We have mixed reactions/emotions the minute we think of retirement. While very few (less than 10 percent of the population) are appropriately prepared for their second innings, most of us start getting insomniac nights on the very thought of how we will manage our expenses for the remaining 20-30 years, when the active pay would have come down significantly or even become nil.
Most people start preparing for retirement very late in life. Also, many of us have no clue how much corpus is going to be wanted to fund the biggest goal of our life. Thanks to technology today, we have numerous resources available online to give us a broad idea of how to plan for evacuation. Once we have a clear retirement age and corpus in our mind, the thought is to then choose the right retirement vehicle based on a person’s risk and return profile.
Common retirement investment decisions
Let's look at the benefits most maximum of us have for our retirement goals and which ones are preferable to most people. Since there are primarily two points for the retirement purpose – accumulation and distribution. The investment vehicles can be different for distinct phases. With my interaction with various levels of investors, the following options are most omnipresent for building retirement corpus – employees' provident fund (EPF), public provident fund (PPF), national pension scheme (NPS), bank fixed deposits (FDs), mutual funds (MFs), equities, etc. For the administration phase, people use a combination of the following to generate a steady monthly income – pension from the employer, interest from bank FDs, dividend income from equities / mutual funds, rentals, investments from endowment/pension policies, etc.
The theory of an orderly withdrawal plan (SWP) is becoming very popular over the last few years. I firmly understand this is a pathbreaking idea whose time has come. Just like the systematic investment plan (SIP) has been a super-connected thought in the previous five years, SWP will become an even more important idea in the next ten years. An SWP offers greater versatility in terms of cash flows, and it is highly tax-efficient too. But not too many characters in our country are aware of this concept.
Just like a SIP, where we keep spending money every month to create a larger corpus in the future, an SWP can use the corresponding corpus for withdrawing a small sum every month to meet our retirement investments for the next 20-30 years. Monthly departure from an FD is a kind of SWP too. But in an FD, since we only eliminate the monthly interest that we earn, our principal remains intact. In the state of SWP from a mutual fund scheme, if the monthly removal rate is less than the rate of return we earn, we will end up should a much bigger portfolio in the long term and vice versa too.
E.g., let us choose a dynamic hybrid equity fund which is one of the oldest funds in the industry and spends around 65-75 percent in equity and the remaining in debt. This kind of stock can be suitable for a moderate risk of investor demanding approximately 10 percent return over a ten year period. If someone has advanced Rs one crore as on 1st January 2000 and repeals Rs 50,000 per month, i.e. Rs 6 lakhs per annum and keep improving the withdrawals by 5 percent (of the initial annual withdrawals) to meet up with the rising reflation, then the investor would have removed around Rs 1.88 crore till date (Dec 14, 2020) from 251 repeated installments. Even after drawing regular monthly returns for the last 20 years, she is sitting on a corpus of Rs 4.64 lakh because her investment has produced her an annualized return of 12.46 percent while her withdrawal was at 6 percent only.
There are multiple benefits of SWP plans as listed below:
-SWP can be prepared from any Mutual Funds - Be it Debt, Hybrid or Equity
-It can be caused by any day. We can choose to invest the lump sum corpus and start SWP from the following day itself.
-You can choose any number to withdraw from SWP and can also change the amount any number of times in the future.
-It is much more tax-efficient related to monthly dividends received from Mutual funds for people who are in the highest tax section.
-It is entirely adjustable. You can withdraw a lump-sum amount also at any point at the moment.
-You can transfer the funds or withdraw the entire investment amount too at any point in time.
There is an essential caveat though. The returns are not assured. Since the returns are market-linked, the investor has to determine the fund according to her risk profile. If markets are going down for a prolonged period of time, the corpus may not last long. In such situations, one has to calibrate the monthly withdrawals respectively. A better idea would be to have withdrawals from a debt fund for the first three years and keep replacing it at regular intervals by booking profits from the hybrid/equity fund.