpus?

Now, imagine the impact of the same thing over your life span. Assume you start earning at the age of 30 Years; and regularly save and invest 33% of your income in the safe heaven Bank FD. The return you generate would at max keep in line with inflation, so logically speaking your two years of saving would take care of 1 year of expenses; so assume you work till 60 years (so you work for 30 years) and when you retire your safe heaven can at max take care of your expenses for 15 years and you will run out of your retirement fund.

Just introspect,

·         Have you started saving from the age of 30

·         Have you kept aside at least 25% of your income as savings since 30 years

·         are you intending to work till 60 and is your job secured till 60 Years

·         Have you deployed your savings to create capital

If your answer is yes for all the above highlighted points, then you can be sure you would retire comfortably; otherwise you need to seriously think of a proper plan.

Bank FD’s are like banyan tree; As banyan tree does not allow any vegetation to thrive below it, FD’s will not allow your capital to grow. So think before investing.

Retirement planning is no more an option, it’s a necessity.For any Investment Planning feel free to get in touch with me on 0965-65708812 /91-9845366753

How long would an investment portfolio of Re 1 crore at retirement last

Mr X retires with an investment portfolio of Re 1 Crore (cr) and is concerned about how long would his investment portfolio last or take care of his financial needs?

Longevity of protection from his investment portfolio depends on three important factors

1. Inflation (Non Controllable factor) – Inflation is the rate at which general level of prices for goods & services is rising. India’s Average inflation since FY 2000 (over last 17 years) stands at 6.5%. Mr X does not have any control over inflation and hence for analysis purpose let’s assume 5% long term inflation.

2. Monthly Investment Cash flow requirement (Controllable factor) – How much monthly cash flow Mr X requires from his investment portfolio depends on various factors like his other sources of income, life style, financial commitments etc.

For ex: Assume Mr X requires monthly expense of Re 1 lac for comfortable living. He gets a monthly pension of Re 25,000. So his monthly cash flow requirement from the investment portfolio would be Re 75,000 (Re 1 lac- Re 25,000).

3. Investment portfolio return (Controllable factor) – Mr X asset allocation would determine his return. Mr X could decide to park his money in an Bank SB account (potential to generate 0-3% CAGR return); invest in Fixed deposit instruments like bank FD, corporate FD, Bond Mutual Fund (potential to generate 4-10% CAGR return); invest in Equity instruments like Direct Equities, Equity Mutual Fund (potential to generate 8-15% CAGR return) or invest in alternative assets classes like gold, silver, real estate, REIT. Investors should take into account the tax impact as it would reduce investors return.

Mr X wishes to withdraw monthly Re 75,000 to meet his expenses and he is aware that inflation would push up his monthly expenses. The chart below depicts how long would Mr X  investment portfolio of 1 cr would last under various return scenarios.

Mr X investment portfolio would last / take care of his financial needs for only 8 Years at 0% return (held as cash). However if Mr X had wisely deployed his investment and generates 12% return on portfolio (Equity) then his portfolio would last/take care of his financial needs for 21 Years. Thus a wisely invested portfolio would last longer.

Conclusion: wisely selected investment portfolio during working years can significantly ease financial burden on retirement. if you don’t make your money work for you during working years then you might end up retiring late or lower the quality of life on retirement.

From the above example an investment portfolio held in fixed instruments (at 6% return) would last/take care of Mr X financial needs for only 11 years; while same portfolio held in Equity securities (at 12% return) would last/take care for 21 Years. Thus from the example a well held investment portfolio frees Mr X for 10 years (21 years-11 years); make your money work for you and retire comfortably.

Retirement Planning: Balanced Fund Vs Fixed Deposit

Everyone would like to retire financially sound. However majority of the investors would build corpus for retirement over their working years by investing in fixed deposit instruments. FD return most of the times just cover inflation and thus real return (adjusted for inflation) in FD would be 0-2% and returns are taxable.

I advocate balanced funds offered by Mutual Fund Houses for retirement planning. Balanced funds invest in a mix of Equity (generally 60-70%) and bond (generally 30-40%). Equity investments aim at generating capital appreciation, while Bond investments provide capital protection and reduce fund volatility/risk.

Selected Balanced Fund Vs Fixed Deposit (Since Inception)

If an investor had invested Rs 1 lac in BSL Balanced 95 Fund in the year 1995 (at the time fund launch), his worth today would be close to Rs 56.5 Lac when compared to FD worth of Rs 5.03 Lacs; thus investment in BSL Balanced 95 fund would have made you rich by Rs 51.46 Lacs. All the selected funds have generated higher return than the FD in the long run

Selected Balanced Fund Vs Fixed Deposit (Last 5 Years)

If an investor had invested Rs 1 lac in BSL Balanced 95 Fund five years back his worth today would be close to Rs 2.15 Lac when compared to FD worth of Rs 1.46 Lacs; thus investment in BSL Balanced 95 fund would have made you rich by Rs 68,590. All the selected funds have generated higher return than the FD over last five years

Conclusion: Balanced fund with the mix of equity and bond can offer the best from both the asset class. Capital appreciation from equity & reduced risk from Bond. Selected Balanced funds clearly outperformed FD both in the short (over 5 year period) as well as long run (since Inception/fund launch)

Investor’s ability to take risk would be high when they have active income (Employed), higher income levels, longer investment horizon (still has sufficient time for retirement/essential commitment); If your current situation provides you enough flexibility to take risk then you should seriously consider putting your money work for you by investing in Balanced fund instead of FD. Plan well for happy & financially sound retirement

Feel free to place your comment and for any queries related to personal finance, you can reach me @ smartportfolioadvisors@gmail.com.