Retirement corpus structuring – A Reader query

From time to time I get queries from my Blog readers that will resonate with the larger investor community. One such query was sent by a reader recently after he read my recent posts on retirement corpus structuring. I wanted to address it as a post here.

His query was as follows:-

Taking portfolio 1 as the base, if a person retiring this year from a private firm, has a house to live and corpus of around 2 crore in the following manner –
Debt portfolio – 50 lakhs in EPF, 10 lakhs gratuity, 20 lakhs PPF, 25 lakhs from LIC (maturing in 2022, premiums paid) and 10 lakhs in liquid funds/FDs for emergencies.
equity – 60 lakhs in Mutual funds and 25 lakhs in Shares. How should the corpus be structured to provide regular income in retirement, taking care of inflation?
Let me only try to do a structuring of corpus here as I have already explained the broad principles in the earlier posts. The assumptions are a current annual expenditure of 7 lacs per year, life expectancy is another 30 years and expenditure being double and 4 times in the next 2 decades respectively.
Without further ado, let me give my suggestions now :-
  • Take the 60 lacs from PF and gratuity and put in in Vaya Vandana Yojana and Senior Citizen Saving Scheme. This will have to be done by the investor and his spouse separately. This will give 4.8 lacs per year as interest.
  • Use 20 lacs PPF to withdraw 2.2 lacs every year for the first 10 years. Along with the interest, this will take care of the 7 lacs needed in the first decade.
  • When the LIC money becomes available, invest it in equity balanced funds. This will amount to 50 lacs by 2028, assuming a return of 12 % annually.
  • In decade 2 the average expenses will be 14 lacs. This will be funded through:-
    • 4.8 lacs will be available as before.
    • 50 lacs from Balanced fund will be redeemed @ 5 lacs per year.
    • 60 lacs MF will become 1.8 crores in 10 years with a return of 12 % annually. Take 40 lacs and put it in some hybrid fund such as MIP or Equity Savings Funds. 4.2 lacs each year can be used for the remainder of 14 lac expenditure.
  • In deccade 3 the average expenses will be 28 lacs. This will be funded through:-
    • Stocks which will reach a value of 1.93 crores in 20 years
    • MF which will reach a value of 4.34 crores in 10 years from 1.4 crores base.

So at the end of 3 decades the couple will still have some amount left, which can last them a few more years. It is highly improbable that they will live beyond 95 years, so it is a very safe plan.

I hope the plan addresses the issue at hand. In case there are any queries on this, I will be happy to address the same.


Retirement income framework – understand the allocation

I get a lot of queries in my blog and Facebook group about how to structure a corpus so that the retired person gets enough monthly income in retirement. Most of these people have a home and are not really extravagant in their spending. Ideally they would like to have regular monthly income with a degree of safety attached to it.

I have written earlier that a combination of Debt, Equity and Stocks should be the way to go for all stages of life, with the provision that the proportion changes in favour of debt as you grow older. However, there are many people who are worried about the volatility in the markets and clearly uncomfortable in a scenario where they might have to withdraw money in a declining market. At the same time, a debt only portfolio will work if the corpus is large enough to deal with inflation over a period of 3 decades.

Let us simplify it then in terms of different scenarios. The first scenario is where you only want to have Debt in your portfolio:-

  • Assume an annual expenditure of 8 lacs per year
  • Retirement period of 30 years conservatively
  • Real return from portfolio is zero as Returns match inflation
  • Corpus needed will be 2.4 crores
  • Rough assumption is that expenses will double every 10 years.

So you can see from here, if you have 2.4 crores corpus you can withdraw 8 lacs every year and not worry at all about markets and equity etc. But what if you do not have 2.4 crores but only 2 crores. How does that change the situation? Let us see below:-

  • Assume same expenses and longevity as in the first scenario.
  • Put 20 years amount into Debt and the rest in Equity.
  • So we have 160 lacs in Debt and 40 lacs in equity.
  • Assume that inflation makes expenses rise by 100 % in 10 years.
  • Assume equity returns of 15 % annually.
  • The Debt investment will be adequate for first 20 years.
  • The Equity part will become 654 lacs in 20 years at 15 %
  • Even if you take 12 % return on equity, the amount in 20 years will be 386 lacs.
  • Annual expenses after 20 years will be 32 lacs per year
  • So 10 year costs are 320 lacs.

As you can see the trick is to let Equity grow for a long time so that the differential return when compared to inflation really works to your advantage.

I hope with this you will be able to get your own situation in retirement mapped out. The basic idea is to deal with Debt in the first decade or two and have access to equity money for later on. Yes, if you have enough in Debt then you probably do not need a lot of equity allocation. Let us now look at the general formula then.

  • Expense of X lacs per year and longevity of Y years
  • You can be in pure debt if corpus available with you is more than XY lacs
  • If you have less than XY lacs then your allocation must be between Debt and Equity.
  • In general with a corpus of 75 % of XY lacs you should be all right.
  • Assumption is that your Equity portfolio grows at 12 % to 15 % long term and inflation is such that your expenses double in 10 years ( roughly 7.2 % )

All that you really need to do now is to plug in your values and check out the allocation required for a rich and productive retirement. I will do another post this week on specific portfolios and withdrawal strategies for 2 different levels of corpus.

Vaya Vandana Yojana is good for senior citizens

One of the good aspects of the current year budget has been the focus on senior citizens. While the tax slabs have not been changed, the exemption of interest income up to 50000 Rs is a good thing for all of them. Another benefit is the extension of Vaya Vandana Yojana for 2 years and changes in the terms.

The VVY was introduced last year and had interest payment up to 8.3 % annually on investment up to 7.5 lac Rs per senior citizen. Now it has been made 15 lacs maximum with flexibility of withdrawal in case of Medical emergencies. The monthly interest is 8 % and the annual yield goes to 8.3 %. You can buy it online or offline through LIC.

How should senior citizens use this? Well, you can invest up to 30 lacs in it now, for both you and your spouse. Along with the Senior citizen saving scheme, where you can potentially put another 30 lacs, this will give you a total interest income of 40000 Rs per month. While all of this is taxable, the tax incidence is practically zero for the couple.

This is something that all senior citizens should take advantage of. With a regular income of 40000 Rs per month assured, they can now think of putting the rest of their money in other mutual funds of different types to add to their income. In case they have a PPF account then there is also a possibility of withdrawing money from there in a tax free manner. With some intelligent structuring it will be quite possible to have an income of up to 80000 or so per month, with low tax incidence.

So, if you are a senior citizen and are looking at regular income, go for VVY. Yes, interest rates may rise but it will take a while to catch up to 8 % and a bird in hand is always worth more than two in the bush.

I will outline in the next post how a corpus of 1.5 crores including PPF can be structured for senior citizens to maximise income with low tax incidence.

How to realign your MF portfolio

In several of my earlier blog posts, I have covered practically all aspects of MF investments and you should be in good shape if you are starting off to create a MF portfolio from scratch. However, as some readers reminded me, most of us are already having an MF portfolio and some of us are having SIP investments in several funds. Different portfolios for different goals can also lead to people holding more funds than is either necessary or desirable.

The good thing is you can realign your portfolio and get into a logical allocation quite easily. As I have covered the basic logic of my suggested portfolio structure and SIP / one time investments I will not repeat them in this post. You can read these posts here and here. In this post I will outline a simple method by which you can realign your portfolio.

Step 1 : Be clear about your intended portfolio structure:

  • For the long term you need just 4 funds – a large cap fund, a mid cap fund, a multi cap fund and a small cap fund. If you want to hedge your bets you can add an International fund, mainly US based.
  • You do not need to have any Balanced funds, Sector funds or Thematic funds.
  • Always go for Direct funds as the lower cost will enhance your returns significantly over the long run.
  • Remember you need only 1 portfolio for all your goals and not a separate one for each goal.

Step 2: Map your current portfolio to the above portfolio structure:

  • Check if the funds you hold are aligned to the above portfolio. If not then discard them logically from your portfolio.
  • For the aligned funds, check if they are suitable for your portfolio. Read about how to select funds here. If any of the funds are not suitable then discard these.
  • We will decide what to do with the discarded funds later on.

Step 3: Get to your new portfolio structure:

  • Take whatever you have got from step 2 and add other funds based on the portfolio structure and the selection method.
  • Now you have s set of 4-5 funds in your portfolio. In all of these your investment value is either zero or equal to the earlier investment, in case you are retaining any of your earlier funds.

Step 4: Decide on your investment amount per month:

  • To begin with use a SIP calculator to check what should be your monthly investment. You can take any rate of return between 10 and 15 % based on your comfort level.
  • You can start by putting equal amounts in all 4-5 funds. However, if you prefer a fund type over another then you can tweak with the monthly SIP amounts. It does not matter a great deal, as long as you have got the portfolio correct.
  • Increase the SIP amount every year based on the availability of extra money to invest.

Step 5: Redeem the discarded funds at the right time and invest into your new portfolio:

  • Redeem your discarded funds at a time when it seems right. There is no exact formula but you can observe the trends and take a call. For example, if the Nifty reaches a level between 10800 and 11000 now it will be a good time to redeem the funds that you do not want to be in any more.
  • There is no rush in this, your investments are growing even if you have discarded the funds logically from your portfolio. Once you have redeemed the funds be in cash or keep the money in a liquid fund, till it is time to buy.
  • Invest the above money through one time purchases of the funds in your new portfolio at an appropriate time.

As you can see from here realignment of the portfolio is a fairly simple exercise, once you are clear about the mechanism. If you feel that you need to do it, the right time to start is NOW. In case you are not invested in the right funds then any further investment in them is completely senseless.

In case you have any questions on realigning your portfolio, comment on this post and I will be happy to clarify.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.

Equity MF dividends – the whole story

After my last few posts I am getting a lot of enquiries from people as to what they should do about their schemes with dividend options now. Many are unclear about the tax and how will it be treated in their hands. In this post I wanted to demystify the dividends from equity MF and suggest ways about how you can deal with them.

To begin with let us understand how a Dividend option of an MF scheme is different from a stock. Any company, whose stock you hold, will pay you dividends from the profits that it makes in a quarter or year. Based on the amount of dividend paid the stock price will normally fall initially but may well rise later. In the case of a Dividend paying MF scheme, the dividends are being paid out from the assets held by the scheme. As some of these assets are liquidated the NAV of the fund will necessarily fall after a dividend is declared. Yes, it may rise again if the stocks in the MF scheme portfolio do well but it is fundamentally different from the stocks.

Let us now examine the taxation aspect of dividends before and after the budget. When a company declared dividends it was out of the profits where taxes have already been paid by the company. Therefore the dividend that investors received was tax free. In the case of equity MF schemes too they did not pay any holding tax and whatever dividend the investor got was again tax free in their hands. After the budget the situation remains the same for stocks but has definitely changed for MF schemes. These will now have to hold a tax of 10 % before distributing the dividends to the investors. This is the Dividend Distribution Tax ( DDT ) newly introduced in this budget. Remember that Debt funds always had a DDT of more than 28 % earlier and continue to do so.

How does this change things for you now? Well, for one you will have lower dividends for your equity MF schemes due to the DDT. Typically this will be 10 % lower. It will continue to be tax free in your hands. For example, I had invested 2 lacs in the dividend option of a  Value Fund series NFO from ICICI. Every year I would get 15000 Rs dividend from this investment. All things remaining equal, the value of this dividend after the new DDT rule will be 13500. If an investor is depending on these dividends for passive income then he will need to get this shortfall from somewhere else.

In general Dividend option is not a good idea for equity MF now – note that companies pay tax on their earnings and this is reflected in the stock price and also the level of dividend they pay to their investors. Equity MF are investing in these companies and are again paying DDT. Finally when you redeem these investments you will again be charged LTCG tax at 10 %. It will be much better to just deal with the Growth option where you just pay LTCG tax when you redeem your units.

Let us now look at some classes of investors who are currently invested in these MF schemes and what they should do about it:-

  • If you are in the active income earning stage of your life, there is no logic in having Dividend options for your MF schemes. Change all of them to growth. Even if you need the money you will be better off just redeeming some units as and when you need to do so.
  • If you had chosen this option in order to do some explicit profit booking by the Fund houses then your concept was wrong. Fund Managers will churn their portfolios as and when required and these benefits will reflect in the NAV of your scheme. There is really no need to invest in the Dividend option for it. You should also change it to Growth option.
  • People in the retired or FI state may have invested in these schemes as a means of getting regular income. Some Balanced funds have schemes where they distribute a monthly dividend. Note that all of these are subject to DDT now – so either you will get less dividend in your hands or the fund NAV will fall more if the same dividend is to be maintained.

Except in the last case, where some people may want a hassle free receipt of dividend as compared to redeeming units on their own, there is really no point in Dividend options of MF schemes now. In fact, with online redeeming being possible, anyone can sell units of MF schemes rather easily and I will definitely recommend that.

Short conclusion to the story – change all your MF schemes to Growth option right now!!

How should you invest in Mutual funds now?

Whichever way you want to look at it, the Finance minister has definitely sent all MF investors in a tizzy with his LTCG taxation on equity. This was always likely to happen and many investors, used to a diet of high growth with no taxes to account for, are shocked and wondering what they should do with their existing investments and new ones. I will give you a very clear recipe in this post that you can follow effectively.

To begin with, the popularity of MF investment through SIP were due to two main factors. The first was the marketing skills of the Fund houses and the awareness on inflation created by the myriad financial blogs and Facebook groups. Investors realised that traditional investments such as Fixed deposits, PPF, LIC schemes, Bonds etc would not keep pace with inflation and they had to look at equity to a certain extent for meeting their important life goals. For these set of people, investing in MF seemed like a less risky idea as compared to direct equity. The successful model of sales and distribution put in place by Fund houses have ensured that they have mopped up amounts nearing 1 lac crore annually.

However, there was another reason which many are not cognisant about. When the Finance minister change the LTCG indexation benefits from 1 year to 3 years in his first budget, he actively pushed people away from schemes like Fixed Maturity Plans. With declining interest rates, longer holding period and reduced inflation unfavourably affecting the indexation benefits, suddenly Debt funds were really not a good option for people wanting to park their money in short term. The Fund houses responded by coming up with schemes like Arbitrage funds and Equity Savings funds where the safety was greater than pure equity funds, returns were better than Debt funds and the holding period needed to be one year only for getting tax exempt returns. Many Fund houses even offered monthly dividend on Balanced MF schemes which were particularly suited to retired people, in search of a regular monthly income.

Thanks to the FM all this is a matter of the past now. Given the current situation, how should you deal with your MF investments? I have put together some simple guidelines for different types of investors, that will give you a clear road map of what you should do:-

  • If you are an investor whose goals are still some time off:-
    • Keep investing in your SIP as before but add 10 % to the amount for taking care of the eventual taxation.
    • Make sure you have only Growth option schemes in your portfolio as it makes little sense to get dividends now, unless you really need it.
    • If you have set up STP for your monthly flows into SIP, evaluate if this makes sense. You will be taxed for selling the funds now.
    • As churning is detrimental to your returns now, make sure you select the right MF schemes and stick to them for the long term. Yes, you still need to review etc but change the scheme only when really needed.
    • The longer you hold your investments the better it will be for you. Redeem only when you actually need the money, not otherwise.
  • If you are an investor with major goals coming up:-
    • Check out if you can meet your goals through existing Debt investments and keep your MF investments running for a longer term.
    • If this does not work, redeem from your MF schemes only the amount you need right now for the goal. For example if your child’s college fees are 20 lacs in 4 years and 5 lacs per year, then redeem only to the extent of 5 lacs.
    • If the markets manage to go up beyond the Jan 31st levels within March ( this is unlikely, but you never know ), redeem your MF units to the extent of the money you need for your goals in the next Financial year.
    • As before, avoid Dividend options and if you have any MF schemes with these then change it to Growth.
  • If you are retired or in need of regular passive income in your Financially independent state:-
    • If you had set up Arbitrage funds, Equity Savings funds or invested in Dividend option of some close ended equity NFO’s check your taxation impact and decide if it is making sense.
    • If you are a senior citizen take advantage of the 50000 Rs interest exemption and the LIC scheme with 8 % interest.
    • Rearrange your MF investments so that you only get the Dividend amounts that you need regularly. For any sudden or unplanned expenditure, you can always redeem your MF units within a day.
    • Do not churn your MF investments needlessly, you will end up paying more taxes by doing this.
    • Finally, even in the new tax regime, do not give up on equity MF. It is important for you to remain invested as a hedge to inflation.

As you can see from above, there is a need to take stock and possible reorganise your MF portfolio. However equity as an asset class and Mutual funds as an investment vehicle are still the best in the business and you should continue to bet on them.

If you have any specific queries I will be happy to answer them through my Blog or through the two Facebook groups that I run.


The impact of budget on your investments

When you are in the middle of a storm it is difficult to stay calm. The immediate aftermath of the budget yesterday has been a sharp fall in the markets – the fall is significant for the Sensex and the Nifty and brutal for the mid cap and the small cap indices. I thought of writing this post about the overall impact of the budget on your investments but it will probably be a good idea to start with the markets first.

Now as any of us who have been in the markets for some time will know, the markets do not like surprises. In the budget of yesterday, there were 2 elements which were not really surprises, yet the markets were hoping against hope that they will not take place. The first is the fiscal deficit figure whose importance is really in how the world views us financially. Not only have we not met the projected 3.2 % but, what is far worse, we are pegging the next year target too at 3.5 %. The financial discipline which was the hallmark of the last few budgets seem to be slipping. The second is of course taxing of LTCG for equities. While this had to happen some time, the markets are clearly shocked at it being done now and in not doing away with STT. Out of the two factors, the first will spook the FII’s and the second will be more of a problem for domestic investors. It was therefore expected that the markets will fall today, but the extent of the fall has been shocking.

Let us take a look at the LTCG part in closer detail. There are several issues in it which have not been understood well. By and large, people investing in stock markets are the relatively better off people in our society as compared to those who do not. It will be unfair not to tax LTCG at all, given the increasing income disparities we are seeing in society today. So if the government had to run welfare schemes such as Ujala and the Health scheme the money had to come from somewhere. This was the obvious choice and the other was raising the cess from 3 % to 4 %. I am a little surprised that LTCG period has only been kept at 1 year. This along with the little difference from the STCG rate will mean that there is really no incentive for holding equity long term.

Let us now look at what it means for investors in tangible terms:-

  • All your gains made so far are well protected as the price on 31st Jan, 2018 will be taken as the cost price. Though you will be charged for future gains from this price, your current valuation of portfolio is protected.
  • If you sell your stocks and MF in the next FY, it will be possible to structure the sale so as to minimise the taxes. For example every one of us will have some stocks in our portfolio which lose heavily. This will be the time to square off these losses with the gainers so that you do not have to pay much taxes. 
  • As far as MF goes most of us are doing it for some long term goal and we can just continue to do so. Yes, you will pay some taxes on future gains but not on your past ones. Investors doing SIP should simply continue, you may now want to bump up the amount by 10 % to take care of the taxes when you redeem. Note that this is mainly true for the Growth option.
  • If you have chosen the dividend paying option in your MF investments then the DDT will come into place from April. You will now roughly get 10 % less dividend as compared to what you were getting earlier. If this forms part of your passive income then you will need to secure this gap from somewhere else.
  • Indexation not being there is a good thing as you can simply sell it now at any point in time, without worrying about the indexed cost price. In any case, indexation works best with debt products where the returns are linearly unidirectional.

In summary what should your actions be?

  • Clean up your portfolio by selling stocks you do not want to keep, especially if they are losing money. Make sure that your overall gains after squaring off the lasses are not more than 1 lac so that you need not pay any taxes next year.
  • Continue with SIP in your MF investments, look into increasing the monthly outlay to take care of the eventual taxes.
  • Dividend option in MF schemes is a bad idea now. You will be paying DDT twice and again pay taxes on LTCG. Go for the Growth option, if you need money you can simply sell off some units.
  • Rest of your investments in Debt etc can continue as before.

So you will see, there is no real reason to panic at all at an individual level. The markets are doing so as they had gone up a lot and would anyway have corrected. This bad news has given it a reason to do so now. If it was not this it would have been something else.