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Last week, I wrote about the need for retired investors to have a growth component in their corpus to fight inflation. In the financial advisory space, it’s a challenge to convince retired investors to take risks in order to achieve capital appreciation in their portfolios. Many choose a compromised lifestyle and curb their expenses in retirement.
What should they do instead?
There are only two ways to create a large corpus: saving a large part of the income, or investing the saving in growth assets. In a country of savers, the first has been the natural choice. However, the second deserves attention.
An investor who is saving for retirement is trying to replace the human asset with an investment asset that will generate the required income. The salary at the beginning of the earning years will be adequate, but seem too small 30 years later before retirement. Similarly, the corpus and its fixed income at the time of retirement will seem adequate, but become too small 25-30 years into retirement.
This is why the savings set aside for retirement needs long-term capital appreciation. It may be woefully inadequate for the savings deployed in fixed income assets, yielding just about the rate of inflation as annual return, to meet the challenges of retirement. This is why ‘safe’ allocation in the accumulation phase is harmful for the investor’s wealth.
It is not as if savers have not looked strategically at growth assets and inflation adjusted incomes. Many have invested in a second house with the intention of earning a rental income. However, this strategy has its negative consequences. First, many retirees find themselves asset-rich and cash-poor, holding property bought several years ago, which fetches a moderate, inadequate rent. Second, many find it cumbersome to apportion assets among heirs when wealth is concentrated in property. Despite its constraints, the option of creating a rental income is also a choice available only to a small proportion of investors, who may have a higher disposable income, high savings and access to bank loans.
It is for this reason that the mandatory saving programmes for a larger population of investors should include growth assets. The Provident Fund, which is the default choice of the salaried class, has long invested only in fixed income assets, considering equity as risky. It is an injustice to the saving class of ordinary investors that, in the garb of safety, their long-term savings are denied the opportunity to grow in value over time and enable a better quality of retired life.
There is a widespread concern that a long-term goal such as retirement should not be subjected to the risks of growth assets like equity shares. This argument primarily rests on the volatility of stock markets. Stock markets enable entrepreneurs access to risk capital, but their design includes a mechanism for continuous evaluation of businesses based on publicly available information. This not only creates volatile prices, but also triggers bull and bear phases, when investors overreact to information and its implication for the unknown future. To invest in the stock markets is to expose oneself to this volatility.
The risks are further accentuated by the fact that the investor’s need for accessing the corpus might coincide with a bear market, when prices have fallen steeply. There is no choice but to carefully construct an accumulation strategy for building a retirement corpus for an investor. This responsibility lies with the financial adviser. First, the asset allocation needs to align with the investor’s life cycle. Second, the strategic allocation needs tactical tuning so that the downside risks are contained. Third, a careful selection of funds is needed to ensure that the corpus is invested in diversified portfolios that are well managed. This requires skills in fund selection.
Educating and persuading investors to take a strategic view of retirement planning is tough when they fail to pick what is good for them, sticking to traditional choices even if they don’t work. This is a challenge advisers have to take on, especially during these changing times, when today’s investors will retire but not earn a pension, and refuse to seek financial support from their children.
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