For most of us who have an EPF account at workplace or are investing in a separate PPF, these seem to be the sole retirement plan(s). Savings through these methods may have been viable a decade back. However, for the coming generation of retirees on EPF, and the lack of pensions could mean that they're at risk of running out of capital after retirement.
Should you consider investing in mutual funds? Here’s all you need to know.
(1) Mutual funds are risky. I may be unable to recover my investment!
It is true that mutual funds, particularly equity funds, fluctuate with market trends and can consequently be very risky. However, data from equity funds over the long term indicates that the risks are evenly distributed over the long run.
Over a period of 15 years, the chance of losing money in stocks is negligible. This means you will never lose money if you remain in the market for this long. In addition, the equity funds have produced an inflation-proof return in the long run.
(2) Mutual funds can provide too many exposures to equity markets.
Mutual funds, to most people, refer to investing in the equity market. However, this isn't the case. Mutual funds can provide an opportunity to participate in a broad range of moderate-risk to low-risk debt instruments, too.
They allow you to invest in gold with no physical holding and also allow you to investigate the evolving international markets, like those in the U.S. Mutual funds which also provide a mixture of debt and equity with the equity component that is either extremely low or high, depending on the risk you are willing to take.
A well-diversified basket gives you the exposure to different asset classes with a single product, referred to as mutual funds.
(3) Mutual funds are not able to provide steady returns as deposits do.
They can't offer guaranteed returns or an income stream that is guaranteed as deposits do. However, let's get this straight. What's the goal of saving money to retire?
It's about building an adequate amount of money until you are retired. A healthy portfolio can be invested in secure investment options, in order to provide a regular each month or year for you, in order to replace the loss of business income or salary after you retire.
To build wealth, regular interest pay-out options do not aid in creating wealth since the chances are that you won't be able to invest in the future.
Even if the choice is combined, you face an investment risk because you could get lower interest rates (when the time comes to renew investments when they have matured) than what you had been receiving earlier. Your EPF which has a different interest rate each year takes on this risk.
Equity funds, because of investing in the markets continuously (and accepting cash positions only when justified), are not subject to this risk of reinvestment.
Standard Guidelines For Retirement Investing With The Mutual Fund
The primary rule to adhere to when it comes to investing in mutual funds in the event you decide to invest for retirement, is to maintain a moderate exposure to stocks in the beginning and gradually decrease it by shifting the funds to debt and other traditional savings options like tax-free bonds or deposits.
The shift, if you've invested for a minimum 15 years, could begin as early as 5 years before the date of retirement.
Many people feel the pinch because of the fact that they are exposed to equity just several years before retirement and assume that equities will yield high returns in just a few years. A market downturn, in the event of a down market, could eliminate capital.
The third principle is to adjust the balance of the mutual funds’ portfolio at least every year. This is the process of bringing your portfolio to the initial asset allocation if the equity, debt, or gold portion of your portfolio shifts off-kilter.
A third principle can be that your retirement portfolio is managed without any themes or fancy sector funds to boost your portfolio. If you decide to get exposed to such funds, make sure you restrict the amount to 10% and ensure that you get rid of the subject at least a couple of years before the time you plan to retire. The last thing that a retirement portfolio requires is the risk of volatility from financial instruments that are cyclical.
Fourth principle: The retirement savings account should comprise a basket: EPF, PPF, mutual funds and other traditional debt options like deposits.
Fifth rule: If you are exposed to mutual funds after retirement, don't rely on them to declare dividends. Those who require regular income can consider systematic withdrawal plans (SWP) alternative to design the plan of his/her choice. SWPs can also be tax efficient, since they are eligible for capital gains indexation benefits when it comes to the debt fund that is held for one year.
(DISCLAIMER: The views expressed are the author’s own and have nothing to do with OTV’s charter or views. OTV does not assume any responsibility or liability for the same.)