When it comes to retirement planning, a lot of work needs to be done in advance. The sooner the planning begins, the better it is. The portfolio may include distinct types of financial instruments depending upon the objectives of the individual as well as his/her strategy to achieve the target. Risk taking capacity is a major factor in personal financial planning and depending on that the entire portfolio is built. There are many people who do not like to take risk in later years of life and stick to safe investments. Similarly, if investments begin at an early age, the risk bearing capacity could be more or flexible enough. So, equity shares or other volatile investments can be part of the portfolio. You should not consider it as a gambling option.
Pension is not available to all the private sector employees. Investing in safe instruments will keep your principal intact but the returns are always comparatively lower. To make the portfolio earning fairer returns, it is inevitable to include equity as a part of it. If you start planning during later years of your life when you are close to retirement, at least a certain amount of your investment should go towards equity. Plus, the government owned banks or entities too may not always be fruitful enough to fetch you guaranteed returns. Risk is an element that cannot be zeroed even by choosing government backed securities.
It is important to understand that diversification is the only way to manage risk.
How can investing in equity make a difference?
It offers long-term growth. Inflation is an ever present factor and is going to make value of your investments go down over a period of time. When you include equity in your portfolio, the growth factor works against inflation. With age the value of your portfolio should grow to compensate the inflation risk. When the funds grow, a small portion is taken by inflation. The rest consists of a larger portion earned through equity investment. Let the fixed deposits do their work, while the equity part will grow and add to your wealth. FD rates are falling and with rising inflation, the returns will be eaten and there shall be no gain left for the investor. Fortunately, the rate of inflation is in single digits and that’s expected to continue in the coming years.
Studies suggest that even after retirement, you should deploy a part of your funds to seal the gap in your portfolio left by the fixed deposits. If you have Rs. 1 Crore by the time you retire, and on account inflation in the next five years say at 6%, the value of your portfolio will come down if the money is kept in a FD. The same amount when invested in a mutual funds, that invests 60% in equity and the rest in debt instruments, the value will go up to Rs. 1.20 crores. But if is invested in equity, it can go up to Rs. 1.35 crores. The portion of fixed income asset class will give you steady income while the funds invested in equity will give you appreciation in terms of value.
If the equity is invested via large cap mutual fund schemes, or in a balanced fund that invests in debt securities, the returns could be attractive. Try not to withdraw and follow a systematic withdrawal pattern to let the funds stay invested for a longer time to wipe off the effects of market volatility. It is better to invest in a way so that the large amount of funds is not stuck for earning a fixed and lower amount of income.
How much should you invest in equity?
The rule of thumb for asset allocation between stocks and debt/fixed income generating funds is that the stock portion of your portfolio should be 100 minus your age. If your age is 46, you may choose to invest 54% of your portfolio in equity. Size of your portfolio is another determinant. If you have surplus money, you can go to extremes. However, wise step is not to completely invest in stocks.
Stocks can go down and it may hit you both financially and emotionally. Your future income is going to rely on the asset allocation within the portfolio and that should be a guiding factor. You cannot use the funds which are meant for generating monthly income towards any volatile, market linked securities. If you are an experienced investor and if you have owned stocks all your life, then you will better understand that the markets are bound to face bad times together with good ones. You can take help of a professional advisor when you do not understand the market trends. However, it all depends upon your own goals, risk taking capacity, surplus funds along with experience to handle the equity portion of your investments before taking a plunge. Overall, keeping a certain portion in equity is not at all a bad or risky alternative. The traditional myths about equity, refraining an investor from investing in them is not supported due to many reasons explained above.
Smrutirekha Bhoi