For most of you, holding an EPF account with your company or investing separately in PPF could be the only retirement plan in place. This means of saving may have held water about a decade ago. But for the upcoming generation of retirees, dependence on EPF and lack of pension may mean that they are at a real risk of falling short of capital, post retirement.
Just take a look at the kind of returns that your Employee’s Provident Fund (interest declared by the central government) was delivering about 2 decades ago and how steadily the rates have been declining. This is no different with your PPF account.
At the same time, consumer price inflation (CPI) has been on the rise, particularly in the last 5 years and has crept to an average of 10.2% in the last 5 years (taking the old CPI rates for Industrial workers, as the new CPI is available only from 2011).
That means, your net returns from your provident fund or PPF would actually be negative!
Now, if you have not built enough wealth for your retirement, chances are that you will not sustain yourself costs post retirement with just the interest income from your kitty. You will have to start spending your capital as well; reducing the corpus left to generate interest income. Now that is not a happy proposition.
Now, just take a look at the graph below. It is a simple example, assuming Rs 500 a month contribution to EPF, with an annual increase in contribution by 5%. Similar money is invested in Franklin India Bluechip as well.
After 10 years, the differential in your corpus is 33%. It would be even higher with a longer period, as interest is compounded annually in your EPF, while equity funds undergo continuous compounding by way of remaining invested in the markets.
Elsewhere too, lower interest on traditional options has meant that people looking to save for investment scout for mutual funds.
This is why a majority of the households in countries such as the U.S. invest their retirement savings through mutual funds; so much so that retail investors’ retirement holdings alone account for 50% of the mutual fund assets in that country.
So what is preventing Indians from investing in mutual funds? Here are some of the myths that need to be busted for you to ensure you are not left grappling at the last minute:
1. Mutual funds are risky, I will lose my money
No doubt, mutual funds, especially equity funds, move with the market forces and can therefore be risky. But long-term equity fund data shows that the risks are evened out over the long term.
In fact over a 15-year period, chances of negative returns in the stock market are nil. That means, you cannot lose money if you stay invested that long. And to top it, equity funds have delivered inflation-beating returns over the long term.
2. Mutual funds will give too much exposure to equity markets
Mutual funds, for most people, mean investing in equity markets. This is not true. Mutual funds offer exposure to a wide range of low-risk to medium- risk debt instruments too.
They offer exposure to gold without holding them physically and even allow you to explore evolved international markets such as the U.S. Mutual funds also offer a combination of equity and debt, the equity part being either very low or reasonably high, depending on what risk you can assume.
A well-diversified basket provides sufficient exposure to various asset classes using a single product called mutual fund.
3. Mutual funds cannot give steady returns like deposits
Yes, mutual funds cannot guarantee you returns or provide fixed outflow of interest income like deposits. But let’s get this one straight. What is the objective behind saving for retirement?
It is to build a decent corpus until you retire. A healthy corpus can then be invested in reasonably safe investment avenues, to generate some monthly or annual income for you, to substitute the loss of salary/business income, once you retire.
This being the objective, going for regular interest payout options do not help the purpose of building wealth because chances are that you will not diligently reinvest.
Even if the option is cumulative, you run a reinvestment risk because you may end up with lower rates (when you renew your investments after they mature) than what you received earlier. Your EPF, with varying interest rate every year, assumes this risk.
Equity funds, by way of being invested in markets all the time (and taking cash positions only if warranted), do not carry such reinvestment risk.
Rules for retirement investing using mutual funds
The first rule to follow in mutual fund investing, when you invest for retirement, is to hold reasonable exposure to equities in the early years and gradually reduce them by moving them to debt funds and other traditional saving options such as tax-free bonds and deposits.
The shifting process, if you have been investing for at least 15-20 years, can start even 5 years ahead of your retirement.
Most people burn their fingers simply because they take high exposure to equities just a few years ahead of retiring and expect equities to generate high returns in a short time. A down market, in such instances, can even wipe the capital.
The second rule is to rebalance your mutual fund portfolio, preferably every year. This involves bringing your portfolio to the original asset allocation, if the equity, debt, gold proportion in your portfolio moves out of kilter (note that this can be done in a click with FundsIndia’s Retirement Solutions).
The third rule is that your retirement portfolio can do without any theme or fancied sector funds to pep your portfolio. If you do wish to take such exposure, limit it to 10% and ensure you exit the theme at least a few years ahead of your retirement. The last thing a retirement portfolio needs is volatility from cyclical funds.
The fourth rule is that your retirement kitty should be a basket – EPF, PPF, mutual funds (equity and debt; with gold being optional) and other traditional debt options such as deposits.
The fifth rule is that if you have some exposure to mutual funds post retirement, don’t depend on them to declare dividends, if you need monthly income, use the systematic withdrawal plan (SWP) option to create your own annuity plan. SWPs are also very tax efficient, as they enjoy capital gains indexation benefit in the case of debt funds held over a year (equity funds are exempt from capital gains tax).
Following the above will likely ensure that you build a comfortable retirement corpus without burning your fingers.