The Mutual Fund Show: How Retirees Can Add Equity To Their Portfolio
An elderly couple sit on a bench. (Photographer: Chris Ratcliffe/Bloomberg)

The Mutual Fund Show: How Retirees Can Add Equity To Their Portfolio

Falling interest rates erode returns on fixed income instruments. Lower inflation adjusted returns hurt senior citizens the most as they mostly rely on interest income on their lifetime savings.

Retirees should have exposure to equity as well, Sunil Jhaveri, founder, MSJ MisterBond, said on this week’s Mutual Fund Show. Jhaveri classified senior citizens’ requirement into four categories: regular cash flow, emergency cash, safety of principal and some wealth their children could inherit.

As long as the first two requirements of regular cash flow and emergency cash are taken care off, such investors need not worry about other two, he said. And he suggested Dynamic Asset Allocation Funds to retired investors. Such funds invest in a mix of debt and equity and alter allocations depending on their view on stock markets.

A dynamic asset allocation fund rebalances between equity and debt in a pre-defined manner and thus gives stable, long term returns, especially for people who don’t want an equity risk, but also want better than fixed income returns, Jhaveri said. While pure-play equity funds could outperform over longer periods of time, he said returns may remain choppy and investors needing regular cash flows would be better off with a product like dynamic asset allocation fund.

He cited the period between 2004 to 2009 when the benchmark-linked funds returned losses but the dynamic asset fund remained positive.

Watch the full interview here:

Here are the edited excerpts from the interview:

Sunil, in your years of dispensing financial advice to your clients and some of them might be HNI, some of them might be middle-income people, are people changing the way they save and invest now for retirement or rather deploy that money during retirement?

Jhaveri: I’ll be 60 next year so am I supposed to be in a debt instrument going forward? I don’t think so. I’m saying a 100% no. The way we look at a senior citizen is that as soon as they turn senior citizens—it can be 55 or 60, whenever they retire, rather let’s call it retirement time—we tell them that you should not be in volatile instruments like equity and you need to be in a more stable product like debt instruments—it can be LCDs, it can be fixed deposits; it can be mutual funds, etc. But that’s where this entire disconnect starts. Please understand the concept. The concept of rule of 30-30, which says 30 years of your professional life and 30 years of your retirement life, and sometimes the retirement life is longer than the professional life. In such a scenario, if during 30 years of your professional life equity has generated returns for you and created wealth for you, what stops you from investing in equity as an asset class? I’m not saying 100% equity because you don’t want that volatility attached to that, but I am saying that you should have an infusion of flavours of equity. So, if you want to beat the inflation on an on-going basis, and still generate regular cash flow and maybe wealth for yourself as well as your beneficiaries, then the best way to do it is infuse some flavours of equity. So that’s the starting point.

The disconnect in the myth of not investing in equity as an asset class for senior citizens is what should be broken.

A lot of people are not comfortable with mutual funds, forget equity mutual funds, they’re probably not even comfortable with debt mutual funds. So what can they do? You are saying that people even if they’ve not invested in equity at all in their entire life or mutual funds in their entire life, this is the right time to start doing it for the retirement?

Jhaveri: Absolutely. The disconnect is because they treat financial assets as their own generation assets. Unlike property and jewellery which they own, they treat it as a multi-generation asset and they don’t mind and they’ve never looked at the price of property or the price of jewellery once they’ve bought it and then they know that this particular asset class will be transferred from one generation to the next generation to the third generation, and that’s the reason why they don’t bother looking at it on a day to day basis. Now, once you start looking at your financial assets as the multi-generational asset, which it should be just as your property and your jewellery, then they will have a different take and a different way of looking at these investments. Unless and until you have, as I said infusion of flavours of equity. Let me give you one example — at the age of 60, we are asking a person to invest in debt instrument or maybe he’s used to investing in debt as an instrument. But that 1 crore adjusted for inflation, assuming 6% inflation, after 25 years, the value of that 1 crore in terms of its purchasing power is only going to be Rs 23 lakh. So, what risk have they not taken? The biggest risk is not taking any risks, what Mark Zuckerberg has said. I’m saying that this is classically true for senior citizens who don’t use equity as an asset class, thinking that they want to avoid volatility, they don’t want to be in a riskier asset class because they’ve always treated those financial assets as ‘my generation asset’ and never as a ‘multi-generation asset’.

This whole idea or notion of 1 crore at 6% inflation after 23 years is 23 lakh—does it assume no returns from the debt investment or minimal returns?

Jhaveri: It assumes some returns but that return is going to be eaten because that’s a regular cash flow which we are going to eat and we are going to be depending on that cash flow for day-to-day requirements. When you are in a professional life, you will have incremental cash flow beyond what you’re spending and that’s the reason why you’re able to save and then that’s the reason why you’re able to invest. But in a no-generation-of-income kind of a story, which happens post the retirement period, there will be some income generation on the debt instruments but that is what you’re going to be consuming yourself but at the same time. But the purchasing power of that 1 crore, that 1 crore has to grow over a period of time—it’s like saying that 25 years back if I had taken an insurance of Rs 25 lakh, which was a big insurance in those days because people used to take one lakh and two lakh term insurance at that point in time, what is that Rs 25 lakh worth currently if I am no longer there for my beneficiaries? So, put it in that perspective and you will realise what I’m trying to say.

A person who is retiring, let’s say, three years from now, or one year from now, or has just retired, and has parked money in banks, in fixed deposits and in debt instruments, too. You are saying introduce a flavour of equity, but what about safety?

Jhaveri: As I said safety is really not a concern as long as they get regular cash flow and emergency cash. These are the two main aspects. What do senior citizens want? They want a regular cash flow, they want emergency cash, they want safety of principal and they want to leave something behind for their kids. These are the four requirements of any senior citizen. As long as your first two are taken care of, which is your regular cash flow and your emergency cash, they should not really bother about the safety of principal. If the senior citizen is leaving behind 1 crore or 95 lakh, and they have a beneficiary who can take the journey forward for the next 30 years thereafter; so, why are they bothered? They have to differentiate between cash flow requirements versus returns. For a senior citizen or for a retiree, the most important aspect is the regular cash flow rather than the returns part of it. The returns will definitely follow. The returns will be there on debt instruments also and returns will be there in schemes like Dynamic Asset Allocation Fund. Slowly and steadily you must infuse flavours of equity so that corpus should be invested in your Dynamic Asset Allocation Fund. Keep aside some liquid fund for your emergencies etc. You do a SWP (systematic withdrawal plan) from there [the scheme] for your regular cash flow requirement.

What is the ideal strategy according to you?

Jhaveri: I’m giving a specific example—if you have invested in one of the schemes in 2010—a Dynamic Asset Allocation Fund which re-balances between debt and equity based on the market valuation. When the markets are expensive, they will reduce the exposure to equity and vice versa. You have invested Rs 1 crore in April 2010 and you had done a systematic withdrawal of Rs 8 lakh per annum, which is Rs 67,000 per month. After withdrawing Rs 83 lakh from 2010 to 2020, the current value of the scheme is still Rs 1.48 crore. So, on the Rs 83 lakh SWP, you only ended up paying Rs 3,40,000 as tax. If the same Rs 83 lakh had come to you as interest from fixed deposits, assuming 30% tax rate, you would have ended up paying Rs 24,90,000 as tax on that FD. So, you’re making your investments attractive by an infusion of flavours of equity, and tax efficient over time. By the way, a lot of investors depend on dividend for the long run, which is a wrong way of looking at it because dividend can only be declared out of realised profits. The best way to go about it is to invest in a growth option, in a DAF kind of a scheme, and then do as a SWP. So, you start with a less percentage 6%-7%, let the cushion build up in your portfolio, and then if you want to increase your SWP from 6% to 7% to 8%. If your value of Rs 1 crore has grown to Rs 1.48 crore, in spite of Rs 83 lakh withdrawal over this period, you can easily start withdrawing 10% per annum instead of 8%.

Sunil, can you simplify this? Let’s say on April 1, 2010, a senior citizen is investing Rs 1 crore in a Dynamic Asset Allocation Fund, so how does this Rs 67,000 come about? Is it an ad hoc assumption of a particular sum that the person will remove every month? How does that come about and how does the current value go up to Rs 1.48 crore?

Jhaveri: So, this is assuming an investment of Rs 1 crore initially on which we are withdrawing 8% per annum, which is Rs 8 lakh per annum divided by 12 is Rs 67,000 per month. The underlying scheme has grown at higher than 8% per annum, that means it would have grown at 10% or 12% over the past 10 years or so and that’s the reason in spite of the withdrawal of Rs 83 lakh or Rs 8 lakh per annum, the current value of that scheme after that withdrawal is also Rs 1.48 crore.

So, you’ve chosen a conservative withdrawal assumption of 8% because this scheme has actually grown higher than 8%.

Jhaveri: Absolutely. I’d say have 6% or 7% to start with, the Rs 1.48 crore would have been looking at maybe Rs 1.6-1.7 crore currently.

Sunil, is there a way to assume the kind of average return that a Dynamic Asset Allocation Fund from Aug. 27, 2020 could deliver over the next 10 years?

Jhaveri: It’s very difficult to judge what it will deliver over the next 10 years or so. But let’s assume the past average of five year daily rolling returns is 10% in that product. If that be the case, they will start with a 6% or 7% and then you build on that. Mind you that at some point in time, you will dip into your principal. Let’s say that you started in 2019 with a Rs 1 crore investment and you started doing straight away with a 8% withdrawal and on top of that, the markets have also corrected. Maybe you are at 93 lakh or 95 lakh currently in its value, but over a longer period of time because of the underlying growing at higher returns than what you are withdrawing, will takeover on the average side and then finally you will have this kind of figures which you just saw. Worse comes to worse, let’s assume that I leave behind 95 lakh but I’m still getting my regular cash flow which I wanted. Now, what is the dilemma of a senior citizen? First of all, interest rates are at decadal lows. At 5%-6% kind of a fixed deposit rate, on which you will end up paying 20%-30% or 10% tax, whichever tax bracket you are in, you have rising medical bills, you have wealth erosion because of the inflation eating into your purchasing power, your life longevity is increasing because nowadays you see that people live till 85 or 90 also. So, your longevity is also there. So, how do you survive during this long period of time when there is no income generation possibility for a retired person? They need a regular cash flow, they have earned this money, it is their hard earned money. Now, parents being parents will always think I want to leave something behind for the kids. Now, that’s an emotional side of the story, but I’m saying will I sacrifice my living peacefully and comfortably just so that I leave something behind for the kids? For example, if I leave 90 lakh instead of 1 crore, how will impact the beneficiaries? They have 30 years more to go.

Sunil, what would a Dynamic Asset Allocation Fund do, or would Dynamic Asset Allocation funds be currently available in the market?

Jhaveri: There is one category called balanced fund, which is now called hybrid fund, which is totally different from these Dynamic Asset Allocation Funds, which I call re-balancing funds. Please differentiate between the two and we are not recommending hybrid funds or balanced funds because they are 65-70% always in equity as an asset class. So, I’m not talking of that segment at all. In Dynamic Asset Allocation Funds, they will be minimum 30% in equity if the markets are extremely expensive and maximum of 100% in equity if the markets are extremely cheap. And they will do re-balancing on a daily basis or a fortnightly basis or a monthly basis or in whichever way, but they will do re-balancing based on the market dynamics in terms of expensive or cheap and that can be based on price-to-earnings, price-to-book, dividend yield or a combination of all these three factors. Practically, every AMC or a mutual fund house has a Dynamic Asset Allocation fund from ICICI Prudential to Motilal Oswal to SBI to DSP to Nippon. Every single fund house will have a Dynamic Asset Allocation Fund.

Usually funds invest less than 65% in equity, and the taxation is not like an equity fund. That is not a hindrance when it comes to this?

Jhaveri: Not at all because if you’re 30% in equity, 35% will be in arbitrage, so that makes it 65% minimum in equity, and arbitrage is a 100% hedged equity position, so it is absolutely safe as far as the investment side is concerned. But then you treat arbitrage portion as a debt portion only. So just to make it equity taxation they resort to arbitrage or they can go short on Nifty.

Sunil, a lot of people have said if indeed a retired person has some corpus, which the person can use in the current scheme of things, then wouldn’t it be advisable to invest in pure equity funds because over the long term, nothing beats the returns in equity funds. Do you agree with that or do you reckon that it’s better to have the entire corpus brought in into a Dynamic Asset Allocation Fund strategy right from the word go?

Jhaveri: I totally don’t believe that a senior citizen should be in 100% equity products. If at all you want to create your own Dynamic Asset Allocation Fund through asset allocation strategies, that is entirely your call but it’s a very difficult proposition for individual investors to do that. And that’s the reason why this DAF category is very popular. I like that as a category. Whenever we want to go to a conservative asset class we go to a DAF kind of a category. Having said that, let me explain to you what a person who’s likely to be retiring in the next five years should do. If I were to do an SIP in an equity fund, SIPs have delivered negative returns over five years also— from 2004 to 2009 or from 2015 to 2020 as we have seen till March. And if I wanted to retire after five years, if I’m starting with a negative corpus naturally where would I go? So ideally, SIP also for somebody who’s about to be a senior citizen or is already a senior citizen, should happen in a DAF-kind of a product because generally DAF over a three year period does not deliver negative returns. I’m just making a general statement. Individual DAFs may have different performance analysis, but 99% DAFs do not generate negative returns over a three year period.

Sunil, anything that we missed out in terms of advice via use of mutual funds or DAF products for senior citizens?

Jhaveri: The other advantage of getting into a mutual fund is that you can do re-allocation between the beneficiaries right from day one. So let me give you an example. Let’s assume that I have a sibling and my parents wanted to invest say Rs 1 crore— Rs 50 could be in my mother’s name and my name as a second name. Another Rs 50 lakh could have been in my mother’s name again and the second name should have been my sibling’s name. Whenever this person is no longer there, the transmission of units happens and that’s the reason why allocation of the wealth of that senior citizen happens automatically and there is no requirement of a will, etc. Of course the will should be a part and parcel; I’m not saying that you should not have a will for a senior citizen but even if it is not there, you’ve done your allocation, you’ve been your distribution of your wealth based on what you wanted to do post you not being around automatically on day one of your investment also. So that is one positive side of the story as far as the mutual funds are concerned. Regular cash flow and tax efficiency is the second side of the story and infusion of flavours of equity and creating wealth beyond your cash flows also. So all this put together is not really available in many traditional products so to say.

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