When I wrote, a few weeks ago, about the questions you should ask before buying a product, I received an overwhelming response. Several readers recounted their experiences of being sold wrong products, and as is sadly the case, a majority of these is retired investors, whose lifetime savings has gone into these products. This has inspired me to write about planning retirement and choosing products with care.
An investor with a large corpus to deploy is an easy target for unscrupulous sellers and care should be taken while making investment decisions.There are three stages in retirement planning. The first is the pre-retirement phase, when the investor begins to save systematically with this goal in mind. While textbooks recommend an early start, beginning as soon as one is employed, the reality is different.
For the first 10-15 years of employment, most of us have too many commitments. Buying a car, purchasing and furnishing a home, having a lifestyle we dreamt of, taking holidays, educating children, and caring for siblings and elderly parents, are all demands made on our income, leaving us with little to save.
The money we put in the provident fund account and, perhaps, investment for reducing tax are the only savings many of us manage. I call it the magic 40s, when most of us find that we have gone up the professional ladder, have taken care of most needs, and that our saving ratios are going up. Retirement planning takes centrestage around this time. Most retirement products in the market target such investors.
The crux of the idea is that with 15-20 years on your side, you can invest in long-term products, while you continue to earn and allow the money to grow over time. At this stage, investors have no income requirement, can take downside risks, and have a long enough time horizon to ride through risky developments that may occur en route.
The second stage is when the investor has retired and holds the corpus that was accumulated over time. There is the need to invest this amount and earn a steady income. Some investors realise that they need to make lifestyle adjustments to align themselves to their new level of income.
Some are confident about spending a part of the corpus on travel, gifting and such indulgences, others seek a second career to augment their incomes, but most are unwilling to risk the corpus while looking for investment options. The primary concern soon after retirement should be to cover the risk of outliving the corpus. Choosing a fixed income product, such as an annuity or a deposit, will surely generate income, but this will not be an inflation-adjusted specific amount.
Inflation, on the other hand, is a compounding number that will grow exponentially. A 10% return at 60 years might look like the ideal thing, but inflation growing at, say, 7% compounded rate, will overtake the returns in a mere 10 years. The real value of the 10% income will only fall with time. Investors should bifurcate their corpus, and deploy a part of it (at least 40%) in long-term growth products that will appreciate in value. This enables the corpus to grow and help generate an enhanced income when needed.
Third stage is the period after 10-15 years of retirement. This is the time when the investor is about 75 years old and, perhaps, not able to take risks, continue with a second career, or invest for longer time horizons. The focus is on earning low-risk, regular income. The investor also needs a draw-down plan, which involves a decision on how much corpus is to be left for heirs and how much can be consumed.
If one reconsiders the three stages in terms of the investments to choose, the first stage would be growth-oriented, where one would use equity and real estate to create wealth, take risks and have long-term horizons. The second stage would be balanced between equity for growth, and deposits and annuities for income.
One would have a medium-term horizon and take moderate risk. The third stage would be income-oriented, with low risks and shorter horizons. Several 70-year-olds are sold Ulips, which are repackaged and have words such as ‘pension’ ‘retirement’ and ‘benefit’ in their names, leading investors to believe these are meant for them. The truth is that all these products are meant for younger investors, who have time on their side and can contribute to these over time. These are for the investors in the first stage.
Other people are fooled into buying endowment plans and annuities and hope to get a regular income. These are second stage retirees, who need income that is inflation-indexed, and these products do not fit the bill. Then there are those in the 60-65-year bracket, who buy various insurance products with the view to saving taxes, and are now worried about keeping the commitment while dealing with the high costs and low surrender value.
All these cases of wrong product choices point out how product risks have never been explained or understood. A Ulip may save some taxes, but runs the risk of low returns over short time periods. An annuity may generate regular income, but runs the risk of diminishing real return due to inflation, over time. The need to have flexibility to modify investment contributions is important to these investors, a facility that fixed premium payments do not offer.
A retired investor should test a product by asking three questions. What is the return after costs? What is the expected time to hold before getting the return? What is the flexibility to modify en route? The risk to the product will be evident in the answers to these questions. Saving tax is a lesser objective in comparison, however smart it may seem.
Source: Economic Times
An investor with a large corpus to deploy is an easy target for unscrupulous sellers and care should be taken while making investment decisions.There are three stages in retirement planning. The first is the pre-retirement phase, when the investor begins to save systematically with this goal in mind. While textbooks recommend an early start, beginning as soon as one is employed, the reality is different.
For the first 10-15 years of employment, most of us have too many commitments. Buying a car, purchasing and furnishing a home, having a lifestyle we dreamt of, taking holidays, educating children, and caring for siblings and elderly parents, are all demands made on our income, leaving us with little to save.
The money we put in the provident fund account and, perhaps, investment for reducing tax are the only savings many of us manage. I call it the magic 40s, when most of us find that we have gone up the professional ladder, have taken care of most needs, and that our saving ratios are going up. Retirement planning takes centrestage around this time. Most retirement products in the market target such investors.
The crux of the idea is that with 15-20 years on your side, you can invest in long-term products, while you continue to earn and allow the money to grow over time. At this stage, investors have no income requirement, can take downside risks, and have a long enough time horizon to ride through risky developments that may occur en route.
The second stage is when the investor has retired and holds the corpus that was accumulated over time. There is the need to invest this amount and earn a steady income. Some investors realise that they need to make lifestyle adjustments to align themselves to their new level of income.
Some are confident about spending a part of the corpus on travel, gifting and such indulgences, others seek a second career to augment their incomes, but most are unwilling to risk the corpus while looking for investment options. The primary concern soon after retirement should be to cover the risk of outliving the corpus. Choosing a fixed income product, such as an annuity or a deposit, will surely generate income, but this will not be an inflation-adjusted specific amount.
Inflation, on the other hand, is a compounding number that will grow exponentially. A 10% return at 60 years might look like the ideal thing, but inflation growing at, say, 7% compounded rate, will overtake the returns in a mere 10 years. The real value of the 10% income will only fall with time. Investors should bifurcate their corpus, and deploy a part of it (at least 40%) in long-term growth products that will appreciate in value. This enables the corpus to grow and help generate an enhanced income when needed.
Third stage is the period after 10-15 years of retirement. This is the time when the investor is about 75 years old and, perhaps, not able to take risks, continue with a second career, or invest for longer time horizons. The focus is on earning low-risk, regular income. The investor also needs a draw-down plan, which involves a decision on how much corpus is to be left for heirs and how much can be consumed.
If one reconsiders the three stages in terms of the investments to choose, the first stage would be growth-oriented, where one would use equity and real estate to create wealth, take risks and have long-term horizons. The second stage would be balanced between equity for growth, and deposits and annuities for income.
One would have a medium-term horizon and take moderate risk. The third stage would be income-oriented, with low risks and shorter horizons. Several 70-year-olds are sold Ulips, which are repackaged and have words such as ‘pension’ ‘retirement’ and ‘benefit’ in their names, leading investors to believe these are meant for them. The truth is that all these products are meant for younger investors, who have time on their side and can contribute to these over time. These are for the investors in the first stage.
Other people are fooled into buying endowment plans and annuities and hope to get a regular income. These are second stage retirees, who need income that is inflation-indexed, and these products do not fit the bill. Then there are those in the 60-65-year bracket, who buy various insurance products with the view to saving taxes, and are now worried about keeping the commitment while dealing with the high costs and low surrender value.
All these cases of wrong product choices point out how product risks have never been explained or understood. A Ulip may save some taxes, but runs the risk of low returns over short time periods. An annuity may generate regular income, but runs the risk of diminishing real return due to inflation, over time. The need to have flexibility to modify investment contributions is important to these investors, a facility that fixed premium payments do not offer.
A retired investor should test a product by asking three questions. What is the return after costs? What is the expected time to hold before getting the return? What is the flexibility to modify en route? The risk to the product will be evident in the answers to these questions. Saving tax is a lesser objective in comparison, however smart it may seem.
Source: Economic Times
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