A certain part of the corpus has to be invested in equity to ensure growth, says Uma Shashikant.
The question about equity investment in retired investor’s portfolio never really goes away. It comes back in many forms. Isn’t it risky? Does it not put one’s life’s savings in harm’s way? Wouldn’t it not be tough to rebuild any loss?
There are at least three much repeated reasons to include equity. First, a retired investor’s wealth must be armed to fight inflation. Without a growth asset like equity, an investor might be left to earn a small rate of fixed interest income that may barely cover inflation.
Second, investors might discover that the corpus they have accumulated falls short of their post retirement needs. This may be because the money was conservatively invested in fixed income products, even in the accumulation stage. Or because it was drawn to meet other financial goals. Or because the retirement needs were grossly underestimated. Without equity investment, the portfolio may not have a chance to grow and appreciate in value.
Third, if a retired investor plans to utilize the income alone and leave the corpus behind for the next generation or consume a portion and leave behind the rest, the investment must match the age, risk and needs of the beneficiary. A conservative fixed income portfolio will grossly reduce that inheritance. Unless the retiree plans to utilize all the corpus in his or her lifetime, this mismatch will persist.
Most retirees know and have heard these arguments. They are also aware of the falling interest rates and the low income their deposits and bonds are offering. But they cannot come around to taking the decision to actually invest in equity. Why is it so? What can be done to help them diversify their portfolios and add a much needed growth element that equity offers?
First, equity investment should not be equated with day trading on stocks. Many hold a poor opinion of equity investing as they liken it to gambling. Recklessly handed out tips, news about irrational rise and fall of stock prices, and the unexpected twists and turns make many think of equity as risky and unpredictable.
While there is no denying that equity is a risky investment, trading or gambling are not the only ways to participate. For some stocks that sway precariously, there are others that belong to solid businesses that grow and prosper over the years. Equity investing can be undertaken as a long-term investment in the business prospects of well managed businesses. Taking the time to see how the top 100 stocks have behaved over time can show how real businesses have gained immense value with time. The case for equity cannot be appreciated without this understanding.
Second, the choice of investment vehicle leaves many retired investors wary. If one should hold stocks, how does one choose them? If one must buy equity mutual funds, which is the appropriate one from so many names? What about the schemes and plans that get routinely peddled to just retired investors with a corpus to invest? How does one choose?
Retired investors, especially if they are a first time investors in equity, should only choose the best for their equity investment. Just the top names in the equity market will only do. The choices then are between two types of products – index funds that invest in the top stocks; or blue chip large cap equity mutual funds. There is no need to add and spike this choice with risky products that venture beyond this subset of equities.
Return from equity investing is delivered only when one invests in a diversified portfolio of stocks; not from individual picks. Return from equity is protected when this portfolio is managed to throw out the non- performers from time to time; this is best done by professionals. An index fund or large cap equity fund just fits this bill. It only holds the best stocks, and it ruthlessly discards what is not top notch. A retired investor must know that product choices can be simplified if they apply themselves to it. They should also take comfort from the fact that a bequest is valuable when it holds the best stocks.
Third, how much should be in equity? Even if a retired investor is convinced about investing in an equity index to earn the benefits of growth offered by this portfolio, how much should one invest? There are so many theories about the right proportion. One advocates keeping two years’ expenses in cash; five years’ expenses in fixed income and the rest in equity. The buckets are replenished by moving from equity into the other two as needed. The problem is that such an approach may end up putting a large portion of one’s wealth in equity, a risk a retired investor may find tough to bear.
The proportion to invest in equity should be primarily guided by risk evaluation. There is no denying that equity markets will move up and down, modifying the value of the retired investor’s wealth. Many don’t want equity investments for just this reason. Which is why ascertaining with some confidence how much of short-term swings can be tolerated for long-term growth, is essential.
A retired investor knows that they won’t be using all of their corpus at the same time. They know that some portion would remain stashed away from use. Assume for example that portion is 50 % of the corpus. Assume it is invested in equity. Also assume that it can lose 80% of its value if the equity markets crash. That means a 40% loss of corpus. Too steep.
The computation to run is how much of loss can a retired investor take in their stride while using the rest of the corpus without panic. Knowing fully well that what has dropped in value is not going to be used, and that it will get restored with time is critical. If that number is 20 %, that is the maximum loss on corpus that one can tolerate, equity allocation thus cannot be over 25%. Make that personal estimation and stick to it. Some equity allocation is way better than none.
How about operational details? Invest a lump sum? No. Staggered participation is easier on the mind. Should one book profits? No. The equity portfolio is already being actively managed. That will do. Should one time the market? No. There is no science to that activity.
Retired investors should consider equity investments so the money they currently don’t utilize grows and the value is available to them and their heirs. Nothing but a diversified portfolio of blue chips will check the box for quality. And nothing more than a proportion that allows peace of mind through market swings.
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By Uma Shashikant (The writer is Chairperson, Centre for Investment Education and Learning) By ET CONTRIBUTORS | May 24, 2021