How to invest in a target date fund for retirement in India?
This article explains how to create a target date fund to simplify retirement planning in India.
How to invest in a target date fund for retirement in India?
Posted on 01 Mar 2023
Author: Sayan Sircar
13 mins read
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This article explains how to create a target date fund to simplify retirement planning in India.
š Topics covered:
- What is a target date fund?
- How to create a target date fund in India?
- Does this synthetic TDF work as the real one?
What is a target date fund?
A target date fund (TDF) is a mutual fund created for a long-term goal like retirement. They are popular in the US and are not yet available in India. The premise of a TDF is to allow the investor to invest in a single fund tagged to their desired retirement year. They invest in that fund throughout their earning period and then withdraw from the same fund in retirement. TDFs are typically fund of funds, i.e., mutual funds holding other mutual funds.
This article is a part of our detailed article series on Target Date Funds. Ensure you have read the other parts here:
-
How to invest for a single goal using Target Date Funds in India?
This article extends the concept of a target date fund for one-time goals like house downpayment for investors in India.
-
What are target date funds and why do we need them in India for retirement?
This article introduces the concept of the target date fund and explains why they are a good option for retirement planning.
How to create a target date fund in India?
Indian Asset Management Companies (AMCs) do not yet offer a target date fund. This fact means that we will have to create our own. Hereās how to go about it step-by-step:
Step 1: Choose the year of retirement
The year of retirement is well-defined for those in a salaried job. However, professionals like doctors, CAs, lawyers etc., will not have a defined retirement date. Still, they can choose an approximate year after which they will likely scale down their earnings from a peak.
If you are planning to retire early, i.e. go for RE in FIRE, note that the calculations here assume 40 years spent in retirement, which might be too little in your case. Feel free to contact the author directly to understand how to create a TDF for you that will be valid for over 40 years.
Our calculations below assume 40 years spent in retirement. We will take the case of a person retiring in 2034.
Step 2: Calculate asset allocation
Use the Arthgyaan goal-based investing calculator or the web-based calculator to determine the asset allocation of your retirement.
| Retirement year | Years left | Equity % | Debt % |
|---|---|---|---|
| ā„2039 | ā„15 | 60.00% | 40.00% |
| 2038 | 14 | 59.85% | 40.15% |
| 2037 | 13 | 59.55% | 40.45% |
| 2036 | 12 | 59.10% | 40.90% |
| 2035 | 11 | 58.50% | 41.50% |
| 2034 | 10 | 57.75% | 42.25% |
| 2033 | 9 | 56.85% | 43.15% |
| 2032 | 8 | 55.80% | 44.20% |
| 2031 | 7 | 54.60% | 45.40% |
| 2030 | 6 | 53.25% | 46.75% |
| 2029 | 5 | 51.75% | 48.25% |
| 2028 | 4 | 50.25% | 49.75% |
| 2027 | 3 | 48.75% | 51.25% |
| 2026 | 2 | 47.25% | 52.75% |
| 2025 | 1 | 45.75% | 54.25% |
The example above shows that the asset allocation is 57.75% in equity and 42.25% in debt for retiring in 2034. We can create the portfolio in two ways:
- one equity index fund and one debt mutual fund in a ratio of 57.75% to 42.25%
- one aggressive hybrid fund (benchmark of 65% equity and 35% debt) and one debt mutual fund in the ratio of 88.85% in the hybrid fund and the rest in the debt fund. We choose 88.85% in the hybrid fund since 88.85% * 65% = 57.75%.
š How much to allocate to aggressive hybrid fund?
Hybrid allocation = Target equity proportion / 65%
Here 57.75% / 65% = 88.85%.
The hybrid fund allows tax-free automated rebalancing.
Here 57.75% / 65% = 88.85%.
The hybrid fund allows tax-free automated rebalancing.
You can perform rebalancing via switches from the AMC website if these funds are from the same AMC. This feature can vastly simplify the yearly review process.
We can now start a SIP in these funds in the calculated ratio. If there is any lump sum amount that needs to be invested, that amount should also be invested in the same ratio.
šNote: The asset allocation in the table above assumes āmediumā category risk profile of the investor. If your risk profile is more aggressive, then you should choose a fund with a retirement date after your actual one. Conservative investors should choose a fund with a retirement date that is before their actual year.
The calculation above is for investors who are not retired. If you are already retired, you can use this asset allocation:
| Retirement year | Years past | Equity % | Debt % | Cash % |
|---|---|---|---|---|
| 2019 | 5 | 43.72% | 50.03% | 6.25% |
| 2014 | 10 | 41.00% | 52.44% | 6.56% |
| 2009 | 15 | 37.20% | 55.82% | 6.98% |
| 2004 | 20 | 31.50% | 60.89% | 7.61% |
| 1999 | 25 | 22.00% | 69.33% | 8.67% |
| 1994 | 30 | 9.00% | 80.89% | 10.11% |
| ā¤1989 | 35 | 0.00% | 88.89% | 11.11% |
Step 3: Revisiting the portfolio a year later
Since we have two funds in the portfolio, we must rebalance by ourselves after a year of starting. A year later, the investor is still retiring the same year. Therefore, the asset allocation has changed to a more conservative one. Specifically, the original year of retirement was 10 years away. Now it is 9 years away, the asset allocation needs to be, as per the year left = 9 row in the above table to be 56.85% in equity and 43.15% in debt. You need to rebalance your portfolio to reach the new asset allocation, readjust the SIP proportions and move on.
We will repeat the rebalancing exercise at least once a year or preferably after major market movements.
Does this synthetic TDF work as the real one?
We review the positives and negatives of TDFs from our introductory article, What are target date funds and why do we need them in India for retirement?, one by one against the implementation we have proposed above.
Ensuring the positive features of the TDF
Simple:
The main selling point of a target date fund is simplicity ā one fund to invest in, nothing to track and easy to manage. For busy and non-expert investors, both young and old, TDFs work very well.
The main selling point of a target date fund is simplicity ā one fund to invest in, nothing to track and easy to manage. For busy and non-expert investors, both young and old, TDFs work very well.
A single-fund TFD cannot be created in India since no AMC offers it. However, if the investor follows the process described in this article, it is a relatively simple process that needs to be implemented:
- two funds to be chosen
- a review to be performed once a year
If you can locate an out-of-the-box solution that does this, you should use that.
Diversified:
A target date fund is well diversified between equity, debt and cash with a professionally decided asset allocation and glide path that manages risk by rebalancing and moving to a higher portion of safer assets as the retirement date approaches.
A target date fund is well diversified between equity, debt and cash with a professionally decided asset allocation and glide path that manages risk by rebalancing and moving to a higher portion of safer assets as the retirement date approaches.
We have chosen an asset allocation and glide path that offers a reasonable chance of meeting retirement goals per our goal-based investing framework. We will share the results in a future article.
Emotion free:
The fund's asset allocation and rebalancing plan happens without the risk of overaction or inaction by the investor. Since the investor has no role in deciding how to react due to market movements, it reduces the risk of taking the wrong decisions like panic selling or not rebalancing due to inaction or fear of taxes.
The fund's asset allocation and rebalancing plan happens without the risk of overaction or inaction by the investor. Since the investor has no role in deciding how to react due to market movements, it reduces the risk of taking the wrong decisions like panic selling or not rebalancing due to inaction or fear of taxes.
There are two ways to implement a target date fund-based retirement portfolio:
- as a Do-It-Yourself (DIY) investor who implements the entire process, including review and rebalancing by themselves
- as per the advice of a professional who sticks to the review process
Tackling the disadvantages of a target date fund
Customizability:
A target date fund does not allow customization. At best, you can mix 2-3 TDFs to replicate a custom asset allocation to have some limited amount of control on the asset allocation and glide path.
A target date fund does not allow customization. At best, you can mix 2-3 TDFs to replicate a custom asset allocation to have some limited amount of control on the asset allocation and glide path.
The plan implemented in this article is fully customisable per the investorsā requirements like their investing experience, risk profile and goals.
Fund expenses:
Implementation of the target date fund is important from a cost perspective. In India, mutual funds offer tax-free rebalancing inside the fund. However, it is difficult to fund such hybrid funds at lower expense ratios. Most of these funds are also active funds, making it difficult to know what will happen next with the asset allocation due to calls made by the fund manager.
Implementation of the target date fund is important from a cost perspective. In India, mutual funds offer tax-free rebalancing inside the fund. However, it is difficult to fund such hybrid funds at lower expense ratios. Most of these funds are also active funds, making it difficult to know what will happen next with the asset allocation due to calls made by the fund manager.
There are two aspects to the concept of minimising costs. Fund management charges like total expense ratio (TER) and rebalancing charges due to tax are the two primary cost sources in a portfolio.
- if you have separate funds as per asset class, like one equity and one debt fund, then, as per present tax lows, you need to pay tax on rebalancing. You can choose funds with low TER, like index funds, and pay rebalancing taxes
- if you are using hybrid funds for the core of the TDF, then rebalancing inside the fund is tax-free, but these active hybrid funds have high TER
AMC risk:
If you are investing in a TDF, you now have AMC concentration risk since TDF underlying funds are usually from the same AMC.
If you are investing in a TDF, you now have AMC concentration risk since TDF underlying funds are usually from the same AMC.
Suppose you are implementing a TDF of your own. In that case, you can minimise AMC concentration risk by choosing different AMCs for each of the funds. However, if you invest in funds from different AMCs, you must sell and buy in two separate transactions.
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