Saving for retirement has a very long-term investment horizon and equity-based assets could be a good choice Who does not dream of having a peaceful time during their sunset (retirement) years?

For this, most people invest a portion of their earnings to build a robust retirement corpus. However, there is always a debate on whether one should invest in equity or debt while saving for retirement. The latter (debt) school of thought is orthodox and is based on the belief that one should not take risks while saving for retirement. The former (equity) is based on historical asset class trends which indicate that equities may provide higher returns over the long run. Further, the asset class also helps to stay ahead of inflation when one retires. Inflation would cause the biggest difference between expenses now and post retirement.

Treat retirement as a specific goal

In fact, one must treat retirement as a specific goal and invest accordingly. Just like provident fund (PF) is deducted since the first salary, one must start investing in equities via mutual funds since their first pay cheque. Systematic Investment Plans or SIPs in equity funds would enable regular and disciplined savings as well as help to beat inflation by providing higher returns in the long run.

Just like the PF contribution increases with salary, one must aim to increase the SIP contribution every time there is a salary hike. One could follow a simple rule of thumb and allocate an equal amount towards SIP as is the contribution towards PF (both by employer and employee). Of course, the more the merrier. Besides SIP, one may also look at a few more avenues to have a larger retirement corpus like investing a portion of the annual bonus / incentive (if any) in an equity fund earmarked for this goal. A part of the saving in an ELSS (Equity Linked Saving Scheme) fund, which currently provides tax exemptions under Section 80C of the Income Tax Act, 1961 could be another stream of possible inflows towards the retirement kitty.

One may also have a casual conversation with retirees to get an insight into the expenses post retirement, mainly to gauge the impact of inflation. They would perhaps give you examples of how day-to-day expenses have grown over the past three to four decades since their first employment. These discussions could provide greater insights into the importance of retirement planning.

How to estimate actual retirement corpus?

While it may be difficult to estimate the actual retirement corpus, one may extrapolate current expenses and pad them with an assumed inflation rate to arrive at a tentative retirement corpus to get a broad idea. One can then work backwards and arrive at the monthly investment needed to reach this amount. It is also important to bear in mind that under no circumstances should an SIP be stopped as it would reduce impact on the final corpus as the power of compounding and rupee cost averaging works well if investments are regular.

Follow a Glide Path

Equity, however, is a volatile asset class wherein some years may be extremely good in terms of returns while some could be lack luster. To ride over this, one must invest a higher amount in equities at a younger age and gradually reduce equity allocation as retirement nears. This is called a glide path by which one is protected from the extremes of equities closer to retirement by gradually but regularly moving equity allocations to comparatively less volatile fixed income products.

This can be done through Systematic Transfer Plans (STP) offered by mutual funds which can regularly transfer investments from equity to debt funds. Also, one need not completely exit equities but may have a marginal allocation during retirement depending upon one’s capacity to bear risk. For regular expenses during retirement, one may start a systematic withdrawal plan (SWP) from the portfolio by specifying a fixed monthly amount. Accordingly units will be redeemed and the equivalent amount credited to the bank account every month. By withdrawing a fixed amount from the retirement corpus, one can also bring in spending discipline.

Summing Up

Saving for retirement may be incomplete without investing in equities as it helps to provide higher inflation adjusted returns. Inflation would cause the biggest difference between expenses now and post retirement. Mutual funds could be one of the avenues to invest in equities through their Systematic Investment Plans (SIPs). One must try to save from the first pay cheque and aim to invest a similar amount in SIPs as your PF contribution (both from employer and employee) every month. It is equally important to raise the SIP amount following any salary hike. Besides SIP, one may also invest on an adhoc basis like allocating a portion of the annual bonus/ incentive to enhance the retirement kitty. While there are calculations to arrive at a tentative retirement corpus, it would still be prudent to invest as much as possible and have a larger disposable surplus to tackle any exigencies during the retirement phase. Lastly follow a glide path as you near retirement.

This article is dated December 16, 2014. Information contained in this article is not a complete representation of every material fact and is for informational purposes only. Regulatory/ taxation details, if any are provided on a best effort basis and are as per the existing laws and subject to change from time to time. The recipient is advised to consult an advisor/ tax consultant prior to arriving at any investment decision.