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 any mandatory pension schemes may mean that they are at some real risk of falling short of capital, post retirement.
From returns as high as 12% for a good part in the 90s; interest in EPF has been on a steady declining trend, delivering less than 9% in recent years.
The recent announcement about making small saving rates more dynamic, in line with market rates (change every quarter), also means that the days of locking into fixed rates are almost over. Your fixed income instruments too would have dynamic rates and that also means lower rates in a falling rate scenario.
Other than PPF, most of you may invest money for your retirement in fixed deposits. Now, besides these instruments being tax inefficient, their returns, post tax, hardly beat inflation.
Consumer price inflation (CPI) has been on the rise, particularly in the last 10 years and has crept to an average of 8.5% annually over this period. That means you need to earn a little over 12% (if you are in the 30% tax bracket) to beat inflation. If you have been investing in deposits, thinking you are building wealth for your retirement, think again.
A last option that many think will solve their retirement fears is to buy a pension plan. True, a pension plan will do what it says — provide you with pension. But can you be sure if the pension is sufficient? Will it be sufficient, when the premium you pay actually generates returns not over 6% in most cases? Yes, because insurance companies provide you with a fixed income, they also park your money (till retirement) in low risk, low returning options. That also means that the pension you get will be sub-optimal and not even cover you cost of living 15-30 years from now.
Capital erosion
A corpus built for a comfortable retirement has to be large enough to generate sufficient interest income to meet your post-retirement needs. Otherwise, you will have to start spending from your capital as well; thus eroding it, perhaps well before you lifetime. Now that is not a happy proposition.
But you have a way out. And that is by investing a part of your investment, in your earning years, in equity/equity mutual funds.
Despite equity funds demonstrating sound long-term performance, investors tend to keep away from equity for their retirement planning. Why is this so?
It is primarily the belief that one loses money in equities. No doubt equities per se can be risky but when invested in fundamentally sound companies, they can be extremely rewarding. Equity mutual funds have demonstrated that the risks are evened out over the long term.
In fact over a 15-year period (which is the time frame for your PPF), chances of negative returns in the stock market in nil. And to top it, equity funds have delivered inflation-beating returns over the long term.
By following a few simple rules to investing in equities, you can avoid burning your fingers and also build a comfortable retirement fund.
The first rule is to use the mutual fund route to investing in equities, if you are not familiar with the stock market. This removes your need to track and monitor regularly as experts do it for you. It also allows you to save regularly using systematic investment plan (SIP).
The second rule is to have higher exposure to equities in your early earning years and then gradually reduce by moving them to debt funds and other traditional saving options such as fixed deposits, post office schemes and tax-free bonds when you are few years away from 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 your capital.
The third rule is to stay invested in the markets through ups and downs and not exit when the market is down. Your paper losses may move to profits in a while. But if you sell, you are making those losses a reality. Have a long-term view and do not give way to emotions when you see markets tumble.
Following the above will likely ensure that you build a comfortable retirement corpus, far better than through other traditional options.
(The author is Head of Mutual Fund Research at FundsIndia)