Most retirees assume that their Fixed Deposits (FD) are all they need after they retire. This could prove detrimental to their financial health. We’ll tell you why.
Two decades ago, conservative investors looked at only traditional fixed income options after retirement, such as Fixed Deposits, since inflation was low while returns were high. For example, the National Savings Certificate (NSC) offered a good 12 per cent and the Reserve Bank of India (RBI) website says bank deposits were about 13 per cent.
As per the study titled ‘Inflation over the Decades’ (authored by Bornali Bhandari, Fellow, NCAER and Rumki Majumdar, Infosys) inflation declined consistently during the period between the early 90s till 2005 and was at 4% – 5%. So, the real return (interest rate on investment minus inflation) was easily 5% – 7%. But things are topsy turvy today with high inflation and low deposit rates. Inflation might become moderate in the coming year but will still be high.
Additional Reading: How Do Interest Rates Affect Inflation?
Deposit rates have already come down to 7%, which in reality are lower still after you factor in the tax charged on the returns. Therefore, it is getting increasingly harder to create any wealth, in the long run, using Fixed Deposits alone. So, what role should fixed income investments such as Fixed Deposits play in your portfolio as a retiree?
These investments basically provide three things – safety of capital, liquidity and regular income to retirees. This means that you should be investing in these investments to (a) shield your portfolio from volatility, (b) maintain liquid assets for use during contingencies, (c) as a stable source of regular income and (d) to save taxes.
Here’s how to use these investments wisely and what else you can do.
First determine what percentage of your portfolio fixed income investments should form. Most times, 70%-80% of a retiree’s income should be invested in fixed income products and should be spread across different investments. This means you should look at other options such as company Fixed Deposit, debt Mutual Funds and Non-Convertible Debentures. You should take into account the Provident Fund (PF) and mandatory benefits that you receive after retirement to determine the asset allocation. Not including them will result in you investing excess money in fixed income options. This will ultimately mean lesser returns in the long run.
The next thing you need to look at is the amount that should be invested in each product. The amounts you need to invest in each instrument should be based on your needs. For instance, those with pension could give priority to higher returns while those with no regular income should look at generating the same. So, based on your requirement, you should invest in fixed income investments that – provide liquidity, give regular income and help save taxes.
Investments with a lock-in (beyond a small percentage) should be avoided. This is because there are higher chances of contingencies during your retirement and you will need more liquid funds than when you were working. For liquidity, you could choose to invest in bank Fixed Deposits. Those with a higher risk appetite could consider debt Mutual Funds. When you stay invested in the long term (more than 3 years), you get indexation benefits for your capital gains.
Fixed Deposits do not give you any indexation benefit. So, investing in debt funds might be a good option as the taxation is much lower than FDs, while the returns are better than that of bank savings accounts. You could also invest in a gilt fund (Mutual Fund that invests in Government securities) now that interest rates are falling. Even though gilt funds are meant for the long term, with falling rates, you could benefit from them within a year. But it is important to choose funds with low or no exit load to maximise your returns.
Additional Reading: Fixed Deposits Or Liquid Funds: Where To Park Your Surplus For Stable Returns?
For those not receiving a pension, creating an income stream should be the first priority. In order to generate an income, you need to invest a lump sum and conservative investors could look at post office Monthly Income Scheme (MIS), Senior Citizens Savings Scheme (SCSS), Mutual Fund Monthly Income Plan (MIP) and bank Fixed Deposits (monthly/quarterly payout).
In order to reduce reinvestment risk, you could split your deposits into different time periods. Currently, bank FDs might provide slightly higher returns then PO MIS but it is expected that PO MIS rates would be better in the coming months as bank deposit rates might go down further. Those with higher risk appetite can choose corporate deposits and Mutual Funds. Mutual Fund MIP is less risky when your investment horizon is 3 or more years.
When you choose corporate FDs, always go in for rated deposits as the credit risk would be lower than that of unrated ones. Liquidity is a big issue. Most companies do not allow premature withdrawal of deposits. Also, there are many firms that have defaulted on interest payments. This is precisely the reason why you should not choose long tenures when investing in company deposits.
Another way you could make higher returns is by reinvesting money which remains idle in your Savings Account. Reinvestment should be done based on the kind of income you receive. Dividend and other income from investments can be reinvested in bank Recurring Deposits (RD). Obviously, for those in the higher tax brackets, corporate and bank FDs might result in greater taxation and they should choose tax efficient fixed income products.
You can use Section 80C of the Income Tax Act for investments in SCSS and 5 year bank FDs to get the tax advantage. You could even consider tax free bonds, available in demat form. These bonds are free from all taxes except the capital gains tax if you sell them in the secondary market.
Tax free bonds issued by government and public sector firms would be ideal for senior citizens and enough to cover the cost of inflation. And even though the Public Provident Fund (PPF) might provide greater tax benefits, it is best to avoid it if you are over 65 years. This is because it has a long tenure of 15 years and liquidity is low. Is there any way you can maximise your tax savings? Retirees should split their investments between self and their spouse’s names in order to have maximum tax-efficient returns.
Additional Reading: Are Mutual Fund Retirement Plans Suitable For You
All in all, there are four important aspects to check when choosing fixed income products after you retire. The first is liquidity. Inability to redeem investments when needed can be the worst thing for a retiree. The second is credit quality and the third is tax efficiency. The fourth is the frequency at which you would receive income. Keeping an eye on these aspects will ensure a peaceful and comfortable retired life.