Choose the right option- Business News
facebooktwitter

Choose the right option

Your retirement plan should be a mix of different investments. We analyse the various instruments and tell you how they can fit into your plan.

  • September 23, 2010  
  • |  
  • UPDATED   00:00 IST

Which is the best financial instrument to invest in for retirement? A difficult question, not because there are so many options but because investing is not a onesize-fits-all exercise. Different options suit investors at various stages of their lives. It all depends on their risk appetites and financial situations.

Also, one should not lose sight of one's overall asset allocation while choosing an investment option. The PPF is a good tool, but it would be counterproductive to  put all your eggs in the safety of a debt instrument that is often overtaken by inflation. Stocks and equity funds are wealth creators, but it would be foolhardy to binge on them when retirement is less than 10 years away. A black swan like 2008 could have wiped out 50% of your life savings.

A good retirement plan should ideally be a combination of a variety of investments. Just as you use different tools to perform a multitude of tasks, all these options can work for you in diverse ways. We look at the investment options commonly used to save for retirement and tell you how and where they can fit into your plan.

NATIONAL PENSION SYSTEM
No more an ugly duckling

Returns: 6-8% (Debt), 9-12% (Equity)
Risk: Low (Debt), Moderate (Equity)

Since its birth two years ago, the National Pension System (NPS) has been in the crosshairs of too many people. Investors found it too complicated. Distributors shunned it for lack of incentives. And financial planners didn't like the tax on withdrawals or the limited liquidity that it offered. But changes in the NPS structure and tax laws have turned this unwanted, ugly duckling into a beautiful swan, which perhaps offers the best way to save for retirement. In December 2009, a second tier was added to the NPS structure, which injected liquidity into it.

Investors in the Tier-II accounts are allowed to withdraw from the corpus, unlike in Tier-I, which can be accessed only when the account holder turns 60. The bigger and more significant change was the tax exemption proposed for income from annuities under the revised Direct Taxes Code.

If passed, this will change the way Indians save for retirement and make the NPS the household name that its architects had envisioned. This is how the NPS scores over other options: Flexibility: One needs to invest a minimum of Rs 6,000 a year in the NPS, with at least four contributions in a year. There is no upper limit.

The scheme is portable and can be operated from anywhere in the country. Costs: The NPS charges are very low compared with those of Ulips and pension plans from insurance firms. For somebody investing Rs 50,000 a year in NPS, this works out to less than 1%. The Tier-II account is more of a low-cost mutual fund.

Choice: A subscriber can choose from six fund houses to manage his money and switch if he is not satisfied with the fund. He also gets to pick the debt-equity mix of his investments.

Availability: Anybody between 18 and 55 years can join the NPS. It is sold through almost 10,000 outlets across the country, including bank branches and post offices.

Tax efficiency: The revised DTC draft proposes to make annuity income from the NPS tax-free. Besides, there are no tax implications when you switch between options or change from one fund house to another. The other good thing about the NPS is the lifecycle choice of funds that is the default option. Under this option, the asset allocation is defined by the age of the subscriber and changes as he grows older.

So, even if the subscriber does not know the ABC of investing, his money will be deployed in a way that suits his lifestage. In the first year of its operation, the NPS generated average returns of 12%, which is a good 4 percentage points higher than the yield of a PPF account. This was possible largely because the NPS invests up to 50% in equities.

OUR ASSESSMENT
By bringing annuities under the EEE regime, the revised DTC has made the National Pension System the best way to save for retirement.

However, experts point out that a 50% allocation to equities may be too cautious for someone who has 25-30 years to retirement.

"The immediate cost should not be the only criterion for selecting a plan. Pension plans from insurance companies may allow an individual to take higher risk and allocate more towards equities," says Ranjeet Mudholkar, principal adviser & director of the Financial Planning Standards Board, India.

Also, the NPS works best if you are investing more than Rs 30,000 a year. The bulk of the charges are fixed and a subscriber who pours in Rs 6,000 a year in the scheme will end up paying roughly 8%. However, somebody who puts in Rs 10,000 a month (Rs 1.2 lakh a year) will pay less than 0.5%. The PFRDA has announced that the charges will come down further as more people join the NPS.

PF, PPF AND BANK DEPOSITS
Dangerously safe

Returns: 7-8.5%
Risk: Nil to very low

Fixed-income investments act as ballast in a portfolio, lending it stability and preventing it from tipping over when the going gets rough. As we have seen in the past two years, equity markets can behave like the ECG graph of a person with heart condition.

For many salaried people, the monthly contribution to their Provident Fund (PF) account and a matching contribution by their employers is a neat way to build a retirement corpus. There's also the Public Provident Fund (PPF), where a contribution of Rs 70,000 every year grows to a gargantuan Rs 25 lakh in 15 years. What's more, the PF and PPF are protected from the taxman at every stage. There's tax exemption on the amount invested, interest earned and withdrawals.

This is what makes fixedincome investments the most popular savings option for retirement in India, with almost Rs 42,000 crore of household savings locked in bank deposits. After all, isn't it better to be safe than sorry? As it turns out, you can be sorry for being so safe.

OUR ASSESSMENT
With wholesale price inflation in double digits, you are losing money in these ultra-safe investments.

With wholesale price inflation in double digits, you are losing money in your PF and PPF accounts. The purchasing power of your money is diminishing faster than the returns it is earning. Bank deposits earn even less and the income is taxable. So the posttax return works out to less than 4-5%. Investors need to factor in inflation while lining their nest egg with only debt.

"Retirement is a phase when one has nothing to risk and everything to lose. So there is an undue emphasis on the need to be 'safe'," says Arindam Ghosh, head of retail sales, J.P. Morgan Mutual Fund. Incidentally, headline wholesale price inflation is not the only way rising prices can hurt your retirement kitty.

"There is not only inflation but also the ever-changing lifestyle and social norms. A microwave or a washing machine, which people could do without earlier, has become quintessential for living today," points out Mahhendra Jajoo, executive director and CIO, fixed income, Pramerica Asset Managers. There is also the interest rate risk to watch out for while investing in long-term deposits. If interest rates go up and your money is locked in at a lower rate, you miss out on the chance to earn a higher return. The only option is to foreclose the FD after paying a penalty.