Managing Portfolio In Retirement Years:

Retirement period is considered to be a new beginning for an individual. It is the time to unwind and pursue hobbies, which you were not able to pursue due to lack of time during your working life. Whether to plan vacation to unexplored locations or pursue the hobbies of gardening or photography, what is required to make your retired life a pleasurable experience is proper asset allocation of your retirement fund.

Your post retirement period on one hand is the most relaxing period of life after putting long years of working life and also on other hand it's a period when fresh income will stop and you will have to

Manage with whatever retirement corpus you have generated during your working life. With higher life expectancy, increasing cost of medical treatment and double digit inflation, life has become more challenging for a retired individual.

As we already now, the interest rates have been on a downward trend for few years now. The government would want to bring the interest rates in line with the market rates on government sponsored saving schemes like PPF, Postal Schemes etc, with some premium for retail investors. The post tax return from the traditional investment avenue of bank fixed deposits is also very low. Inflation, coupled with rising medical costs and lower interest rates leaves little option to retired individuals in terms of investment instruments, which can generate decent inflation beating, post-tax returns.

Consider Inflation Monster:

During working life, the inflation effect more or less get nullified as your income grows in line with the inflation rate but during retirement, inflation eats into your savings as you no longer have a growing income. So it becomes essential that your portfolio generates inflation beating return.

Lets consider that your monthly expense when you retire at the age of 60 is 25,000 per month. With inflation of 8% this will grow to 1.16 lakhs per month by the time you turn 80 years of age. So obviously your retirement kitty must earn return over and above 8% just to keep you floated and in today's environment there is perhaps no fixed income debt product, which can give you above 8% post tax return.

Add Equity Flavour to Your Portfolio:

We have always emphasized that long term equity is the only financial asset which can give you the most tax efficient inflation beating return. Although it comes with its own share of volatility but you can't escape from having equity flavour in your portfolio if you want your retirement kitty to provide for your post retirement years. It must be noted that the post retirement years can easily extend to 15-20 years.

We have also emphasized on the importance of having long term investment horizon when it comes to equity investment as duration increases, volatility comes down substantially. Thus the investment horizon is long enough for a bit of equity exposure. The quantum of equity exposure depends on the requirement and the amount of retirement kitty already available.

Importance of Asset Allocation:

There is no doubt that debt should be the major part of the your portfolio. The equity component should be only that kitty which you are unlikely to consume in the next 7-10 years. Normally, a component of 10-25% would suffice if you have a decent retirement kitty. Please note that the equity component must strictly be need driven.

The important thing to remember is to maintain proper asset allocation between equity, debt and physical assets (say real estate) during retirement years. Taking exposure to equity through diversified equity funds or balance funds are advisable rather than going for buying equity shares directly from the market. Having ideal allocation between these three asset classes can protect you from potential downside of equity and generate inflation beating return. Further, the asset allocation would slowly reduce on the equity component as you age and should ideally be nil by the time you reach say 70 years.

Use Transaction Options Effectively:

Mutual Funds offer two different kinds of options to investors. Systematic Withdrawal Plan (SWP) and Systematic Transfer Plan (STP). During early years of your retirement you can let money grow with your equity component and then gradually either start withdrawing profit component as annuity or start transferring to liquid funds to protect your portfolio from potential equity downside.

Doing STP/SIP in Retirement Years:

This may sound little strange on face of it but remember that on retirement an individual gets large

sum of money as retirement funds. This entire fund is not going to be used at one go. After keeping aside funds equivalent to meet the first 3 or 5 years of expenses and after investing pre decided component in debt, rest of the funds can be put in liquid/short term category of funds and STP can be done to diversified large cap funds. Remember that STP works on the same principles of SIP and generates similar benefit of rupee cost averaging to investors.

Conclusion:

The awareness on the need for retirement planning has increased in recent years. There are large number of individuals who want to retire early, even as early as late 40s. In such a case, the traditional age mark of 60 years no longer holds true for many of us. With sound planning, proper asset allocation and a bit of aggression can go a long way in making sure that your peaceful retirement years are sustained for long.

As families seek to improve their financial situation and develop plans for the future, a logical first step is to determine their present financial position. A common tool used to determine same is the net worth statement which is a personal balance sheet listing the assets and liabilities of the household, with total net worth being the difference between the two. However, there is a lot we can know about our portfolio than just this measure. We would encourage investors to do an annual assessment of their financial situation to understand the same and to also chalk out a plan for progress for the future. In this issue, we will talk about the wealth of information which can be gleaned from a personal financial statement than just the bottom line.

Usage:

Application of the ratio analysis technique to personal financial offers potential in expanding insight into specific strengths and weaknesses of a family's financial situation. The ratios are presented below with indications of how each ratio might be used to assess liquidity, solvency, or the general financial position of a particular investor/family. The information should provide more specific directions in assisting the client to develop financial goals. A ratio typically expresses a relationship between two or more data points /information /parts of the financial statement and provides a context in which to evaluate various aspects of the financial situation.

Key Ratios:

1. Emergency Funds - Liquid assets / monthly expenses: Liquid assets are those assets which can be easily sold/liquidated and quickly converted to cash without any loss of value. This ratio provides insight into the adequacy of liquid asset holdings to cover monthly expenses if the family experiences a sudden loss of income due to loss of income for any reason. This ratio may be modified to include financial assets which are not in ready liquid form but could be easily redeemed and converted in cash.

   Financial experts typically suggest at least 3 to 6 months of coverage depending on the situation, assets covered, income stability, the number of dependents, and so on. The higher the ratio, the better it is for families.

2. Debt Exposure - Assets /total debt: This ratio examines the relationship between assets and the total debt obligation of the family. Please note that which assets to be included here is of primary concern. If you only include liquid assets, the ratio will indicate how easily you could close off and repay all your debt. However, you could also include all your redeemable financial assets in addition to liquid assets. In such a case, it would show a different picture of your debt ratio. Together these ratios help in determining whether the family has overextended itself or has maintained a debt level within reasonable limits given the family's level of assets.

   Experts suggest that a ratio of say at least 10% (assets as % of the debt) and above should be comfortable when only liquid assets are considered. When total financial assets are considered, then 30% may be considered a minimum level to indicate a healthy financial situation. If you are only considering long-term asset creating debt like home loans, then again the ratio of 10% should be acceptable.

3. Net Debt Position - Total debt/ Net worth: Normally the debt position of a family is not evaluated unless the situation is extreme. This ratio expands our understanding in assessing the debt position of the family by relating total liabilities to total net worth value. Experts recommend that families should keep this measure below 1.0 or 100% meaning that that total debt should never be more than your total net worth. However, if a family has recently purchased a long-term debt, like home loan, this ratio may go a bit higher in initial years. During such times, you could exclude that home loan debt and other such asset-creating long term debt and look at the ratio again. Experts suggest that in such a case, your debt should not be more than 40% of your net worth.

4. Debt servicing ratio - Monthly debt liabilities / Net income: The debt servicing ratio measures how easily you can service your debt. In other words, it is the ratio of your EMI to the net income. You must never let the total debt obligation cross 40% of your net income. The less it is the better. The idea is that the rest of the 60% has to be adequately saved for consumption and savings. However, this ratio for most individuals living in urban areas may touch dangerous levels of even over 80%. Increase in EMIs compromises your lifestyle and your ability to secure a better future through savings. One should aim to move from a situation of high debt and low savings to a situation of no debt and high savings as your age/income increases.

5. Liquidity of Portfolio: Liquid Assets/Net Worth: This measures the proportion of total net worth held in liquid form. This type of net worth component ratio should be evaluated after considering the family's financial goals rather than as an objective standard. If the majority of the goals are of short term or near to maturity, then the proportion of liquid assets should be higher. However, if you are having long term goals not anywhere near to maturity, your assets should be held largely in non-liquid assets like say equities. The reason being that such assets will provide better returns than liquid assets. Thus, it is up to the financial advisor /family to ascertain the right/optimum portion of liquid assets in your net worth.

   One can further modify this ratio to also include all financial assets in addition to liquid assets as part of the total net worth. This ratio would indicate if you are investing too much in non-liquid and financial assets like gold, property, etc. One may think of ensuring a good balance between financial and non-financial assets with more bias to the former.

6. Savings Ratio - Savings / Net income: This ratio is used to show you how much money you are saving over a specified period. It is strongly advised to have a savings rate of at least 10% to 20% of your net income. The higher the number, the better it should be. In times when you do not have any debt EMIs or other expenses, one should be shrewd enough to let this ratio grow as much at possible. The equation should be calculated as income (-) savings = expenses whenever you are planning your monthly budget. Making the most of your available cash-flow and directing it towards savings is very essential as times may change in future when savings may not be that easy.

Conclusion: While there may be many more ratios for understanding personal finance, the above ratios are the key ones that help you understand your portfolio construction, your security and your savings behaviour better. Do not just stop at looking at net worth or the current value of your investments. Go beyond, take some time out, at least a couple of hours every month to calculate and track the trend of your personal finance ratio. Believe us, it will do wonders to your knowledge and your financial situation.

Most of us, if not all, are in a journey from scarcity or deprivation towards financial well-being and ultimately financial freedom. A big part of financial freedom, to me, is having your heart and your mind free from the worries for the needs & necessities in life. Most, like me, may have traveled many years in search of this elusive freedom but are yet to reach a point where anyone of us can jump and say, “Hurray! I have made it!!”. Worse still, we do not know for sure if we would say that line even once in our lifetime. This uncertainty was disturbing. What is the point then in slogging for decades in our work if we could not be financially free? What was that I was doing wrong? Was I on the wrong path? The questions where simple but profound and had to be answered. But sooner than later, the realisation was thankfully clear to me.

We have all perhaps, spent too much criticizing all factors external for what we do not have today. Whether it be business, salary, markets, friends, family, our advisors and so on. Rarely do we realise that it is only our decisions and actions in our past that has led us to what we are and what we have today. That's the only true fact. It is our own experience, our own mistakes and the lessons from our past hold that now hold the key for our future. Understanding these lessons, some from our own and some from other's lives, can help us take control of our journey towards financial freedom. So let us pause for a moment and recall our own important lessons of life. Here are a few lessons that I could recall,

TIME NEVER COMES BACK:

Time is the most important resource that we have in our hands. One could always make and loose money and again make some money but time once gone cannot be bought back. To know, that we have only limited productive years of our lives remaining before us, is humbling.

Worse, what's the point of financial freedom at an age when you are too old to do anything exciting? The lesson was that we had to make the most of whatever time we have and we have spend and plan time as our most valuable resource. The time we have now is more precious than it was at any time in past or will be in future.

IT IS EASIER TO AVOID DEBT THAN PAYING A DEBT:

Ajay, a friend, had a decent job with good salary. But even after years of working, had no wealth created. It turned out that he had three loans – home, personal and vehicle loans that he was repaying apart from the fat credit card bills that hit his salary account regularly. It was clear, Ajay was not investing in his future but was still paying for his past. Ajay still continues to toil in his old job when he could have done so much more! Apart from the financial hit, being in debt often makes us feel suffocating, discouraging and makes us avoid taking any risk in our lives. And that perhaps costs a lot lot more. The lesson learnt was to avoid getting into debt and spending only on what we needed rather than what we desired or wanted. Even if debt could not be avoided, it was better to reduce to the maximum extent possible, especially when it came to depreciating assets.

NOT BELIEVING IN THE POWER OF COMPOUNDING:

Long back I remember hearing the stories of wealth creation by investing in equities over 15-20 years in time. I also distinctly remember reading about SIP and mutual funds and the power of compounding over long time. Today, when I look at the returns for the past 10-15 years given by some equity mutual fund schemes, I often think of the great wealth that I had missed creating all this time. It is amusing that neither me nor my bank balance remember where I saved or spent the money that I had during all these years. The one regret I now have is that I should have invested more and more to the extent I could have in equities and had the patience to hold the investments all this time. I could very easily have been an example of wealth creation myself. The lesson learnt, and the hard reality is that, the power of compounding in equities is true and it is only me that stopped it becoming a reality in my own life.

QUICK MONEY IS LIKE A MIRAGE:

Vijay, another friend, I remember invited me to join a plantation scheme of some company in north India. But Vijay was not alone and I often got to hear of many other schemes to invest into and get high returns. Some networking schemes promised to make me millionaire faster than any else could. Mind you, these schemes were very popular and some are even today. While I was fortunate to have not invested heavily into these schemes, my friend Vijay and a distant relative did loose a lot. Last heard, a panwala in my locality who had recently closed shop; was running a chit fund and he disappeared overnight with over s2.5 crores! The lesson that I fortunately learnt very early in my life, at a small price, was that promises of quick money making schemes are seldom true. It is always better to trust and invest in legal and governed financial products, even if the promise is not too high rather than to invest in dreams and unsolicited avenues. What puzzles me more now is why people like Vijay and that distant relative had so easily trusted these schemes while shying away from equities all the while?

I HAVE TO TAKE CONTROL:

Looking at the past, I also realise that I have procrastinated many decisions and never took control at the right time I should have. The reasons that I can find and justify today are only of lethargy, indecisiveness and the general lack of a vision or a goal in future as a compelling force to take timely action. Fear, lack of knowledge or resources or operational issues turns out to be the least important reasons today even though they might have resulted into many decisions being not taken. On procrastination, I find that many decisions that I chose to procrastinate, even for few days, ended up being extended into months and some were even never taken. Lack of vision or financial goals in life is another big reason why most of us find ourselves still looking for answers to fund those goals. The lessons learnt are many here but they all boil down to one thing. We need to take control of things NOW else everything else will take control of us, day by day, each day.

CONCLUSION:

Life is the best teacher if we want to learn, be it financial matters or otherwise. Peeking into my past experiences has only made me realise this and made me more humble. Today, when I look back, I believe it was not the right decisions or the intelligent ones that I made but the wrong ones and those decisions that I did not make which are more responsible for my present. The timeless principles of investing – start early, save regularly and save in right asset class instantly come to my time. They sound very grounded and appear golden today; somewhat matching the shade of hair colour on my forehead. Perhaps, had I trully believed in them long before I started colouring my hair, I could have afforded my own hair stylist today.

- An Experienced Investor.

Following are some tips which can help you in building and managing your Emergency Fund:

Ask your advisor: Your emergency fund must be sufficient to meet emergencies. Contact your financial advisor and give him the details of your fixed and variable monthly incomes and expenses, including EMIs, leisure, medical expenses, credit card payments, etc. He will help you in determining the amount you need to keep aside for emergencies. He will also guide you with respect to the assets you should invest in, as an emergency fund will serve its purpose only if can be liquidated easily in case of an emergency.

Keep it separate: You must always keep your emergency fund isolated from your normal savings account. This will help you curb the temptation to withdraw your emergency fund for your usual or recreational expenses. An emergency fund is supposed to meet emergencies only, it should not be used on new clothes, vacations, casinos, etc. Because if you use it now, you will not be left with anything then.

Cut down the unnecessary expenses: If you feel you are not left with enough money after your monthly expenses and other investment commitments, and hence you cannot start investing for an emergency fund.

Think again! Yes you can, there are many things you spend on every month, time and again, which you don't even require. The expensive shoes and clothes you buy, which you seldom wear, the gold and silver you buy only to stack in your locker, and the like can be exchanged with bringing in mental peace and stability into your life.

Use unusual income: Most people plan to buy the latest gadget or go for a vacation when they are expecting their annual bonus, or a sudden gain, or sale proceeds from old furniture or other household

items. But you as an investor must set priorities, and providing for emergencies would definitely occupy a higher position than purchasing the latest 55 inch LED TV. So, use your next bonus in contributing to your emergency fund.

Invest Regularly: Like your other monthly installments of expenses and investments, make it a habit to invest for your contingency fund regularly. You must keep aside a fixed sum from your monthly income dedicated towards emergency. This is a good approach as you may not be getting big surprise money any soon or you may not have lump sum money to invest plus it builds discipline in saving and investing.

So, the bottomline is reach your advisor and build an emergency fund. Remember it is an 'Emergency' Fund and shouldn't be touched unless an emergency happens. Follow the above, with discipline, perseverance and a little extra commitment, you can protect yourself and your family from the unlooked-for emergencies. The emergency might not happen in the next twenty years, but when it does, you'll be happy to look back that you took this decision this day. Remember your family's future is dependant on you.

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