Weighing Mutual Fund Options For Senior Citizens

Safety of capital, growth above inflation, regular income and liquidity are some of the primary concerns for those senior citizens who want to derive returns from their mutual fund investments. Is this possible? Yes, it is, as is made evident through this article by Rakesh Deshmukh that analyses the investment scenario for the elderly. 

Mutual funds are becoming increasingly popular and are considered a promising investment avenue, especially for those of us in our younger years when time is on our side. As young investors, we have the luxury of investing consistently and remaining patient, knowing that we have decades ahead of us to achieve our financial goals or plan for retirement. But the question remains—are mutual funds equally beneficial for senior citizens? [EasyDNNnews:PaidContentStart]

As we age, our risk tolerance decreases significantly compared to our younger days when a steady flow of salary made it easier to take on higher-risk investments. For senior citizens, not only does the ability to work diminish, but so does the capacity to take financial risks. Worrying about potential losses in volatile markets can cause stress and sleepless nights, especially when relying on the hard-earned savings from one's working years. 

The mutual fund schemes we typically choose in our younger days, such as those with high equity exposure, may not be suitable for our parents or elders who are approaching or have already entered retirement. Their primary need is capital preservation and a steady income stream, rather than aggressive growth. 

The key to mutual funds lies in long-term commitment, patience, consistent investment, and the power of compounding. While compounding works better in the long term, after attaining senior citizen status, this type of long-term investing may not be possible for everyone. So, the question is: are there any mutual fund options for senior citizens? In this article, we will explore and find the answer to help you plan for your loved ones who are approaching retirement or are already retired. 

Investment Goals for Senior Citizens
The first and the most important step investors should consider is finding the objective and goals for which they are investing. We as young investors invest money with specific goals in mind, such as a child’s education, an overseas trip, buying a house, starting a business, marriage, buying a car, and so on. But what would be the goal for senior citizens, who have likely already fulfilled these responsibilities by the time they reach retirement age? 

For senior citizens, the key financial goals should be:
■ Safety of Capital - The first and the most important goal is to prioritise low-risk investments that protect the principal amount, minimising the chances of financial loss.
■ Growth Above Inflation: While safety is paramount, it’s equally important to ensure that investments grow at a rate that exceeds inflation. Inflation erodes purchasing power, meaning the same amount of money buys less over time.
■ Regular Income: In addition to safeguarding capital, senior citizens often require a consistent source of income to meet daily expenses and maintain their lifestyle. Regular income ensures financial security and peace of mind in retirement, covering living costs without depleting the principal amount too quickly.
■ Liquidity: Liquidity refers to how easily and quickly investments can be converted into cash without significant loss in value. Senior citizens need access to their money for emergencies, healthcare costs, or regular living expenses. Liquidity becomes a crucial factor at this stage, so investments should be easily convertible to cash. Unlike real estate, where selling property can be cumbersome, mutual funds offer the advantage of easy liquidity, allowing investors to sell their holdings with just a few clicks at any time anywhere, round-the-clock. 

Fixed Deposits as an Option
In the past, people were not as focused on their money and investments. The most common options for senior citizens were fixed deposits (FDs), post office schemes, and annuity plans. Both FDs and post office schemes were popular for their guaranteed returns, and for a steady income, they often chose annuity plans, where they invested a lump sum or made regular payments. In return, the insurer would provide a fixed or variable income, either immediately or starting at a future date. 

Problem with FDs
Let's say you retire at the age of 60 with a corpus of ₹1 crore and invest it in an FD at a rate of 7 per cent. Your yearly expenses are ₹5 lakhs. You also must consider the inflation rate, as over time, inflation will erode the value of your money. For this scenario, let's assume a 5 per cent annual inflation rate. In the first year, your interest would be ₹7 lakhs, and the withdrawal would be ₹5.25 lakhs, leaving a corpus of ₹1.0175 crore at the end. By age 70, inflation-adjusted withdrawals would exceed what you earn in interest on your remaining corpus. 

By age 80, these inflation-adjusted withdrawals would be almost three times what you earn in interest. When you turn 84, you will be able to make your last full withdrawal to meet your annual expenses. However, by age 85, you would face a shortfall of ₹10.33 lakhs. If interest rates decrease, this shortfall could occur as early as age 80, leaving you unable to cover your retirement expenses. 

Relying solely on a fixed deposit may sustain you for about 20 years of retirement. However, beyond that point, you would not have enough money to live stress-free. This is a serious concern, but one that can be avoided with a well-balanced investment plan incorporating both fixed income and equity. Furthermore, we have not yet factored in Income Tax. If we do, you may deplete your funds even earlier than in the scenario described above. 

Age Factor – Key to Effective Asset Allocation
The core idea behind age-based asset allocation is that your exposure to investment risk should decrease as you age. This concept primarily applies to the proportion of equity in your portfolio, as equities tend to offer higher returns but come with greater risk. A simple rule of thumb for determining your equity allocation is to subtract your current age from 100. This suggests that as you get older, your portfolio should gradually shift from equity investments to more conservative options like Debt Funds and fixed-income securities. 

For example, if you are 25 years old, 75 per cent of your portfolio could be allocated to equities, with the remaining 25 per cent in debt and fixed-income investments. Let's say you are 60 years old. In this case, 40 per cent of your investments should be in equities, with the remaining 60 per cent in safe, conservative options like debt funds and fixed-income securities. Within the 40 per cent allocated to equities, it is important to choose funds with moderate to lower risk. At this age, it is not advisable to invest heavily in Small-Cap funds, which involve high volatility and higher risk. 

Now, let’s adjust the traditional thumb rule. When you turn 70, the thumb rule suggests allocating 30 per cent of your investments to equities. However, this 30 per cent is applicable if you already have experience with equity funds and some existing investments, regardless of their risk category. If you do not have this experience, it is wiser to reduce the equity allocation to 15 per cent, with the remaining 85 per cent invested in conservative options. The same modification applies when you turn 80. Instead of allocating 20 per cent to equities, invest just 10 per cent in equities, with the remaining 90 per cent in safer options. 

Mutual Funds Options for Senior Citizens
Contrary to common belief, equity is essential for retirement planning. It helps generate income that adjusts for inflation. For a corpus of ₹1 crore, you should consider investing around ₹40 lakhs in two to three well-chosen mutual funds. Spread the investment over two years to average out the purchase cost and mitigate the risk of entering the market at a peak with a lump sum investment. Here are the options for mutual funds that will make up 40 per cent of your portfolio: 

Balanced-Advantage Funds - Also known as dynamic asset allocation funds, these are a type of Hybrid Fund that invest in both equity and debt instruments. Unlike equity and debt funds with fixed investment mandates, balanced-advantage funds adjust their equity and debt allocation dynamically. Typically, these funds allocate more to equities and less to debt during market downturns, and shift towards debt when the markets are strong. This dynamic approach aims to capture potential gains and mitigate losses in volatile equity markets, making these funds popular with investors. 

Large-Cap Funds - Investing in equity mutual funds is generally advisable if you have an investment horizon of more than three years and can handle moderate to high levels of risk. For senior citizens, large-cap funds can be suitable option as they are less risky compared to other equity mutual funds. These typically offer returns in the range of 12-15 per cent and have a lower risk of capital erosion over the long term. They also help to counteract the effects of normal inflation in the economy. 

Equity Savings Funds - These funds aim to strike a balance between risk and return by investing in a mix of equities, derivatives, and debt. Derivatives help reduce the exposure to equity market fluctuations, lowering volatility and contributing to stable returns. The equity portion offers growth potential, while the debt and derivative components provide steady, stable income. Typically, these funds allocate 65-100 per cent of their assets to equities and 0-35 per cent to debt, creating a diversified strategy for investors seeking moderate risk with consistent returns. 

Conservative Hybrid Funds - These funds allocate 10-25 per cent of their total assets to equity and equity-related instruments, while the remaining 75-90 per cent is invested in debt instruments. The primary goal is to generate stable income from the debt portion, with the smaller equity allocation providing an additional boost to overall returns. This option is ideal for investors seeking better returns than traditional debt funds, but who are also willing to take on a small amount of extra risk for potential equity gains. 

Low-Risk Mutual Funds
When it comes to low-risk mutual funds, they are designed to offer stability and minimal risk while aiming for consistent, steady returns. Here are the options that will make up 60 per cent of your portfolio:
■ Arbitrage Funds: These funds capitalise on the price difference between equity and derivatives (futures) markets. They invest in both equity and debt instruments to provide low volatility and consistent returns.
■ Overnight Funds: These funds invest in debt instruments with maturities of just one day. They focus on safety and liquidity, making them one of the least risky investment options.
■ Liquid Funds: Liquid funds invest in short-term money market instruments like treasury bills and commercial papers. They offer easy access to cash and are suitable for short-term investments, often providing slightly better returns than savings accounts.
■ Ultra-Short Duration Funds: These funds invest in debt securities with a duration slightly longer than overnight funds, usually between 3-6 months. They offer stability with modest returns, aiming to balance risk and return.
■ Low Duration Funds: These funds invest in debt instruments with a duration ranging from 6-12 months. They strike a balance between safety and higher returns, offering more yield than ultra-short duration funds.
■ Money Market Funds: These funds invest in highly liquid, short-term instruments like treasury bills, commercial papers, and certificates of deposit. They offer liquidity and low risk, making them ideal for short-term financial needs. 

Final Words
The first option is to invest the amount in a ratio of 60-40, with 60 per cent in debt and 40 per cent in equities. Let this investment run for one year, then withdraw your monthly expense at the year-end for whole year. Invest the withdrawn amount into liquid funds and use the systematic withdrawal plan (SWP) method for your monthly expenses. Now, the question is: In what proportion should we withdraw, given that we have decided on the ratio for investment in debt and equity but not for withdrawals? 

You can adjust the withdrawal proportions based on market conditions. If the market performs well after your investment of one year and equity mutual funds provide good returns, you can withdraw more from equities rather than debt funds. You must withdraw in a manner that helps maintain the investment ratio of 60-40, as it was at the age of 60. Conversely, if the market underperforms, use the debt portion or the conservative part of your portfolio for withdrawals, as it may offer better stability and returns. 

The second option is straightforward: invest 40 per cent in high-quality, low-risk balanced-advantage or hybrid funds and 60 per cent in debt funds, and then start a systematic withdrawal plan (SWP) to cover your annual expenses at the end of each year. In this approach, you have less flexibility during market downturns, as the SWP will automatically withdraw the set amount from both the equity and debt portions, regardless of market conditions. 

Apart from these options, you should not forget to keep an emergency fund, which should be around 2-3 times your annual expenses. This fund should be placed in high-quality liquid funds or fixed deposits (FDs) to ensure liquidity in case of any uncertainty. Moreover, SWP in debt funds offers more tax-efficient returns compared to bank FDs. Income from FDs or pension plans is taxed at higher rates, whereas withdrawals through SWP are taxed more favourably. Additionally, SWP allows flexibility, as you can easily stop or adjust the withdrawal amount based on your needs, unlike pension plans. 

Furthermore, longevity risk, which refers to the possibility of outliving your savings or investments, is a critical concern for retirees or long-term investors. This risk arises when an individual's investment corpus may be depleted before the end of their life, especially as life expectancy increases. This is particularly problematic if the investment returns fail to outpace inflation or if the withdrawal rate is too high. 

To manage this risk, diversified investment strategies and careful withdrawal planning are essential. Mutual funds that invest in a balanced mix of equity and debt, such as balanced advantage or hybrid funds, can help reduce longevity risk by offering growth potential and stability. Moreover, consider using a portion of the retirement corpus for annuity plans, which provide a guaranteed lifetime income. To simplify, we have not yet addressed the taxation aspect. It's important to consider the tax implications of your investments carefully.