Debt returns take a knock

It may be a good time to either increase allocation to fixed income or move money to equities

It may be a good time to either increase allocation to fixed income or move money to equities. TINESH BHASIN & SANJAY

For people close to retirement, it is bad news. For the first time in 30 years, the interest rate on the Public Provident Fund (PPF) has gone below eight per cent (7.9 per cent now). Recently, the Employees’ Provident Fund Organisation (EPFO) also slashed its rate by 15 basis points (bps), to 8.65 per cent. State Bank of India’s fixed deposit (FD) for five years or more now fetches a meagre 6.25 per cent interest annually. With many people depending heavily on fixed income instruments to save for retirement, declining interest rates mean they need to fine-tune their strategies.

There is some good news, though. Inflation is also not rising; therefore, real returns aren’t negative. With the average FY17 consumer price index at 4.53 per cent, real interest rates on offer are positive for now.

However, investors need to take one of the following two measures. “Either step up investments in debt or make a few portfolio changes to tide over the lower returns,” says Steven Fernandes, founder, Proficient Financial Planners. Returns on debt instruments have fallen by at least one percentage point over the past year, and even more in the case of FDs.

Bhushan Anand, a 54-year-old bank employee, is worried about his ~8-lakh worth of FDs that will mature between May and June. The average annual interest rate his FDs pay is close to eight per cent. Anand wants to reinvest these for six years (until he retires), after which he plans to transfer the funds to the Senior Citizens Savings Scheme. At eight per cent, he would have made ~12.69 lakh. At 6.25 per cent, he will end up with ~11.51 lakh, a difference of ~1.18 lakh. “Investors are today facing reinvestment risk — the risk of their fixed-income instruments maturing at a time when interest rates are on the lower side,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, an investment advisor registered with the Securities and Exchange Board of India (Sebi). Investors need to ladder their FDs (have them mature at different times) to avoid this. The changes you need to make to your portfolio will vary, depending on your age.

Nearing retirement:

Individuals in this segment are going to be the worst affected. Three-four years before retirement, they need to start moving money from equities to debt to avoid market volatility. Like Anand, many prefer FDs over debt funds, as the returns on the former are fixed and the capital is protected. While debt mutual funds are more tax-efficient over the long term and could offer slightly higher returns, they are volatile. “The best way to increase return on investments is to keep some equity in the portfolio, and not move entirely to debt,” says Suresh Sadagopan, founder, Ladder7 Financial Advisories. Allocation to equities depends on a person’s risk appetite. It can be as low as 15 per cent for conservative investors or as high as 40 per cent for those well-versed in equities. “No matter how aggressive the investor is, we don’t advise going beyond 40 per cent in equities close to retirement,” says Sadagopan.

How much exposure you should take to equities should also vary according to the income you will require post-retirement. If you need to use your entire portfolio to generate income, you can opt for monthly income plans (MIPs), which invest 1525 per cent in equities and the rest in debt. In the past year, these funds have given an average return of 12.43 per cent and over five years, 10.28 per cent annualised.

If you can put away a portion of your portfolio for five to seven years, you should look at equity balanced funds. Later, as inflation rises and your income is then not adequate to meet expenses, you can do a systematic withdrawal plan from these funds, which deliver better returns than MIPs over the long term. Financial advisors suggest withdrawing up to 10 per cent of your investments in a year. Investing for five to seven years will ensure the returns accumulated over the period are able to give you a consistent return, irrespective of market conditions.

Many individuals receive pension post-retirement or have property that gives them a fixed income adequate to meet expenses. Such investors can look at large-cap or multi-cap funds with a horizon of over seven years. Invest in equities through a systematic transfer plan to ensure investment at different market levels. Transfer the money from an ultrashort-term fund to an equity fund over six to 12 months.

If you are in the 40s: As you have over 10 years to retire, increasing your equity allocation by 5-10 percentage points is one solution. If you are aggressive (60 per cent or more in equities), increase it by five percentage points. Those with 40-50 per cent allocation to equities could increase it by 10 percentage points.

Investment advisors say individuals in this group should get out of FDs that are fetching returns lower than eight per cent and move the money to debt funds. “An investor should rely on debt funds such as corporate bond funds. But, be wary of credit risk. Tax-free bonds are another tax-efficient alternative,” says Anil Rego, founder and chief executive officer, Right Horizons.

If you are in the 20s or 30s: Falling interest rates should not affect investors in this category much. “Such investors should stick to the asset allocation they have decided on. Cyclicality in interest rates mean things will even out for them over the long term,” says Raghaw. Adds Prateek Pant, head of products and solutions, Sanctum Wealth Management: “Investors in this age group should allocate 100 per cent to equities in their retirement corpus and only look at adding debt in once they are in their 40s.” The EPF and PPF automatically takes care of the debt requirement.