Investment Advisory for Retiring Persons

Investment advisory for retiring persons

Are you retiring from work any time soon? While you can look forward to a surfeit of money from provident fund, superannuation and gratuity, it is important that you give a thought to where you will invest it.

If you have no pension or other source of monthly income, you will need to first build a regular income-generating portfolio with your retirement money.

Here are some options. You can use up to 70-80 per cent of your retirement funds to build this portfolio.

REGULAR RETURNS

If you have reached the age of 60, then the Post Office Senior Citizen's Income Scheme, remains your best bet, both in terms of safety and fixed returns. The added tax benefit also helps reduce your cash outflows. All ESM are considered as Senior Citizen under this scheme irrespective of their age.

With an interest rate of 9.4 per cent, this option will help you beat inflation, given the tax benefits. You can invest up to Rs 15 lakh in the scheme and withdraw interest every quarter.

Tax-free bonds that will be issued by Government companies this year is another option.

Make the best use of them if the rates are 8 per cent or above.

Remember, while you will not get any Section 80C tax benefits, your interest income is tax free. That matters a lot, especially if you are in the higher tax bracket.

The post office monthly income scheme can also form part of the fixed-return portfolio.

But with an interest rate of 8.5 per cent now, it is suitable only if you are in the 10 per cent tax bracket, or your overall income is less than the taxable limit. A good 40-50 per cent of your income portfolio can be safely parked in the above avenues.

The next chunk of say 30 per cent of your income-generating portfolio can be invested in bank fixed deposits that offer attractive rates. Stick to deposits with a 3-5 year maturity. They offer higher rates than longer tenure deposits. You can roll them over again.

Ensure that you restrict your exposure to small co-operative banks to Rs 1 lakh; that's the maximum amount backed by insurance.

Bank deposits also provide some liquidity. In case of emergency, you can always withdraw the deposit prematurely for a small penalty.

If you have a large corpus and the Senior Citizen scheme's limit is too less for you, then increase your investment in bank deposits.

HIGHER RISK

Fixed deposits, debentures and bonds floated by companies fall in the higher risk category. This option is not for the faint-hearted as there is a risk of irregular interest payment.

You may even lose the principal if the company goes bust.

To mitigate this risk, you can stick to top-rated companies.

That means you need to look for ratings of AAA or AA+, given by credit rating agencies. Avoid the unrated ones.

You can also reduce the tenure of bearing this risk by locking in for a period of not over three years at a time.

But with bonds, you may have to enter for a longer period.

Here again, you still have an option (in most cases) of redemption mid-tenure. If such an option is available, go for it.

Restrict your investments in this avenue to 10-15 per cent of your income portfolio.

And remember with bonds or debentures, it is risky to exit before maturity, unless you are aware of bond price movements.

LIQUIDITY AND RETURNS

The more savvy ones can also consider parking up to 10 per cent of the income portfolio in mutual funds.

While these are not strictly income-generating investments, debt-oriented funds such as HDFC MIP Long Term or CanaraRobeco MIP do declare dividends that can perk your portfolio returns. Note that these funds do not promise dividends.

Unlike interest income from deposits, the dividends here are tax-free in your hand. These funds will also provide liquidity.

You can, in your later years, also systematically withdraw the sum (called systematic withdrawal plan), thus providing you with some monthly income. Put down at least 5 per cent of your retirement proceeds in liquid funds.

If that's a hassle put them in a savings account of a bank that pays reasonable interest. Interest on savings account up to Rs 10,000 is now tax free.

BUILD WEALTH

The above options can account for 80 per cent of your retirement funds. The remaining fund can be used to build wealth.

The NSC is a good option, especially if you want to save tax. Large-cap equity funds, balanced funds and fixed maturity plans of mutual funds can also form part of this.

If you are a pensioner, you can go for the above options, with some modification. Keep your income-generating portfolio to a maximum of 60 per cent. Invest 20-25 per cent in equity and balanced funds through SIP and the rest in debt funds and fixed maturity plans.

Choosing how to invest your pension is a complex task. Here's some guidance to help you through the maze.

If it's true peopleretiring in 2012 will be far less affluent than they were in 1980, you'll want to make sure your pension is poised to produce the best possible return. But deciding how to invest yourpensionis a far from simple task so here I'll go through the key factors you'll need to consider.

But, let's look at the basics first. When you open a pension you'll be asked where you want your money invested and you'll usually be expected to choose from a range of investment funds. A fund is simply a pooled investment which combines money from thousands of individual investors which is then invested on their behalf by a fund manager.

If you don't make a selection your money will usually be invested in the scheme's 'default' fund. But that's unlikely to be the best choice for you. When it comes to pensions, one size certainly does not fit all!

So it pays to consider your investment options more carefully. But how do you know which funds are a good choice? Well that largely depends on how old you are, your attitude to risk and your investment objectives.

Most funds invest in one or more of the four major asset classes: cash, fixed-interest bonds, property and shares. Let's look at each of these in turn. First up....

Cash

Cash is the least risky asset class because the capital you invest is guaranteed with interest earned on top. However, your capital is at risk from the effects of inflation (rising prices) and an interest rate which could fall.

Because cash is a safe bet don't expect a phenomenal rate of return. Generally, the lower the risk you take, the lower the return. But if you're within say, 10 years of retiring it's a good idea to move some of your pension out of higher-risk assets and into cash to protect its value before you take the benefits.

Fixed-Interest Bonds

A bond is essentially a loan to a bond issuer. In other words, you're lending money to the bond issuer who pays you a fixed rate of interest in return. There are two main types: gilts and corporate bonds. Gilts are issued by the Government while corporate bonds are issued by companies.

Bonds are deemed to be lower risk because there's some security provided by the fixed interest rate. But again, the potential for growth is restricted. As with cash, older investors may wish to move some of their pension fund into bonds as they approach retirement to help preserve its value.

Property

In the context of pensions this relates to commercial property such as offices and retail space, not residential housing.Propertyfunds are higher up the risk scale than cash and fixed-interest bonds.
Traditional property funds own a portfolio of properties which are rented out to tenants to provide you with a yield as well as capital appreciation if the value of the properties rises.

Property funds play a valuable role within a pension portfolio because property has a low correlation with shares. This means the two types of assets are influenced by different factors and often don't behave in the same way which means your investment is more diversified.

Of the four assets types, shares are considered the most risky because values can rise and fall very quickly. But they have the greatest potential for capital growth over the long-term which makes them a suitable asset for a pension which often runs for several decades.

If there's still at least 10 years remaining before you retire, I would suggest your pension is invested heavily in share-based funds to provide the maximum growth potential over the coming years.
Just be careful your pension portfolio isn't too concentrated in one 'flavour of the month' investment fund. If you'd bought a technology fund just when the tech boom hit its peak in February, you'd have been pretty fed up two or even five years later. At The Fool we've usually argued that anindex tracker fundis the best way to go.

An index tracker fund invests in all the companies quoted on a share index with the objective of mirroring - or 'tracking' - its performance. In other words, if you invest in a FTSE 100 tracker fund, your money will be invested in the top 100 UK companies and if they perform well, your investment will rise in value too. But don't forget the reverse is also true. You could combine a UK tracker with say, a global tracker to further balance-out your investment.

So that rounds up your main investment options. These days, it's a challenging time for pensions as all asset classes appear to be suffering. Bonds produced a negative return in 2006 while cash scraped in at less than 0.5%. The performance of UK shares lately has left a lot to be desired. And the property sector has definitely run out of steam for now. That said, try not to be too influenced by short-term returns. After all, pensions should be treated as a particularly long-term investment!