Early start, more equity can beat low interest rates, say analysts

Counter the cut in EPF rate with an asset-allocated retirement portfolio and using instruments like NPS

In the current low interest rate environment, the government recently reduced the guaranteed return on the Employees’ Provident Fund (EPF) to 8.1 per cent, a multi-decade low.

The move has come as a dampener to those who rely on the state-sponsored scheme for their retirement corpus.

However, early starters, who follow a disciplined financial plan, can still end up with a sizeable retirement corpus.

Estimate the corpus required

Your current cost of living can provide a good estimate of your cost of living at the time of retirement.

“Inflate today’s living costs till retirement age. From this inflated cost, reduce 10-15 per cent for costs that you won’t incur after retirement. Use this inflated cost to estimate your annual requirement. The total corpus required to meet this annual cost, adjusted for inflation and taxes, can then be worked out using financial mathematics,” says Arvind A Rao, certified financial planner and founder, Arvind Rao and Associates.

You can also use online retirement calculators or take a financial planner’s help to estimate the retirement corpus. “Four factors determine the retirement corpus: Years left for retirement, life expectancy post retirement, estimated inflation-adjusted retirement expenses to maintain current lifestyle, and growth rate expected in existing corpus and investments,” says Tarun Birani, founder and chief executive officer (CEO), TBNG Capital Advisors.

Exposure to equities is a must

Next, decide on your asset allocation. The asset allocation in a retirement portfolio depends on the corpus required for retirement and health care, and the amount available. “In case there is a shortfall or you have just enough available, take at least some exposure to equity mutual funds to beat inflation and cover for the possibility of living beyond the estimated life expectancy,” says Vishal Dhawan, founder and CEO, Plan Ahead Wealth Advisors.
 

EPF, PPF best bets

Despite lowering of interest rates, EPF and Public Provident Fund (PPF) remain the best bets. Take fixed-income allocation through them as they offer tax-free returns with no credit risk. “The reduced rate of interest on EPF continues to be significantly higher than what other debt instruments are offering. Investors can also invest in PPF and NPS for accumulating a retirement corpus,” says Dhawan.

Those whose EPF contribution is low may also allocate via Voluntary Provident Fund (VPF). NPS is another good option due to its low costs and possibility of generating high returns.

Don’t shun equities

If you have more than five years to retire, allocate some money to equity mutual funds. Stagger your investments since a systematic investment plan reduces timing risk and makes you disciplined.

“The longer the number of years left to retire, the higher the allocation to equities you can have, since they enhance the return potential,” says Birani.

Closer to retirement, increase your debt allocation. Rao suggests that those in the 30-45 age bracket should have a 75:25 allocation to equities and debt. Thereafter, keep shifting 10-15 per cent of your corpus from equity to debt every five years till 55. Between 55 and 58, reduce equity exposure to 25-35 per cent.

Mistakes to avoid

Avoid procrastination. Only by starting early and investing regularly can you build an adequate corpus. “While the return from debt instruments will be lower than from equities over the longer term, they are required to lend stability to the retirement portfolio,” says Rao.

Retirement is a long-term goal. Don’t focus on the short term or look for quick fixes.  “Keep in mind the long-investment horizon. Interest rates go through cycles. Equities can be volatile in the short term but returns from them even out over the long term. Finally, look for lower-cost solutions, and avoid moving your money completely from one asset class to another,” says Dhawan.