Posted On Monday, Jul 13, 2015
At a recent Path to Profit (investor education & awareness program) event in Bhubaneswar, one of the investors raised a few questions on financial planning after retirement. He is about to retire. His savings are good and his obligations of buying a house, or providing education for his children was over. His question was that since equities are likely to generate good return in the long run, why is his financial planner discouraging him from investing a large portion of his savings in equities?
He also commented that many of the financial planners he encountered, did not have any active financial planning for the post retirement phase. His experience of investing in equities went back to the year 2011 and later.
To our friend in Bhubaneswar, and to others in such situations, here are a few illustrative situations, and some broad pointers on financial planning for a post retirement phase.
Mr Nagesh, is aged 58 years, and retired from active work after receiving a provident fund of Rs 50 lacs. He did not have a pension plan, no financial liabilities and he needed approx Rs 22,000 for his monthly expenses. With limited knowledge on equities, he invested Rs 5 lacs in a mutual fund and the balance in fixed deposit which earned him 10%. He would meet his monthly expenses through the FD interest. It was a raging bull market and his equity investment doubled in a year. Based on his new found wealth, he picked up expensive tastes. Wine, regular use of radio taxis/cabs to name a few. He became a little overconfident about his investments, and thought this dream run would continue. He added Rs.15 lacs to his equity portfolio, removing it from his FD, assuming that he could control his costs and the excess interest that he received in the first few months could also be utilised to meet his monthly obligations. His equity portfolio was now worth Rs 25 lacs and his total assets worth Rs. 55 lacs.
Things suddenly changed. The increased tensions in the Middle East pushed up oil prices. Additionally on the Indian border, India-Pakistan tensions escalated. The worries on a poor monsoon made the foreign investors nervous. Markets declined. The initial decline in stock prices did not worry Nagesh. The markets appeared to stabilise a little, but a sudden international contagion, resulted in stock prices declining by 50% and his equity portfolio was now worth only Rs 12.5 lacs and the overall assets at Rs 42.5 lacs. Nagesh could not think of adding, and was unsure if the markets would bounce back, although he knew that eventually it bounces back. He was a nervous wreck; he had presumed that he could take some losses and also some volatility. But what took place in a matter of months was beyond his ability to handle stress. He sold his equities at a loss and wound up his equity portfolio. In the next two years, the markets bounced back by 200%, but he was out of it.
Understand the impact of volatility on the portfolio, and on your lifestyle. If your investment experience is limited, go slow on your equity investment.
Another example is of Pradeep. He was in a similar situation like Nagesh, but he had the capacity to withstand volatility. However, just around the time when the markets declined sharply, his wife fell ill and he needed immediate cash for her treatment. He did not have adequate medical insurance for his wife. He was forced to sell part of his equity portfolio and book some losses as he did not want to disturb his fixed deposit, which generated the regular monthly income.
In any asset allocation plan, keep some amount of cash which could be easily accessible..
Planning for retirement and after retirement is very crucial.While a steady income is necessary to meet the monthly expenses, it is equally important to ensure that some portion of the portfolio continues to grow. Equities are a good asset class to own for growth and for protection against inflation. Remember equities tend to give high returns, but its value being volatile makes it a higher risky asset to own.
Here are some broad thoughts or guideposts for financial planing after retirement.
|•||Due to advances in medical science, lifespan has increased. The post retirement phase could be as high as 30 to 40 years. Any financial plan should assume long living phase.|
|•||The exposure to equities could still be high. Regular income needs, appetite to witness volatility of the equity portfolio, will be the key input for deciding the amount to be invested in equities.|
|•||For those who plan to invest more in equities after retirement, the investment can be done gradually rather than in one go. Systematic transfer plan and systematic investment plans are options for gradually increasing the exposure to equities.|
|•||As the investor ages, exposure to equities could be slowly reduced by having a systematic withdrawal plan. The withdrawal plan needs to be adjusted based on the value of the portfolio and the income it generates.|
|•||Make investments which are tax efficient. For example, the long term capital gains on equities are tax exempt, while interest income from fixed deposits are taxed. Having some amount of investments in equities not only helps in reducing the tax incidence but also helps in growing the assets.|
|•||Keep some amount of assets in liquid funds, or any assets which can be liquidated quickly without incurring any loss or substantial loss. The amount to be invested in liquid assets could be a few months of expenses.|
Financial planning does not end with retirement. The accumulated wealth should provide for growth, generate adequate income and not fall short at a time when the earning capacity is limited.. Inflation could eat away the wealth if growth assets are not included. Recognise and understand the different risks that could arise and take steps to mitigate those risks.
Many risks can be anticipated and an investor can save and invest prudently. Some of the ways in reducing risks are
|•||The investor could diversify his investment across equities, debt, gold and property. In properties, the diversification can be done by investing in different locations and in different types of properties such as commercial, or residential.|
|•||Taking adequate insurance maybe an answer to some of situational risks stated in the above para.|
|•||Urgent need of cash could be addressed by having some proportion of investments in assets that can be liquidated quickly.|
To conclude only the regular 9 to 5 job ends with retirement, responsibilities and the need for sound financial planning for that phase must continue.
Please take guidance from your financial advisor before taking any investment related decisions.
Disclaimer, Statutory Details & Risk Factors:
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