Retirement Planning: A perspective
There are many clichés that prevail about retirement and related investment planning. One of the most common ones is that one has to be very conservative and one cannot take any risks in the investment strategy because loss of capital can be a disaster. The safe options are thought to be deposits, insurance policies or real estate properties.
Deposits can never grow the money and they are tax inefficient. Insurance policies unless taken very early or at mid-career stages; are not much use for retired individuals. They can be pretty inflexible and not give any results when actually required. On the other hand real estate bought and put on rent results in very poor yields and it comes with significant friction costs like GST, registration costs, higher brokerage and poor liquidity in case of eventualities. At the same time none of these options are bankable prospects from perspective of growing the post inflation value of the monies invested. And growth is extremely important for the retired individual. Investing is not just about beating inflation or preserving value, it is also about maintaining and improving standard of living, it is about actualising some dreams of retired life and most importantly it is also about leaving behind a legacy for the coming generations.
If one retires at 60, one cannot plan for 70. One has to plan to live a 100.
Keeping all this in mind investment planning ‘‘post retirement’’ must have growth of the retirement proceeds as a key objective even while continuing to manage the near term liquidity and the monthly and annual household expenses. Increasingly if one sees the investment pattern of most individuals and even institutions such as the EPFO or other private pension funds, equity investment through mutual funds is emerging as a favoured investment option. Many retired individuals think that equity and its volatility and unpredictability are not for them. I don’t think there is a choice.
A lot of investors have reservations against investing in equities because they feel the need for regular incomes at monthly, quarterly or annual frequency. Equity mutual funds do declare dividends but again dividends from equity mutual funds in their strictest sense should be a function of NAV growth and booking of profits by fund managers from such growth. Whether it is dividend or a redemption by the investor for want of cashflow income; if such outflow happens without growth in NAV, basically it’s the investor’s capital being returned back to the investor. This is where I chanced upon an interesting thought.
Equity can give great returns is now widely accepted but how does one manage cashflows. Fixed income securities like bonds and deposits by nature are interest bearing and the cashflow from the interest fulfils requirements. But as discussed above the return potential of fixed income securities is not great. Just for securing cashflow if one chooses fixed income investments then it’s a mighty sub-optimal choice to make. One can keep emergency liquidity or next one year’s cashflow requirements in deposits and need for cashflows or liquidity doesn’t mean one has to give up on returns on the entire corpus. One needs to learn to segregate the two. Lets say the annual cashflow required by an investor is Rs. 10 L or about Rs. 80,000 a month. Over long periods of time the stock market index itself has returned around 15% CAGR and good funds have delivered anywhere between 20% to 25% CAGR in the same time frame. CAGR obviously in some form represents average returns and average by definition means that there is a minimum and a maximum on which the average is built and while the average may look like a nice and sane number, it’s the minimum and the maximum which gets investors’ goat. It is precisely this frequent occurrence of deviation from the average towards the minimum which trashes the “cashflow” requirement.
Going forward we don’t extrapolate 15% on the index and 20% – 25% on good funds because these numbers came in a different era of inflation and interest rates. For sake of working arguments, let’s say index delivers 10%-12% and good funds deliver in the range of 15%-16% over the next few years. What would happen if one were to invest Rs 1 cr in a fund of choice and instruct the fund to pay Rs. 80,000 per month irrespective of where the long range average (CAGR), the minimum and maximum lies. Just ignore whether we are close to the average phase, whether we are deviating below or above the average and keep taking Rs. 80,000 per month off the table to meet your requirements. What do you think would happen? Intuitively if the fund actually delivers in line with expectations over the entire time frame of investments, one would see that since the return on the fund is much higher than the cashflow required, eventually not only the capital would be preserved like a good fixed income instrument should but also one would end up with some growth like a good equity investment should enable!
The learning is clear – we are making a huge mistake by linking our need for cashflow with the return on the underlying investment. As long as the underlying investment delivers over a sufficiently long period of time, we should not be averse to taking out the required cashflow at regular intervals. The key condition being that at any time the annual cashflow taken out has to be well below a conservative estimation of the likely long term CAGR on the investment. While taking cashflow the capital shouldn’t get eroded to such an extent that the entire future growth is jeopardised.
At the same time we must note that taking our regular cashflows is definitely going to reduce the effective compounding rate and exit returns. But at the same time, it is a way better idea than to park the corpus into fixed income just because we want cashflow without capital fluctuation.
Any investment option can only be evaluated on three parameters: Safety; Liquidity; Returns (SLR).
A fixed income instrument can provide liquidity and safety with regular cashflow (a facet of liquidity itself) but of course it would be sub-optimal on returns. The above plan would keep the investment in a high return investment option and provide liquidity and to that extent fluctuation in capital value has to be tolerated albeit for intervening periods and not at all if the likely exit is sufficiently long term in nature. Need for liquidity doesn’t compromise return and that’s a good option to have.
The Author, Ms. Kirandeep Kaur is CEO, KD Financial Services and is a passionate Wealth Advisor & Financial Consultant, who has been associated with the Armed Forces for close to two decades. An Alumni of IIM-Calcutta, Post Graduate in Treasury & Forex Management and Certified Treasury Manager from the Association of Certified Treasury Managers (ACTM). She brings to the table a vast repertoire of knowledge and experience of financial markets across asset classes. The firm’s core expertise lies in creating customised strategies which accommodate customer’s investment goals with respect to wealth accumulation, preservation and liquidity. She can be reached via email at firstname.lastname@example.org or email@example.com
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