Invest Smart. Why do retirees invest in MFs?

“The best time to plant a tree was 20 years ago. The second best time is now” — this Chinese proverb may also work well for people living in retirement.

There are various investment options that suit retirees, such as Senior Citizens’ Savings Scheme (SCSS), Post Office Monthly Income Scheme (POMIS), Pradhan Mantri Vaya Vandana Yojana (PMVVY), immediate annuities, bank fixed deposits (FDs), tax-free bonds and mutual funds.

Among these, the traditional options such as SCSS, POMIS and Bank FDs offer stable returns while safeguarding capital. These options provide you maximum protection against uncertainty; however, they offer poor protection against inflation.

Mutual funds provide relatively higher returns and help to beat inflation on a post-tax basis. However, mutual funds are relatively riskier investment options when compared to the traditional products. With mutual funds growing in popularity, many retirees are now willing to park part of their funds in mutual funds. So, why do they do so?

Nagaraje Gowda, a 67-year-old retired private sector employee residing in Mumbai, is relying on debt mutual funds for the regular income to meet his monthly medical expenses. Considering the risk factors of capital erosion pertaining to the mutual fund investments, he has invested only around 25 per cent of his retirement corpus into debt funds.

“Capital safety is the prime concern for me and hence I have allocated a major portion of my retirement corpus to tax-free bonds and FDs,” says Nagaraje. However, he feels that mutual funds, though risky, deliver better returns compared to traditional safe investment. “Though debt funds are exposed to credit risk and interest rate risk, on a post-tax basis, the debt mutual funds are delivering relatively higher returns than bank FD and other fixed income related instruments,” says Nagaraje.

Mutual funds are tax-efficient. Under equity funds (which invest at least 65 per cent in equity), long-term capital gain tax (redeemed after a year) and dividend declared are exempted from tax.

Under debt funds, long-term capital gain tax (redeemed after three years) is levied at 20 per cent with indexation which will be almost nil given its double indexation benefit. The short-term capital gain tax rate for equity funds (if redeemed within a year) is 15 per cent. In case of debt funds (if redeemed within three years), the short-term capital gains are taxed as per the investors’ tax bracket.

Meanwhile, the interest income from fixed deposits is fully taxable. For instance, an investor in the 30 per cent tax bracket will receive post-tax returns of 5.6 per cent from a fixed deposit that offers 8 per cent interest rate. Further, this income is taxed every year even though the investor gets it only after the deposit matures. It also attracts TDS.

Being a conservative investor, Nagaraje is right about his investment decision. However, given that dividends under debt funds are taxed at 28.84 per cent, relying on them for regular income may not be a good idea.

Anil Patil, a 73 -year-old Mumbai resident, has allocated up to 25 per cent of his retirement corpus to mutual funds comprising equity funds, balanced funds and ELSS.

“I prefer mutual funds for steady source of income. I am a long-term investor in mutual funds which have delivered handsome returns. I noticed the investment made in balanced funds withstood the loss well during downtrend,” he says. Anil has chosen dividend option in equity oriented balanced funds for getting regular income.

Retirees have to be careful while selecting the funds as there is no assurance for capital safety in mutual funds. A fund has to be selected based on the risk profile of the individual.

If you are an investor with high risk appetite, equity oriented funds are an option. For investors with medium risk profile, balanced funds, equity savings funds, gilt and income funds are suitable. For those with low risk profile, debt funds like liquid funds, ultra-short term funds, short-term income funds and arbitrage funds are an option.

Every individual has his own risk appetite. A high risk investment is normally associated with high returns. It is always advisable for retirees to stick with a portfolio exposing them to low and moderate risk.

Gurunathan, 60, who retired from BHEL Ltd, Tiruchirapalli, prefers to take a little risk. He has allocated around 15 per cent of his retirement kitty to equity oriented balanced funds and has gone for dividend options to get regular income. His portfolio includes bank FDs and investment in the Pradhan Mantri Vaya Vandana Yojana as well.

Gurunathan is well aware of the risks with regard to equity funds and is now considering switching his investment. “Within the lower taxation regime, equity oriented balanced funds provide relatively better returns. However, considering the uncertainty in the market which is trading at its peak, I plan to switch some part to debt oriented mutual funds,” he says.

Periodical review and rebalancing the portfolio based on the market condition, changes in the investor’s risk level and objective will help to hold the portfolio on the right track to achieve the goals. Gurunathan’s plan to change the asset allocation to mitigate the risk of capital erosion to debt funds is a wise idea.

Dilip Sotta 60, a retiree residing in Mumbai, has allocated around 70 per cent of his retirement kitty to mutual funds including equity funds, balanced funds and liquid funds.

He says that he has invested in direct equity and equity mutual funds as he understands the risk involved in them. He adds that he prefers mutual funds due to ease of operation and better returns compared to other instruments. “My portfolio includes liquid funds which could provide me easy liquidity during an emergency,” Sotta says. His investment in mutual funds is mostly through the direct route.

Liquid mutual funds are relatively low-risk, low-return products which are suitable during times of emergency as the redemption proceeds are normally credited in the investors’ bank account in 24 hours. Many AMCs now allow instant redemption facility from liquid funds up to ₹50,000 to individual investors, enabling them to get money in their bank accounts within minutes.

Retirees can also look at Arbitrage funds, an alternative to the liquid funds, suitable for a short-term time frame between three months and three years. Arbitrage funds score over liquid funds as they are taxed as equity funds (long-term capital gain tax if redeemed after a year, and dividend declared is exempted from tax).

For regular income, retirees could consider the dividend options of relatively better performing mutual funds from balanced (equity oriented) category, which have paid dividend consistently. Please note that paying dividend is not mandatory for mutual funds. They can declare dividends only from their realised profits. Opting for the Systematic Withdrawal Plan (SWP) allows you to withdraw a designated sum of money from a fund at regular intervals.

People with moderate risk who have retired recently could deploy their corpus in equity-oriented balanced funds through the Systematic Investment Plan (SIP) for a time frame of at least five years. Later, they can initiate SWP based on the requirement.

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