MARKETS BULLISH BUT PORTFOLIOS REMAIN BEARISH

Ø  Investor Concern: Investors are concerned these days that although the markets are rising and touching new highs frequently, their investments in mutual funds (MFs) are not rising proportionately. In the last six to seven months, the SENSEX 30 navigated between a high of 36,283 on 29 Jan 18 to an all time high of 37,606 on 31 Jul 18. The ebb came when it touched 32,596 to hit its low point on 23 Mar 18. Similarly, the NIFTY 50 traversed between its record high of 11,171 on 29 Jan 18 to an all time high of 11,360 on 03 Aug 18 with the low point on 23 Mar of 9,998. The reasons are explained in the subsequent paragraphs.

  •  Average Returns: As on 20 Jul 18, equity large cap had generated a negative average return during the last six months of -1.85%. The multi cap generated -4.96%, whereas the mid cap generated -10.65% and small cap of -17.44%. Equity sector (technology) generated the best returns at 13.48% followed by debt funds at about 3 to 3.5%. The worst performer was equity sector (infrastructure) that generated negative returns of -18.71%. Given below is the chart indicating the six months (Jan to Jun 18) returns of various fund categories as per Value Research.
  •  Market Performance: In the last three months, 26 out of 30 large cap MF schemes under performed their benchmark. In fact, only 3 to 7 big companies are driving the market and their market caps are zooming to new highs. About 60% of the NIFTY 50 constituent stocks are in the red. Only 19 stocks in the Nifty outperformed the index with positive returns. 31 stocks, comprising more than 50 percent of the Nifty, under performed the index. The poor conditions of the banking sector due to their large NPAs and unbelievable frauds have dipped their stocks to the bottom 10 of the list. The mid and small cap stocks dropped between 20 to 50 percent with some companies going down by almost 80 to 90 percent. Corrections in the mid and small cap space are primarily attributable to the mismatch between earnings and valuations. The stocks in the mid and small cap section had premium valuations that their earnings could not support. So their dream run of last two years started crashing after the Budget 2018. In the Nifty, only 27 percent of mid cap and 19 percent of small cap stocks delivered positive returns.
  • Advance Decline Ratio: The advance decline ratio is a popular market-breadth indicator used in technical analysis. It compares the number of stocks that closed higher against the number of stocks that closed lower. If we compare the total stocks that advanced or declined at the two bourses over last six months, we realize that the ratio has crossed 1 only in April. This indicates that in the other five months, more stocks have declined at these bourses than advanced. 
  •  Tightening of Regulatory Process: The other major contributory reason to the poor performance is the recently implemented SEBI guideline to re-categorize and rationalize the MFs into five broad categories, viz. equity schemes, debt schemes, hybrid schemes, solution oriented schemes and other schemes. Along with this, SEBI also redefined the market capitalization norms for the large, mid and small cap companies resulting in the eligibility of first 100 companies only for large cap. Although this will help the investors in the long term, it has severely constrained the fund managers in the near and short term by reducing their flexibility to decide the market cap norms and switch funds to generate better alpha. Besides, SEBI has mandated all equity schemes to benchmark their performance against a total returns index (TRI), which are calculated after adding the dividends of the underlying companies. Effectively, these results in raising the hurdle for fund managers as the return of TRI indices are typically 1.5-2.5 percent higher than regular indices. Moreover, SEBI has also cracked down on MF Houses who were breaking the norms by investing outside the scheme’s mandate to generate higher returns.
  • Other Reasons: The other reason is the global headwinds generated by the likelihood of trade wars and Fed tightening. The market outflows by FIIs due to falling rupee have adversely impacted the sentiments, which the domestic investors mitigated to a large extent through their sizable inflows. At the national level, FY 2018-19 is governed by eight assembly polls followed by general elections in 2019.

Ø  Investor Advisory:

  •  The investors are advised to maintain their calm and should not prematurely churn their portfolios or exit from under performing schemes. The market cycle auto corrected such dichotomous market situations on its own.
  • Stay invested in equity MFs while maintaining a long term investment horizon and continuing the existing SIP. The market cycle will auto correct after the political and global headwinds.
  • Watch the performance of hybrid funds over the next two quarters since they may stabilize after the turmoil created by the new SEBI regulatory order forcing mergers and fundamental change of attributes.Park your funds in short duration debt funds or FMPs to negate the market volatility and generate better returns than fixed return instruments.

PERSONAL FINANCIAL MANAGEMENT FOR THE ELDERLY RETIREES

Adopt a balanced approach to avoid impoverishment during sunset years

According to Population Census 2011, there are nearly 104 million elderly persons (aged 60 years or above) in India and their share and size is increasing. It was 5.6 percent of the population in 1961 and increased to 8.6 percent in 2011. By 2050, the population of Indians above 65 years will increase almost three times (predicted by US-based Population Reference Bureau). The growth in elderly population is due to the longevity of life achieved because of economic well-being, better medicines and medical facilities, and reduction in fertility rates. In the urban areas, only 56 percent of male and 17 percent of female population is financially independent while the others are partially or fully dependent. Most elderly people become penurious by falling into financial trap due to their overcautious approach to investment. They do not realize that given the longevity, their retired life may extend for 30 or 40 years, which is as long a period as their working life or even more. When a retiree sees a large corpus available to him at the time of his retirement, he may tend to splurge by undertaking leisure vacations, gifting to his near and dear ones or even investing in some fraud schemes to get unrealistically higher returns. Alternately, he becomes a conservatively timid investor who deposits everything in safe and fixed income instruments that give lower returns. Our endeavour in this article is to look at the criticalities of financial planning and systematically explain adoption of a balanced approach for leading a financially stable retired life.

 

There are two types of retirees, viz. Pensioner and non-pensioner. While the former has regular financial backing through his pension, the latter has no such guarantee. This implies that the non-pensioner will have to start with a larger corpus to sustain his monthly expenses, while a pensioner may start his retired life with relatively smaller corpus and sustain through regular pension income. Let us assume that the current monthly expense for both is rupees one Lakh, which will rise @6% per annum due to inflation. If they both live up to the age of 90 years, then their monthly expense during their 90th year will be rupees 6.02 Lakh per month. To sustain his regulated monthly expenses through 30 years of retirement, the non-pensioner requires to start with a corpus of rupees 274.74 Lakh at the real rate of return @1.89% (annual percentage return realized on the investment of 274.74 Lakh @8% and adjusted for changes in prices due to inflation @6%). Hypothetically, if the pensioner starts his retirement with a monthly pension of rupees 0.75 Lakh, he has to cater for a monthly shortfall of 0.25 Lakh and for that, he requires a corpus of rupees 68.68 Lakh.

Given this longevity of life, a question that haunts every elderly person is as to how long will he live and how much money will he require to take care of his old age? We can broadly divide 30 to 40 years of post retirement life into 3 or 4 decades. The first decade of sixties that holds 5.3 percent of Indian population is one of reconciliation and acceptance of the retired life, and then adjusting into it. The next decade of seventies, which is of prime concern for 2.4 percent of the Indian population, is of consolidation of assets and health. Thereafter, the decade eighties is of fragile health and growing dependence on children/domestic help for 0.9 percent of Indian population, whose old-age dependency proportion has climbed from 10.9 percent in 1961 to 14.2 percent in 2011. Finally, only a miniscule percentage attain the extraordinaire decade of the nineties.

When a retiree invests, he is cautious, risk averse, and puts everything in safe income instruments; so, he will not beat the inflation. Although this is sensible and apt for capital protection, it does not help to overcome the inflationary pressures. The primary inflationary pressure is from rising medical and hospitalization costs, which is about 15 percent as compared to the average consumer price index inflation rates of 6.27 percent (average monthly of a calendar year taken over past 20 years). The real rate of return of fixed income instruments is much lower than their indicative interest rate due to the taxability of the interest earned and the inflation cost. We have exemplified this point for better understanding of the readers. Rupees one Lakh invested @ 8% gives a retiree rupees 8,000 as interest in one year. If he pays 20.8 percent tax (inclusive of 4 percent cess) on it, then interest left in hand is rupees 6,336 only, which is effectively 6.34 percent. Further, 5 percent inflation eats into this 6.34 percent interest to give a meagre 1.28 percent real rate of return. Since 1972, even gold has only given average 7.4 percent returns. Therefore, he must invest some percentage of his cash asset in the equity market, directly in stocks, if he has market experience and confidence, or through mutual funds, since they have given average return of 14.3 percent in past 10 years.

The question that arises in the mind is about the asset allocation percentage. As a guideline, he must keep 50 to 60 percent in fixed income instruments to ensure capital protection, about 20 to 30 percent in equity, 10 to 15 percent in debt mutual funds and 5 to 10 percent in gold. The elderly will do well to understand the decision dilemma created due to the risky inverse relationship between size of corpus and percentage of equity investment. If the retiree has a large corpus, then he can afford to invest a smaller percentage (up to 20 percent) in equity since his investment in other assets will take care of his financial needs. However, if his corpus is small, then he should invest a larger percentage (maximum up to 40 percent) into equity to generate better returns to meet his financial needs. Initially the retiree may invest the retirement corpus as per this guideline through systematic transfer plan (STP) in equity and lump sum in other assets.

Asset Diversification Percentage Amt Invested@ Expected Returns Real Rate of Return* Inflation Adjusted Value after 10 Yrs Inflation Adjusted Value in 30 Yrs
Equity 20% 20,00,000 15% 8.49% 45,18,037      2,30,56,281
Debt 15% 15,00,000 9% 2.83% 19,82,885        34,65,056
Fixed Income# 60% 60,00,000 8% 1.89% 72,33,195      1,05,12,063
Gold 5% 5,00,000 7% 0.94% 5,49,224          6,62,685
TOTAL 1,00,00,000 1,42,83,340      3,76,96,085
@ Assuming the retiree has a corpus of rupees 1 Crore to invest

* Assuming CPI Inflation Rate as 6%

# Includes contingency fund (equal to six months expenses) to cater for emergencies invested in Sweep FD for better liquidity.

Thereafter, he should invest to save about 15 to 20 percent of his gross monthly income in equity mutual funds through systematic investment plan (SIP) or directly in stocks. This investment will give a fillip to his savings in his eighties or nineties as their holding period would have exceeded 15 to 20 years. To illustrate and emphasise my point: A retiree investing rupees 10,000 per month in an equity mutual fund over 20 years, generating 12 percent return, will accumulate rupees 99.91 Lakh with a growth of 76 percent in his investment of rupees 24 Lakh.

He must diversify to hedge, which is a technique designed to reduce or eliminate financial risk; for example, gold and equity will offset each other if markets change. As the time goes by, the investment returns from equity start performing better than the benchmark indices since volatility decreases and so does the probability of loss, which is only 3.7 percent after 10 years and becomes zero after 15 years. If required, the retiree must make withdrawals from his fixed income instruments. The usual dilemma is how much to withdraw in a year from the fixed income corpus. Suppose a retiree invests rupees 60 Lakh in fixed income instruments @8% return in an economic environment of 6 percent annual inflation and annually withdraws 5 percent from the corpus. Then, the value of his investment after 10 years, as per real rate of return, will reduce to rupees 43.32 Lakh. If he desires to protect his capital, then he can annually withdraw a maximum 2 percent from his corpus, to match the real rate of return @1.89%. The retiree should hold his equity investment preferably for minimum 5 years so that it can generate returns and then withdraw from it to meet financial goals or augment his sustenance income.

The retiree must also correctly comprehend the tax structure of all these assets to derive maximum advantage. Government levies tax on interest earned in most fixed income instruments, and short and long-term capital gains (STCG and LTCG) tax on equity and debt schemes at varying rates. The point to understand is that government levies tax on entire interest earned during the financial year through fixed income instruments, immaterial of the fact whether the retiree withdraws it or not for his use. However, it levies capital gains tax only on the actual gains made by the retiree during redemption or switching done in the financial year. Government adds short-term debt fund (less than 3 years) gains to the retiree’s income and taxes it at his applicable tax slab rate, whereas, it taxes long-term gains at 20 percent after the indexation benefits. This aspect and the applicable tax rates make investment in debt mutual funds more attractive than fixed income instruments. If the retiree is in the higher tax slab with income more than rupees five Lakh, then financial wisdom dictates that his debt fund investment should be more than his fixed income investment.

Particulars Debt Funds Fixed Deposits
Investment 10,00,000 10,00,000
Return Rate 8% 8%
Lock-in period 3 3
Amount after 3 Years 12,59,712 12,59,712
Effective Return Rate 8.66% 8.66%
Inflation 6% 6%
Indexed Cost of Purchase 11,91,016
Gains (Taxed Amount) 68,696 2,59,712
Tax Paid* 13,739 80,251
Net Gain 2,45,973 1,79,461
Returns after tax 8.20% 5.98%
*LTCG Tax after indexation benefit @20% on for debt fund and Income Tax @30.9% for FD including Health and Education cess @4%

 

A lot is also made of investment in property for financial security and independence. In old age, property becomes a liability due to its regular maintenance and encroachment issues. Therefore, financial prudence lies in staying cash rich and asset meagre. Feel blessed to have one residential property that the retiree occupies and invests his cash assets to provide regular cash flows. The retiree must guard against holding lot of liquid cash that he can withdraw easily or his children may coerce him to withdraw. To obviate this, he should consider making lump sum deposit in the following instruments as they restrict liquidity and give decent returns. One, Pradhan Mantri Vyaya Vandan Yojana (PMVVY) that provides an assured monthly pension of rupees 10,000/- on maximum permissible investment of rupees 15 Lakh @8% per annum for ten years, with an option to also opt for pension on a quarterly, half-yearly or annual basis. Two, Senior Citizen Savings Scheme (SCSS) that provides risk free quarterly returns @8.3% (revised on quarterly basis), on maximum permissible investment of rupees 15 Lakh for five years, which is extendable by another 3 years. Three, Government of India Savings (Taxable) Bonds, which give 7.75 percent assured returns, have 7 years tenure and no maximum investment limit. Four, Public Provident Fund (PPF) that gives 7.8 percent returns (revised on quarterly basis) on maximum permissible investment of rupees 1.5 Lakh per year for fifteen years, which is then extendable by another 5 years. All these enjoy tax benefit under sec 80C of the IT Act, but their returns are taxable as per the retiree’s applicable tax slab except PPF, which enjoys tax exemption.