The crucial questions about retirement planning

By Larissa Fernand |  12-08-19 | 
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Larissa Fernand is Website Editor for Morningstar.in. She would like to hear from you and welcomes your feedback.

A young 26-year old investor called Akhil, sent us an email with a query.

I do SIPs in 5 equity funds amounting to Rs 1.30 lakh every month. I have a fixed deposit of Rs 20 lakh earning a rate of 8.75%. The money in my savings account earns 6.5% per annum. The latter doubles up as an emergency fund and should take care of a year’s expenses.

My target is to create a corpus of Rs 6 crores in the next 14 years so that I can retire at 40.

My question is concerning retirement. Is it advisable to do an SWP from the same funds? Or, must I move my money to a low risk fund, the closer I get to retirement?

I was so impressed with his clarity at such a young age, that I reached out to him. What he revealed was fascinating.

Akhil is employed by an offshore oil rig company and is earning extremely well. He was convinced that at this stage in his life, it is saving and investing that must take prominence. After all, he has zero debt and zero commitments and zero dependents. That is a very sweet spot to be in. What better time to stash it all away? And by opting for this path, the financial freedom and independence he can obtain at a later age would be extremely rewarding.

I have attempted to address various aspects here.

1. Will he reach his target?

My colleague Mohasin Athanikar cracked the numbers based on Akhil’s SIPs.

Since we do not know how much he has accumulated till date, we chose not to take that into account. Neither did we take into account the money in his fixed deposit and savings account.

If the return from his investment is 13% per annum, then he is on track. If we assume the return to be 12%, he can increase his monthly SIP to Rs 1.40 lakh to stay on track.

However, I feel it is better to take a more moderate view on equity returns and stick to 11%.

In such a case, Mohasin explained that if Akhil is keen on sticking to 14 years, he needs to up his monthly SIPs to Rs 1.57 lakh. Or else, if he would like to stick to Rs 1.30 lakh per month, he needs an additional 1.5 years more to achieve his goal of Rs 6 crore.

2. Is it wise to retire at 40?

Akhil wants a corpus of Rs 6 crores. As we have seen above, that is not unattainable. But there are some questions that he needs to answer.

Will this kitty be sufficient for another 40 years, assuming he lives till 80? If he gets married and plans on having children, will this amount be sufficient to include their education? When the number of his dependents increase (wife, children, maybe in-laws or parents), will the corpus fall short?

Akhil was clear that he wanted to retire from his job on the oil rigs. What does retirement really mean for Akhil? It would surely mean putting in his papers in the firm that handles the offshore rigs. But does he plan to work at all after that? Is he planning on pursuing another business? Is he expecting a huge inheritance?

These are issues he will have to address.

3. Should he opt for a Systematic Withdrawal Plan (SWP) from the funds once he retires? OR, must he move his money to a low-risk fund as he gets closer to retirement?

This is where I reached out to a financial adviser. 

The retirement corpus must be safeguarded. And, a cash flow stream must be created from this corpus without attaching any volatility to the kitty. However, some exposure to equity is needed as it has to grow for a number of years.

Akhil should switch from Aggressive to Conservative (asset classes) as soon as the targeted corpus of Rs 6 crores has been achieved. If it is achieved in, say, 10 years, then the switch should happen. There is no need to wait for the allotted 14 years.

The corpus of Rs 6 crores should be shifted to an asset class like a Balanced Advantage Fund or Dynamic Equity Fund (Dynamic Asset Allocation Fund – DAAF).

Now just because the goal has been achieved, it does not mean the SIPs should terminate. They should continue as planned for the entire allotted period, whether it is a balance of 3 or 5 years, or whatever. The only difference being that the SIPs be done into the same DAAF schemes instead of the current equity funds. Why? Because even SIPs are known to have generated negative returns over 5-year periods.

On retirement, Akhil should start with an SWP of not more than 6-7% per annum. So for every Rs 1 crore, he should do a SWP of Rs 6-7 lakhs. DAAF has in the past delivered a CAGR between 12-15%. Hence, the SWP be lower than 12% (in this case 6-7%).

The underlying corpus will keep growing inspite of the withdrawal via an SWP.

4. Where should the Emergency Fund money be parked?

I tackled this in detail in Yes, you need an Emergency Fund. But here I will specifically address his situation.

Normally, I would suggest a bank fixed deposit or liquid fund for an emergency fund; or a combination of both. If Akhil has a year’s expenses in the savings account and Rs 20 lakh in a savings deposit, the combination of the two would be pretty substantial. I don’t see the need to have such a huge amount lying in the bank.

In Yes, you need an Emergency Fund, Financial Coach and Investment Adviser Mahesh Mirpuri suggests an ultra short-term fund or a low-duration fund.

They will generate better pre-tax and post-tax returns as against a savings bank account, as the benefit of indexation is also taken into account.

This money may not be touched for years, if at all. Hence it should earn a better return as against a savings account.

5. Is his selection of funds appropriate?

Here are the equity funds in which the SIPs are being done:

  • Mirae Asset Large Cap: Rs 20,000
  • Kotak Standard Multi Cap: Rs 30,000
  • Canara Robeco Emerging Equities: Rs 30,000
  • L&T Midcap: Rs 30,000
  • HDFC Small Cap: Rs 20,000

There were numerous factors that immediately caught the eye. For one, the portfolio is not scattered all over the place with many funds. The funds are spread out across AMCs and categories. Given his long-term perspective, it is noteworthy to acknowledge the distinct tilt towards smaller fare.

Morningstar’s fund analysts share their views on each of the above funds.

Mirae Asset Large Cap (Large Cap) is run by a highly competent fund manager who has adopted a time-tested investment approach resulting in steady returns across market cycles. The investment philosophy of the fund is based on three core principles: quality businesses with stable earnings, strong management, and attractive valuation. Our analysts have given this fund a Silver rating.

Kotak Standard Multi Cap (Multi Cap) is the largest fund in the multi-cap category. Fund manager Harsha Upadhyaya is a very efficient stock-picker and has executed this strategy with a lot of finesse. His stock-picking leads him to remain loosely aligned to the benchmark. The manager has been buying into a few mid-cap stocks more recently but has retained its large cap bias. Our analysts have given this fund a Silver rating.

HDFC Small Cap (Small Cap) is managed by Chirag Setalvad, an excellent portfolio manager in this space. He is known for his detailed and exhaustive research. There have been multiple strategy changes, which makes us want to monitor the fund for a while before we are more positive on it. However, his ability to execute the strategy with skill drives our conviction on this fund. Our analysts have given this fund a Bronze rating.

L&T Mid Cap (Mid Cap) has been an impressive performer. Soumendra Nath Lahiri is a very experienced manager and has done a stellar job of managing the fund. In 2018, its performance was average and the YTD return is below average. But bear in mind that every fund will experience short-term relative underperformance, depending on the stocks it holds in its portfolio and the way the market perceives them at different points in time. Over a full market cycle, our analysts expect the fund to do well. Our analysts have not rated this fund as of yet.

Canara Robeco Emerging Equities (Large & Mid Cap) recently witnessed a manager change with Krishna Sanghavi taking over the fund. He should be able to steer the fund in a positive direction. Our analysts have not rated this fund as of yet.

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