Why equity investment is must during retirement to avoid poverty in old age

Earlier this year, I received a message from a senior citizen who said his returns from a fixed deposit had fallen by 25%. While it sounded surprising, it was true. It was the difference in what he received from a five-year deposit that he had made in August 2012 and on its renewal upon maturity in August 2017. 

To those who just read headlines on interest rates, this doesn’t make sense. Depending on what you are measuring and how you are comparing, interest rates have gone down by 2 or 3%. But here’s what he said: ‘I was being paid Rs 35,352 every month—subject to income tax— enabling me to lead a worry-free life. Now on maturity I have reinvested the amount in the same bank and I will be paid Rs 26,489.” 

The interest rate on his fixed deposit may have gone done by just about 2.5% , however, his income is down by 25%. In fact, this is essentially an obfuscation in the way the reduction of interest rates is covered in the media. A reduction in the interest rate on a particular kind of deposit, say from 10 to 8%, is a reduction of 20%. If you were earning Rs 20,000 a month, you will now earn Rs 16,000 a month. 

Seniors have retired from the economy 

The entire move towards lower interest rates, while great news for the economy, is of little relevance to older, retired people. Lower inflation and interest rates, better fiscal management and higher economic growth will carry no benefit for them because they are no longer in the earning and accumulative phase of their lives. An older person is not going to get a better job, or a higher salary because the economy is growing. That phase of his or her life is over. 

However, wishing for higher interest rates is not a solution. This yearning for higher rates is there because for years we have been conditioned to ignore high inflation, which is the evil twin of high interest rates. I’m sorry to say this, but the person in the above example is financially doomed. During the course of the first five years of the FD, when he was getting Rs 35,352 as interest income and spending it, he was actually eating away his capital. Out of that income, no more than Rs 7,000 to 10,000 was real income. The rest was just the inflated value of the currency. 

Here’s the key fact that he and crores of others like him ignore: his real income has probably not gone down. If he was spending only his real, inflation-adjusted income, he would probably find that it had actually increased. So how would he have spent only his real income? The answer is, by spending only about 1.5 % of the deposit per year, and letting the rest compound and accumulate. This is based on the assumption that FD rates are about 1.5% higher than the inflation rate. 

Obviously, he would need far more money to do that. Instead of Rs 40 lakh as deposit, he would need more than Rs 2 crore as deposit, which he does not have. There is no complete solution to this particular problem. However, a partial solution lies in the returns that equity can generate. Real (inflation-adjusted) equity returns are actually double or triple that of fixed income. Where a FD can generate 1.5% above inflation, equity will give 3-5%. 

No way out but equity 

There is no way out except to take some exposure to equity in a measured, de-risked and tax-efficient way. The ideal method would be to follow these steps: First, keep a year’s expenses aside and gradually invest the remaining amount into a set of two or three hybrid funds. After that, you can start withdrawing from these funds an amount that is roughly 3-4% per annum of the total remaining sum. 

This will give you an amount that is equal to,or more than, what you are earning from a fixed income deposit today. The best part is that the value of the remaining investment will also grow at roughly the inflation rate. If you can implement this, then there is virtual certainty that you will not be face old-age poverty. Moreover, this approach will also be vastly more tax efficient. 

If one is to avoid old-age poverty, then this fear of equity in retirement must be gotten rid of. There’s no other way. 

                                                                                                                                                                        -etwealth

Is it better to invest in tax saving mutual funds through lump sum or SIP

Section 80C of the Income Tax Act 1961 allows tax payers to claim deductions of up to Rs 1.5 Lakhs in a financial year from their taxable income by investing in certain eligible schemes specified under the Section. Eligible schemes under Section 80C include Employee Provident Fund (EPF), Public Provident Fund (PPF), National Savings Certificates (NSC), Tax Saver Bank Fixed Deposits, Life Insurance Policies and Mutual Fund Equity Linked Savings Schemes (ELSS). Of the various 80C schemes, Mutual Fund ELSS schemes and Unit Linked Insurance Plans (ULIPs) are market linked, while others specify a rate of interest. 

ELSS or tax saving mutual fund is also one of the most tax friendly investment options. Capital gains of up to Rs 1 Lakhs in ELSS are tax exempt. Capital gains in excess of Rs 1 Lakh are taxed at 10%. ELSS has been gaining a lot of interest among investors based on the traffic statistics and queries in Advisorkhoj.com. One of the questions, which investors have with regards to ELSS is, whether they should invest in ELSS in lump sum (up to Rs 1.5 Lakhs per annum) or through monthly Systematic Investment Plan (SIP). 

Lump Sum versus SIP

There is a lot of online content on Lump Sum versus SIP debate. We also have a number of articles in our blog discussing this topic. Our take on this topic in general for mutual funds is that, the lump sum versus SIP debate is irrelevant because comparing lump sum and SIP is like comparing apples and oranges. You will invest in when you have lump sum funds available with you; on the other hand, you want to invest from your regular monthly savings, then you should invest through SIP. If you have lump sum funds available but you keep them lying in your bank account and invest through SIP for a long period of time, then in a rising market you will get lower returns because you will generally be purchasing units at higher and higher NAVs. The decision to invest in lump sum versus SIP therefore should be driven by your financial situation. Does this lump sum versus SIP decision logic extent to ELSS also? We will discuss this in the next section.

Lump Sum versus SIP investing in ELSS mutual funds

To certain extent, the argument made in the previous paragraph extends to ELSS mutual funds also; you can invest in lump sum only if you have funds available, otherwise SIP is the route for you. However, there is a nuance in the case of tax saving investments. ELSS investment in the strictest sense is not one-time because you need to invest every year to claim deductions from your taxable income and save taxes. Your tax saving in that sense is not strictly one time, but more in the nature of regular investments. Therefore, even you are investing in ELSS in lump sum, when if we look over period of time then your investment pattern is in the nature of an annual SIP. In this context, lump sum investment and monthly SIP in ELSS mutual funds can be compared.

As mentioned earlier, you can invest in lump sum only when you have sufficient funds available with you. For example, if you want to invest Rs 1 Lakh in ELSS, assuming you can claim Rs 50,000 deductions from other 80C sources like EPF, life insurance premiums etc, you need to have Rs 1 Lakh in your bank account.

Through SIP on the other hand, you can spread your Rs 1 Lakh annual investment over 12 monthly installments (approximately Rs 8,300 per month) and invest from your regular monthly savings. Is it better to wait till you have accumulated Rs 1 Lakh in your bank account to invest in ELSS mutual funds or invest through SIPs? We will do some scenario analysis to examine this.

Different investors have different savings and expense patterns. Therefore, we will examine three scenarios of lump sum investments made every year, over a period of 5 years. The period of this analysis will be April 1, 2013 to March 31, 2018.

• Rs 1 Lakh invested in lump sum in ELSS on April 1 of every financial year (April 1 – March 31)


• Rs 1 Lakh invested in lump sum in ELSS on March 1 of every financial year


• The above two scenarios are two extremes, one where you are investing at the beginning of the financial year and the other, where you are investment almost towards the fag end of the financial year. So we will also analyze a third scenario, where you invest Rs 1 Lakh in the lump sum somewhere in the middle of the financial, on October 1. This is also the time, when many Indian companies pay Diwali Bonus to their employees.

In all the above 3 scenarios, you will be saving the same amount of tax. We will compare all the three scenarios with a fourth scenario, which is investing Rs 8,300 per month through SIP. Equity Linked Savings Schemes are essentially diversified equity mutual fund schemes, which invest in equity and equity related securities, across different sectors and market cap segments. Different ELSS funds may have different market cap biases; for purposes of this analysis, we will take the market benchmark Nifty 50 as the proxy for ELSS. Let us examine the different scenarios.

Investing in lump sum in ELSS Mutual Funds on April 1, every financial year

In this scenario we are assuming that you have sufficient funds available in your bank account to invest in ELSS tax savings funds at the beginning of the financial year. This scenario may or may not be applicable to you, depending on your financial situation, March 31, 2018 you would have made cumulative tax savings investments of Rs 5 Lakhs, saving around Rs 1.5 Lakhs in taxes over the last 5 years (if you are in the highest tax bracket). The total value of your ELSS investment will be Rs 7.2 Lakhs.

Investing in lump sum in ELSS mutual funds on March 1, every financial year

This is the other extreme scenario but not a very uncommon one. Many tax payers, even if they have investible funds available delay their tax savings to the last 1 or 2 months of the financial year, and scramble to make their tax savings investments towards the end of the financial year.March 31, 2018 you would have made cumulative tax savings investments of Rs 5 Lakhs, The total value of your ELSS investment will be Rs 6.5 Lakhs.

Investing in lump sum in ELSS mutual funds on October 1, every financial year

Let us examine in the intermediate scenario, where you make your tax savings investments on October 1 of every year.March 31, 2018 you would have made cumulative tax savings investments of Rs 5 Lakhs, The total value of your ELSS investment will be Rs 6.75 Lakhs. You can see that, in this scenario your returns are higher than in the second scenario, but lower than first scenario.

Investing through monthly SIP in ELSS mutual funds

Let us now see, how much you would have accumulated if you invested through SIP (Rs 8,400 every month) March 31, 2018 you would have made cumulative tax savings investments of Rs 5.04 Lakhs, The total value of your ELSS investment will be Rs 6.8 Lakhs.

Summary and our take

Our take on this is that, if you expect to have sufficient funds available early in the financial year, it is best to make your tax saving investments early in the year. Your money will remain invested for a longer period of time and therefore, you will get higher returns. You should avoid delay your tax planning till the end of the year because this not only causes last minute hassles but also results in lower returns. We have seen many tax payers missing out on tax savings because they do not have sufficient tax savings funds at the end of the year.

In general, given that different investors have different financial situations, in our view monthly SIP is best method of making tax savings investments through ELSS. SIP not only keeps you disciplined in tax savings but saves you a lot of work. Once you initiate SIP in ELSS through one time ECS mandate, you can keep your tax planning on track for many years, without going through the hassle of making fresh investments every year. As seen in this blog post, you also get superior returns through SIPs.

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Why continue with mutual fund SIPs even when market crashes

Over the past month or so, we are experiencing a period of heightened volatility in the stock market, primarily driven by weak macroeconomics and IL&FS crises. The Nifty has corrected by more than 1,000 points from its last peak.In past, such volatile conditions would have seen large scale mutual fund redemptions and Systematic Investment Plan (SIP) cancellations. But even in current trying times, we witnessed record inflows via SIP mode in September 2018. This is a testimony of the growing maturity amongst Indian investorsHowever, if the market continues to remain volatile and decline further from the current levels, it may cause uncertainty and fear among less experienced investors.

Characteristics of deep corrections

Though we are technically not in a bear market, we will explain some of the characteristics of a bear market for the benefit of investors who have not yet experienced bear markets or very deep corrections. In such conditions, market continues to fall even after a big decline; the Sensex may fall by 1,000 points in a week and then fall again the following week. There may be the occasional pullback rallies which may give hope to investors, but in such rallies stocks are sold by traders and the market falls again. Two questions confront investors in such times:-

• Should I remain invested in stock (or equity mutual funds) or sell (redeem)?


• Should I continue to invest through SIP or stop it?

We will address both these questions in our subsequent sections.

Should you remain invested or redeem?

In big corrections, your mutual fund values may fall every other day or week; it may be tempting to stop the loss by redeeming your investment. However, you should remember that if you have a long investment tenor, correction only causes a notional loss to your investment and not a permanent one, as long as you remain invested. If you have a long investment horizon, you can wait for the market to recover and resume its long term secular growth trend.

In the last 20 years, the Nifty 100 has given 18% annualized total returns, despite at least 4 major (20%+) corrections in the interim. But if you redeem when the market has fallen, the notional loss becomes a permanent loss. If you have a sufficiently long investment horizon, it is unwise to sell or redeem your mutual fund investments after a crash.

Should you continue your SIP when market crashes?

Investors may be tempted to stop / cancel their mutual fund SIPs, when market crashes because the marked to market value of the SIP can keep falling for weeks or months even when you keep investing through SIP. But stopping SIPs when the market is falling defeats the very purpose of SIPs. SIPs work on the principle of Rupee Cost Averaging. By reducing your average cost of acquisition during corrections, SIPs enable you to earn higher returns in the long term. By stopping your SIPs in a falling market, you are depriving yourself of the opportunity to buy units at lower cost. The opportunity cost of SIP cancelation can be substantial in the long term.

Let us explain this further, with the help of an example.

Example

Let us assume you started your monthly SIP of Rs 10,000 in Nifty 10 years back. Let us examine two scenarios. In the first scenario, you stopped your SIP every time Nifty declined 10% from its previous high, redeemed all your units and parked your redemption proceeds in a fixed deposit paying an interest rate of 8%. Then you waited the market to get back to its previous high to resume your SIP. When you resume your SIP, you also re-invested the redemption proceeds parked in FD along with the missed SIP instalments, which we assume were invested in a recurring deposit account (paying 8%) for the time the SIP was stopped. For sake of simplicity, let us ignore premature FD withdrawal charges and exit loads.

In the second scenario, you kept on investing through monthly SIP, irrespective of market levels. Let us now see how much corpus you would have accumulated. With a cumulative investment of Rs 12 Lakhs, you would have accumulated a corpus of Rs 19.7 Lakhs in the first scenario and a corpus of Rs 20.2 Lakhs in the second scenario (where you simply continued your SIP). For all the effort you put in scenario 1, you made less money than scenario 2, where you simply remained disciplined.

Conclusion

• The benefits of Rupee Cost Averaging over a long investment tenor covering several market cycles enables investors to benefit from volatility


• Power of compounding unlocks the real value of SIP mode of investment over a long investment horizon.


• SIP is the best way of investing in a disciplined manner for your long term financial goals. You should continue to invest irrespective of market levels till your financial goal is achieved. 

                                                                                                                                                                   

                                                                                                                                                              - advisorkhoj                                                                               

Are you investing correctly for your child's goals?

If you are an Indian parent, ‘dilemma’ is probably your middle name. When you aren’t in a fix over how to impart the right values to your progeny, you’re possibly fretting over how to ratchet up the corpus for his education and wedding. Which instruments should you invest in? Will these help build an adequate corpus for all the goals? Have you taken the right decision in picking Ulips or should you have opted for the Sukanya Samriddhi Yojana? Perhaps real estate is the best investment, or should you just dump all your money in safe fixed deposits? If you are racked by such queries, you are not alone. 

Most parents blindly feel their way through the investment terrain, randomly putting their money in a disparate set of instruments guided by ignorance and wrong advice. “They make so many mistakes, right from waiting too long to start investments, to not investing consistently, from not securing their own health and lives with insurance, to not having a clear idea about the goal values,” says Priya Sunder, Director, PeakAlpha Investment Services. The result? Inadequate corpus for goals, or worse, risk to parents’ retirement corpus. 

Little wonder then that there was a Rs 4.15 lakh shortfall between what parents contributed and what students claimed they spent on education, according to the HSBC Value of Education Survey 2018. Nearly 61% of parents also wished they had started saving earlier for the goals. As per another study, the 2017 Birla Sun Life Insurance Company Protection Survey, saving for kids’ education was the top worry for nearly 35% of the 1,540 respondents. 

The first step to building a sufficient corpus for your children is to frame clear goals, with defined future values that take inflation into consideration. Then fix correct time horizons for these goals. It’s the time frame and risk associated with proximity to goals that primarily decide where you invest: if there is enough time to reach the goal, invest in equity, but if you have little time left, opt for debt. 

The second step is to build a portfolio with the right asset allocation—optimum mix of equity, debt, real estate, gold—to ensure growth and safety of your investments in keeping with your age and goal horizons. Finally, pick the instruments that fit into this asset allocation. You can either pick a bunch of equity and debt instruments separately, or invest in mutual funds, which have an inbuilt equity-debt combination to suit your risk profile. 

Once you understand this basic investing process, all your dilemmas regarding instruments will be easily resolved. So as you fete your kids this Children’s Day, go through the six questions in our cover story and understand why you should pick one instrument over another. 

                                                                                                                                                                           -etwealth

How long did Mutual Fund SIPs take to recover from the worst market crashes

I started my investment journey in April or May 1998. I had a lot of interest in the stock market going back to my university days, but the beginning of my investment journey was one of the worst times for the stock market because we were right in the middle of the Asian Currency Crisis then. The market crashed nearly 30% and I saw a large part of my meager savings (I had begun my working career then), which was mostly invested in equity, being wiped out. Out of the comfort of the shelter which parents provide during student years, this was a rude welcome to the real world. Fortunately, there was a wise person who would guide me through the troubled waters of capital markets. He told me that, “you still own the stocks and the mutual funds, even though they might have declined in value temporarily. The value of ownership is often underestimated but the potential is enormous. Be patient.”

The key is to stay invested with your mutual fund systematic investment plans

Virtue of patience

I took his advice and patiently waited for the market to recover. My investments did indeed recover in value and in about 15 – 18 months, I was sitting on a profit of 25 - 30%. Then sometime in March / April 2000, the stock market crashed again in wake of the Ketan Parekh scam; again the market fell more than 30%. The first instinct of most investors would be to sell when market crashes, but I had learnt my lesson from the Asian Currency Crisis; so I remain invested and benefited in the long term. Market corrections are undoubtedly stressful for investors, but they provide the most valuable investment lessons which can be enormously beneficial for us in the long term. One of the earliest investing advices which I received and I shared with you, is the virtue of patience. Over my 20+ years of investment journey, my patience has been tested several times, most severely during the Financial Crisis of 2008 when the market fell by more than 50%. But you need to remain disciplined if you want to create wealth. As Warren Buffet opined, emotional intelligence is more important than IQ in achieving investment success.

Mutual Fund Systematic Investment Plans

Somewhere down the road on my journey beginning in 1998, I learnt about a wonderful investment option called Mutual Fund Systematic Investment Plans (SIP). SIP enables you to take advantage of market volatility to achieve Rupee Cost Averaging. Rupee Cost Averaging helps you reduce your purchase price in volatile markets and enhance it in the long term. Over the last few years, SIP has become extremely popular with retail investors. The SIP book in the Indian mutual fund industry has grown to more than Rs 7,500 Crores a month by June / July this year. September saw record SIP inflows despite the market being highly volatile during that month.

The growing SIP book in the face of volatility demonstrates the maturity of the Indian investors. However, based on my interactions with investors, I think there may be some misconceptions about SIP among a section of investors, which we should address. One of the main misconceptions about SIP is that, SIP can never give negative returns. This is a misconception. Whether you are investing in lump sum or through SIP, you are investing in the same universe of underlying assets. If you are expecting protection from volatility through SIP, then you are sadly mistaken. Many mutual fund SIPs have given negative returns in the last one year. Negative short term SIP returns is not a new phenomenon; we saw this in 2008 also, just that SIPs were not as popular back then, as it is now. You should know that SIP helps you take advantage of volatility in the long term, but it will not protect you from short term losses.

Did you know what are the 10 things you should do in volatile markets

How long do SIPs take to recover from market crashes?

While there are many blogs in the digital media, including us, which espouse the benefits of continuing your SIPs in market corrections, there is no denying that deep market corrections or bear markets are stressful for investors. When you continue your SIP in bear markets or deep corrections, with every installment your losses can become bigger. While many Advisorkhoj regular readers understand that these losses are only notional or paper losses, but in deep corrections / bear markets investors would like to know, for how long losses will continue? When their SIPs recover in value? Each bear market is different in terms of the quantum of correction and length of correction. In an attempt to find an answer to this question, we have analyzed the three worst bear markets in the last 20 years.

• Ketan Parekh scam, dotcom crash followed by 9/11 (2000 - 2001):

   This was possibly the longest bear market. The market crashed in March 2000 in the wake of Ketan Parekh scam. There were intermittent recoveries but the market saw corrections due to subsequent crises. The market fell by nearly 40% from the previous all time high. The market bottomed out by the beginning of 2002, but full recovery took much longer. Only by the beginning of 2004, Nifty recovered to its March 2000 levels.



• Financial Crisis of 2008:

   This was the worst financial crisis the world faced after the Great Depression of the 1930s. The Indian stock market crashed by more than 50%. Unlike previous global financial crises, the financial crisis of 2008 was felt around the world, because global economies were integrated than ever before. However, Governments and central banks around the world including our Government and RBI reacted much faster. Therefore, the short term recovery from the 2008 Financial Crisis was faster than the dotcom crash. But the after effects of the 2008 financial crisis lingered much longer. In fact, they are being even felt today, 10 years later.



• US Sovereign Debt rating downgrade and Fed QE taper tantrum (2011 to 2013):

  In 2011, the credit rating agencies downgraded US sovereign debt rating. This caused panic in the market with fears of another global recession and caused stocks to tumble around the world. In 2011, the Nifty crashed more than 20% but recovered in 2012. Again in the middle 2013, the US Federal reserve announced a tapering of their Government Bond purchase program. The nickname for market’s reaction to US Fed’s QE tapering was Taper Tantrum. The stock market became volatile and recovered only by the end of 2013, mainly in anticipation of NDA win in the upcoming 2014 Lok Sabha election.

For purposes of our analysis, let us assume you started monthly SIPs of Rs 5,000 p.m. at the market top and as soon as you started your SIP, the market crashed – this is usually the worst case scenario for investors. We will see how long it took for your SIP to recover its losses and the investment value 5 years later (from the time of SIP initiation). For this analysis, let us assume you invested in Nifty-50 (total returns index).

Conclusion

In this blog post, we have discussed the performance of SIPs in the worst bear markets of the last 20 years. We have seen that SIPs can give negative returns in the short term. It can take 12 to 18 months, sometimes even longer (like in the 2000 to 2002 market), for SIPs to recover from bear market corrections, but over a sufficiently long investment horizon (at least 5 years), SIPs can give good returns even if the correction is very deep. SIPs should always be made with a long investment horizon and you should not let short term volatility bother you; in any case, the short term pain will not last very long. Equity is the best performing asset class in the long term and mutual fund SIP is the one of the best ways of investing in equities for wealth creation.