Can senior citizens get both safety and high returns from their retirement portfolio?
This article provides an alternative to the usual safe investments that retirees choose vs growing their wealth without taking market risk themselves.
Can senior citizens get both safety and high returns from their retirement portfolio?
Posted on 22 Dec 2024
Author: Sayan Sircar
9 mins read
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This article provides an alternative to the usual safe investments that retirees choose vs growing their wealth without taking market risk themselves.
📚 Topics covered:
- Can senior citizens get both safety and high returns from their retirement portfolio?
- The magic triangle of investing: safety, liquidity and returns
- Option 1: Invest in Real Estate
- Option 2: Invest in Stock Markets via Mutual Funds
- What are the benefits of implementing either of these plans instead of investing in safe investments?
Can senior citizens get both safety and high returns from their retirement portfolio?
I ran this poll on Social Media:
Imagine your father retires from active service and gets ₹50 lakhs as retirement benefits: PF, gratuity, and NPS. Does he need:
- Money in retirement?
- Money from safe investments in retirement?
Most of the votes favoured the second option.
The nuance between the above two questions is the premise of this article.
Let’s assume that being financially savvy, you successfully make them avoid the pitches from the LIC agents. But your father is risk-averse and wants to park most of that amount in a mix of SCSS, Post Office income schemes (POMIS) and senior citizen FD earning a blended 8% (say) return (around ₹33,333/month).
Related:
How can children help their retired parents to set up their finances?
What is the problem here?
The capital invested does not grow while the interest gets spent. If this plan continues for 5 years, then the capital stays at ₹50 lakhs, but even a modest 7% inflation cuts the value of the capital from 50 lakhs to ₹35 lakhs. (1.07 ^ 5 = 1.4, 50/1.4 = 35)
Now even with 8% interest, your father gets only ₹23,333/month after adjusting for inflation. It gets worse from there without requiring you to pitch in more and more to supplement their income as the years pass.
In this article, we will cover two ways to get around this problem of losing the growth on the original ₹50 lakhs of capital.
Note: Contribution of the child to the parent’s household expenses is unavoidable in many cases. We will structure it better. In the rest of this article, we will assume that a son is looking for options for investing his father’s retirement portfolio. The same logic, with minor modifications, will apply to a daughter.
But first, we will explore the concept of the magic triangle of investing.
The magic triangle of investing: safety, liquidity and returns
There is a general saying in choosing investments. Out of
- safety of capital
- inflation-beating returns
- liquidity (where you can take out the money anytime)
you can generally choose two of the three. This magic triangle is a subset of our broader RRTTLLU framework where we evaluate investments on Return, Risk, Time, Tax, Liquidity, Legal and Unique circumstances.
For retirees and senior citizens the common investment options are:
- fixed income investments like SCSS, Post Office Schemes, Bonds and FD: High safety with lower-than-inflation returns
- variable return investments like stocks (dividends and capital growth), mutual funds and other similar investments: Lower safety with potentially inflation-beating returns
- real estate with rental income and capital growth: Compromises liquidity to get fairly safe regular income and appreciation with low returns (vs. inflation) unless the house is sold
This article will propose two options to short-circuit the magic triangle to ensure inflation-beating returns without compromising safety and making liquidity considerations immaterial.
Of course, one of the first things to do before even starting to create a retirement portfolio is to ensure that both parents have adequate health insurance via a trusted agent who offices are in the same city to help with claims.
Option 1: Invest in Real Estate
We will consider the case that the family i.e. the son and his father will together invest in a new property to live (for the son along with their spouse and family) or for rental income. What we propose is that:
- the retiral proceeds, barring some amount kept for liquidity and emergencies, be invested in a property as the down payment
- the son takes a home loan and pays the EMI
- the son also pays the ₹33,333/month to his father and increases the amount by 7% (i.e. inflation) every year
The price of the house will depend on the down payment and enough home loan for what the son can spare as the EMI plus the home contribution amount. We can work out the house price like this:
- The income of the son (and his spouse) is ₹2 lakhs/month
- The maximum EMI allowed for a home loan is ₹80,000/month (40% of the income)
- ₹80,000/month EMI implies a ₹80 lakh home loan (15 years at around 9%)
- the cost of the house is then ₹1.3 crores which comes from ₹50 lakhs (from the father) and ₹80 lakhs as a home loan
- The total monthly outlay of the son is then ₹80,000 as EMI and ₹33,333 as home contribution
For an apples-to-apples comparison, we will have to offset the impact of the son not having the ₹50 lakhs down-payment amount already saved.
To ensure that the parents’ assets are protected, the ownership of the house can be registered as one-third with the father, mother, and son.
Benefits:
- The parents’ retirement corpus is used to create an asset for the family
- The son lives in his own house (that will eventually pass on to him) earlier than planned
- The parents receive inflation-indexed amounts every month to take care of their expenses
Other considerations:
- The plan moves inflation risk to the son’s income
- The house to be purchased should be ready to move to avoid a period of both rent and EMI being paid
- The son should pay off the home loan via a step-up EMI in line with salary increases If the child is a daughter, one small change will be to approach a bank for a home loan that approves such loans for property held jointly with parents. All banks do not.
Option 2: Invest in Stock Markets via Mutual Funds
If the son doesn’t wish to take up the burden of the home loan or if a real estate purchase is not immediately planned then investment can be an option.
Here the plan will be:
- Invest the entire proceeds into equity and debt mutual funds for the son’s retirement goal
- The amount invested will be in the name of the father and mother with the son as the nominee
- The son starts paying the 33,333/month 7% inflation adjustment to the parents
- His monthly SIP, which he would have done otherwise reduced by this amount
Benefits:
- This plan moves the risk of the stock market moving up and down from the parent to the son
- The father retains ownership of the retirement corpus since the mutual fund investment is in his name
- The son gets a massive head start over retirement since the 50 lakhs lump sum will get a lot more time to compound vs. the 33,333/month step-up SIP it is replacing
Related:
Building Generational Wealth through an Alternative Retirement Portfolio Planning Technique
Considerations:
- If the parents are not used to stock market investing, the initial period of volatility will unnerve them
- It is good to reiterate that irrespective of market movements, their monthly expenses are never at risk
To implement either of these options in practice, you need two things:
- A good deal of open and honest communication about money, with professional guidance if needed
- A level of trust and understanding, enforceable via wills and legal documentation to implement either plan
The implied return from the mutual fund investment for 30 years, based on the initial monthly amount needed from the retirement corpus (and 7% inflation) is shown below:
| Initial amount | MF Return |
|---|---|
| 5.0% | 9.5% |
| 6.0% | 11.0% |
| 7.0% | 12.4% |
| 8.0% | 13.7% |
In our example, the son needs to get 13.7% from the original lump sum investment since he is contributing 8% of the starting ₹50 lakhs every year. While this return expectation is on the higher side, if we assume that Indian markets will continue the bullish tendencies of the last few decades then quite possible. If you drop the time duration to 20 years, the MF return requirement drops to 11.5%.
What are the benefits of implementing either of these plans instead of investing in safe investments?
Safe investments do not grow capital since their return is lower than inflation. Given that retiral benefits can often be substantial, it is better to find ways to ensure that such a large amount of capital is not wasted. We will implement the following rules:
- Rule 1: Invest only in inflation-beating assets: both houses and stock markets will beat inflation
- Rule 2: Expenses come from cash flows and not via investing: the capital has time to grow instead of being first slowly and then quickly consumed for expenses
- Rule 3: Continuous income coverage via risk transfer: Market risk in both plans gets transferred from the parent to the child who has a much longer time horizon for income and therefore can take more risks
- Rule 4: Reducing interest income lowers taxes on withdrawals: interest income is always taxed at the slab rates. By not having any interest payments and no withdrawals at all from the portfolio, there will be minimal taxes payable
Related Articles
- Building Generational Wealth through an Alternative Retirement Portfolio Planning Technique
- How can children help their retired parents to set up their finances?
- Should you sell your mutual funds to buy a house?
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This post titled Can senior citizens get both safety and high returns from their retirement portfolio? first appeared on 22 Dec 2024 at https://arthgyaan.com
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