Should I forget my Mutual Fund investments for next 20 years and then start SWP for retirement

Firstly, many congratulations on the upcoming addition to your family. Let us now address your questions.

1. What will be the purpose of your real estate investment? Will you invest in a house to earn rental income, get capital appreciation or for your family’s use? If you want to buy a house for your family’s use, then it is not an investment decision; you should take a decision based on your family’s needs. On the other hand, if you intend to stay in our father’s house in the long term, assuming you inherit his house, then a decision to invest in real estate is purely an investment decision. Over the last few years, real estate prices in many parts of India are going through a slump, having fallen by as much as 15 – 20% in some markets. The rental yields of many properties are in the range of 2 – 3%. The rental yield in an expensive real estate market like New York City is around 2.5%, but interest rates are much lower in the US compared to India. In the US the interest rate is less than 2%, whereas in India it is around 7 – 8%. Therefore, if you are looking at just rental income from real estate, there are better and safer investment options for you than real estate. Some people will tell you that, real estate investment is not about rental yield but capital appreciation. For many years, we had capital appreciation, without an in the increase in rental yield and this is the reason why a real estate bubbles have been created in many markets in India, because it shows the speculative nature in real estate investing. In fact many investment experts believe that, as long as there is big gap between rental yield and interest rates, real estate prices will remain depressed in the long term. Therefore, we do not expect substantial capital appreciation, in the medium to even long term, until the “real demand” (not speculative) catches up with the supply. Now coming to your particular situation, since you are turning into / have turned into an entrepreneur, liquidity of your investments should be an important concern for you. Real estate is one of the most illiquid investments. The real estate sector is facing huge over-supply. Construction of many projects are delayed and stalled. If you invest in a project that gets stalled, then your liquidity will be severely hampered, maybe for years together, if you do not find a buyer at the correct price. Mutual funds, on the other hands, are very liquid investments, which you can be redeemed any time, whenever you need cash-flows.

2. Since you are 32 years old, your asset allocation from a personal financial planning perspective, should primarily be in equities. One of the popular rules of asset allocation is the Rule of 100, in which the percentage of your overall assets, to be allocated to equities, should be 100 minus your age. Let us be very clear, what the definition of asset is. In our opinion, asset is something which gives you current cash-flows or will give you future cash-flows. So by our definition, car, jewellery for personal use (or to be gifted in the future) and even the house in which your family stays is not an asset. You should review your total assets, financial and non-financial, and see what percentage of assets is allocated to equities. Some investment experts say that, the rule of 100 is outdated, because we are living longer and have longer retired lives. They recommend the Rule of 120, which the percentage of your overall assets, to be allocated to equities, should be 120 minus your age. By this rule, your asset allocation is quite correct. Further, since you have turned into a entrepreneur, it is important that you separate your business financials from your personal financials. If at any point of time, you have to inject personal funds into your business, treat it like a loan or an equity investment, depending on the nature of your investment.

3. How much money you need for retirement, is dependent on your own personal financial needs and lifestyles. You can check out our Retirement Planning Calculator. You can also check out, our other financial planning calculators, Goal Setting Calculator and Composite Financial Goal Planner Calculator. You can play around with other tools in our Calculator Section, to see if you are on track with your financial planning goals.

4. Let us address the SWP part of your question first. Yes, SWP is the most convenient and tax efficient mode of getting regular cash-flows after your retirement. Please see our articles, Systematic Withdrawal Plans from Debt Mutual Funds give the most tax efficient income and SWP from Debt Mutual Funds give the most tax efficient income over fixed deposits. Let us now discuss, whether you should invest in mutual funds and forget about it for the next 20 years. The answer to your question, in our opinion is, no. There are three reasons why you should continue to monitor your investments on a regular basis, adjust your investments and continue to rebalance your portfolio:-

i. Firstly, how do you know, whether the mutual funds you have invested in are the best funds for the future? Just because, a fund has given great returns in the past, it does not mean it will give great returns in the future as well. Therefore, you need to monitor the investments on a regular basis to see if they are performing as per your expectations. Just like if a fund did well last year, it does not mean that it will do well this year too, at the same time, just because a fund did not do well last year, it does not mean, it will catch up this year. You have to monitor the fund’s performance and see if it is performing consistently well, over a period of time. At time of investing, there is no way of knowing for sure, if a fund will continue to do well in the long term. If a fund is not performing well over a period of time, either in absolute terms or even relative to its peers, you should evaluate the performance of its best performing peers and make appropriate adjustments to your portfolio, from time to time.

ii. The returns of equity and fixed income varies every year. Therefore, your actual asset allocation also gets skewed every year, depending how different asset classes performed that year. For example, let us assume your target and actual asset allocations are 80% equity and 20% fixed income. Let us suppose your total asset value is Rs 1 crore. So at the beginning of year 1, equity is Rs 80 lakhs while fixed income is Rs 20 lakhs. During the year, let us assume equity gives 20% returns, while fixed income gives 8% returns. So the equity value at the end of year 1, will be Rs 96 lacs, while the fixed income will be Rs 21.6 lakhs. Now your asset allocation will be 82% equity and 18% fixed income at the end of the year. This may not be so different from your target asset allocation, but over a few years, it is possible that, your asset allocation gets skewed to an extent that, your actual asset allocation is significantly different from your target asset allocation, which in turn may imply that, there may be a potential mismatch between your actual asset allocation and your risk profile. What is the solution? From time to time, you should rebalance your portfolio, either by shifting from one asset class to another in your portfolio or by readjusting your SIPs to make sure you are investing in the most optimal asset class, as per your own risk profile. How often you rebalance your portfolio should depend on tax considerations, because the tax treatment of equity funds and debt funds are different. For example, if you want to shift from debt to equity funds before 3 years from investment date, you have to pay short term capital gains tax on debt fund returns. Therefore, in such cases, instead of redeeming your debt fund investments and investing in equity, you are better off investing more in debt funds by SIP, than in equity funds. Remember, you start / stop / change your SIPs in mutual funds, at any point of time.

iii. Your asset allocation profile should change as you move closer to retirement. Early in your career, you should have most of your investments in equity but as you move closer to your retirement and other financial goals, like children’s education, marriage etc, you should move a greater proportion of assets progressively towards fixed income, to moderate your risk profile. From time to time, you should optimize your target allocation based on your risk profile (using Rule of 100, Rule of 120 or any other asset allocation rule suitable to your financial situation). How often should you alter your target asset allocation? You do not need to do it every year. You can do it once every 3 to 5 years. You can use hybrid mutual funds to alter your risk profile. You can progressively invest more in balanced funds and later in debt oriented hybrid mutual funds, like monthly income plans.

You need to have a target asset allocation for your retirement. You do not need to zero down on the target asset allocation, at this point of time, because so many thing can change between now and retirement. But once you are past the age of 40 and when you have still 10 years to go till retirement, you should evaluate what your target asset allocation should be for retirement. Depending on your needs then, you should make the appropriate adjustments to your investment portfolio.