Retirement portfolio beyond FDs: Diversify for inflation, longevity risks

The entire retirement corpus will not be needed on day one, so it should be split into growth and income-generation buckets to manage inflation and longevity risks

Senior citizens’ dependence on fixed deposits (FDs) is well documented. Recent media reports, citing Reserve Bank of India data, suggest that this reliance has increased further in recent times. However, retirees need to diversify beyond FDs to manage the multiple challenges associated with their retirement corpus.

 

Allocate to growth assets

 

Retirees need some exposure to growth assets, such as equity mutual funds, to outpace consumer and lifestyle inflation during a retirement phase that can last 25 years or more. 

“A retired person could keep 10 per cent to 40 per cent of their portfolio in a Nifty 50 index fund,” says Avinash Luthria, Sebi-registered investment advisor and founder, Fiduciaries. He says the allocation to equity funds should depend on the investor’s experience with equities. Those with less than five years of experience should remain at the lower end of that range. “The rare senior citizen with more than 20 years of experience with equity could go to the upper end of that range,” says Luthria. 

He cautions that equity crashes can be severe and can last for many years, so retirees should assume their true risk appetite is lower than they think.

 

Which funds to choose

 

One prerequisite for investing in equity funds after retirement is that the retirement corpus must be considerable. “Senior citizen couples with large portfolios above ₹10 crore and the ability to invest through direct mutual fund plans should use a Nifty 50 index fund for its low fee,” says Luthria.

 

Vishal Dhawan, founder and chief executive officer (CEO), Plan Ahead Wealth Advisors, recommends a combination of index funds and flexicap funds for seniors who are comfortable with pure equity exposure. “They should avoid more aggressive categories, such as mid-cap, small-cap and thematic funds, because of their higher volatility,” he says.

 

Not all senior citizens may have the risk appetite for pure equity funds. “Most senior citizens may be comfortable using hybrid funds, such as balanced advantage funds and other hybrid categories that have a small equity component and witness lower volatility,” says Arnav Pandya, founder, Moneyeduschool.

 

One advantage of hybrid funds is that they offer more tax-efficient rebalancing.

 

Instruments for regular income

 

Retirees should generate only as much cash flow from their corpus as they need. “Regular income should come from a combination of instruments rather than a single instrument,” says Dhawan.

 

Senior Citizens’ Savings Scheme (SCSS), bank deposits, highly rated corporate deposits, annuities and monthly income plans of post offices can help generate regular cash flow.

 

“The mix should reflect how much of the retiree’s expenses are fixed and how much are flexible,” says Dhawan.

 

“Diversifying across multiple instruments can help balance sovereign safety and returns over a long retirement period,” says Abhishek Kumar, Sebi-registered investment advisor and founder, SahajMoney.com.

 

Fixed deposits: FDs can provide regular income and carry a lower risk of capital loss, provided the senior citizen sticks to larger commercial banks. They also offer a slightly higher rate to senior citizens than to other investors.

 

“FDs offer liquidity and a predictable rate of return,” says Dhawan.

 

They also have a few disadvantages. “FDs carry reinvestment risk if interest rates fall at maturity,” says Dhawan.

 

Their suitability depends on the investor’s tax slab. “They become less efficient as the investor’s tax slab rises,” says Dhawan.

 

Kumar says FDs do not protect investors against inflation. “Over-reliance on FDs can erode purchasing power because the real rate of return can turn negative after factoring in inflation and taxes,” says Kumar.

 

A prudent allocation to FDs would be 20 to 40 per cent of the income portfolio. “The exact allocation should depend on liquidity needs and the size of the emergency fund,” says Kumar.

 

“Highly rated corporate FDs can also be considered, but investors must check the ratings and financials because these are unsecured instruments,” says Dhawan.

 

Annuities: Annuities help cover longevity risk because they provide income for as long as the retiree lives. “Some annuities can offer return of capital or continued benefits to the spouse, depending on the option chosen,” says Pandya.

 

They also have limitations. “Annuity yields in India tend to be low,” says Pandya.

 

Their illiquid nature can reduce flexibility. “Investors with smaller corpuses may find annuities difficult because the principal becomes inaccessible,” says Dhawan.

 

Annuity returns are not adjusted for inflation and are also less tax-efficient for investors in higher tax brackets.

 

Kumar says no more than 25 to 30 per cent of the retirement corpus should go into annuities.

 

SCSS: SCSS offers a guaranteed return of 8.2 per cent with a quarterly payout. However, early access to capital can attract penalties. “Investors with larger corpuses can park money in SCSS more easily because they can create other sources of liquidity. Those with smaller corpus may find it harder to use it,” says Dhawan. The scheme has an investment cap of ₹30 lakh per person. The interest income from SCSS is taxable at the slab rate.

 

Debt mutual funds: Debt mutual funds can also provide regular income. “The systematic withdrawal plan (SWP) facility allows flexibility to increase, decrease, start and stop withdrawals,” says Dhawan.

 

The SWP from debt funds is also tax-efficient. Only the capital gains component, and not the entire withdrawal amount, is taxed. Tax also applies only at the time of withdrawal and not every year.

 

Do’s and don’ts

 

Seniors should avoid taking too much risk in the income-generating portion of their portfolios. They should also check the liquidity of the instruments they choose. “Do not lock the entire capital into long-term products without keeping a liquid buffer for medical emergencies or lifestyle changes,” says Kumar.

 

Retirement may last 20 to 30 years, so the portfolio should reflect the fact that retirees do not need all their money on day one. “Retirees may make better decisions by dividing money into time buckets,” says Dhawan.