Investing VRS funds -- Creating the right retirement portfolio

Suresh Krishnamurthy

IN THE first part of this article, hedging, insurance and diversification for retirement investing were discussed. In this part, we take a look at the investment opportunities and the factors to be kept in mind in creating a portfolio.

Generally, in the equity area, investors would be better off restricting themselves to mutual funds. Investors can also choose balanced funds to fine-tune their portfolio. In the debt category, there are several opportunities, such as 100 per cent debt-oriented mutual fund schemes; the pension plans of LIC, which are essentially annuities; small savings schemes of the Government, including the PPF; bank deposits; and corporate fund mobilisation programmes, such as fixed deposits and bonds, including bonds offered by financial institutions.

Suitability the key

It is important to remember that the suitability of each of these investment opportunity varies. None of these assets is wholly suitable or wholly unsuitable for an investor. Essentially, it is the suitability of these instruments to an investor that determines whether a particular investment finds a place in his portfolio. This factor must also be borne in mind in the allocation of weights to a particular asset.

Equities and balanced funds

Equities are an ideal asset class to beat inflation over the long term. Over the short term, however, they are quite unreliable as a hedge against inflation. Equities are suitable for investors whose corpus, in relation to their monthly expenditure needs, is fairly large.

Since their corpus is relatively large, and since they can look for their debt investments to take care of their regular expenditure commitments, they can invest in equities to ward off inflation. Also, investors who are relatively young and already have a job to take care of their immediate expenditure commitments should allocate a portion of their portfolios to equities, essentially as a measure to tackle inflation over an extended period.

Still, investments in equity should not be made with any particular term horizon in mind. Investments in equities (direct or through mutual funds) must be made with a perspective to book profits as and when the returns exceed more than a target percentage and not in accordance with any rigid term horizon.

Also, as the value of equities changes, their weights in a particular portfolio also change. It is important to keep track of these weights to determine whether the exposure to equities needs to be pared down or hiked. If these weights are not kept track of, there is a possibility that the original asset allocation would have changed substantially to your detriment.

One way to automatically keep these weights in check is to opt for the dividend option. And, as and when a dividend is declared, it can be invested in debt schemes. This way the proportion of equities can be brought down. However, this can only minimise the problem and cannot altogether do away with the changing proportion of equities.

For example, when stock prices drop sharply, the proportion of equities in the portfolio also declines. It would, thus, be important to book profits in the debt category and invest the proceeds in equities. The procedure of booking profits in equities or debt has to be done periodically -- either every six months or annually -- keeping in mind the tax implications. It is certainly difficult to maintain a portfolio with exposure to equities but it needs to be done.

Annuities, the chosen ones

In a retirement portfolio, the pride of place goes to annuities. Annuities are regular payments which may be equal or increase with time. Annuities may be for a fixed period or for life. They can also be structured such that the payments or a portion of the payments continue after the investor's death. Annuities can also be deferred -- where the payments start after a wait period. They are generally offered by insurance corporations.

Annuities are offered by the Life Insurance Corporation. It has three policies in force -- Jeevan Suraksha, New Jeevan Akshay and New Jeevan Dhara. Called pension policies, these instruments offer an investor a great deal of flexibility in structuring his retirement portfolio. An attractive feature of these policies is that the income received in the form of annuities is tax-free.

The LIC pension policies offer an investor varied choices:

*policies come with or without risk cover, though agents may be reluctant to sell policies without risk cover.

*Policies come with options for return of purchase price or without return of purchase price.

*In a return of purchase price policy, investors get a lumpsum at the end of period for which the payments are in force.

*In the case of without return of purchase price, when the payments end, there will not be any lumpsum payment.

It is important to note than when the choice is for a policy without return of purchase price and also when the annuity is to be paid only for a fixed period, it is important for the investor to set aside a portion of the annuity -- say, 15-20 per cent -- and reinvest it in cumulative investments.

This way, at the end of the annuity period, there would still be some capital left for the investor. This would be useful to either live on in later years or to bequeath to someone special.

Differs for different folks

The choice of a particular annuity depends on the investor. A person who is about 45 years old would go in for a deferred annuity policy. And one over 55 and in need of regular income would opt for a policy that starts paying annuity immediately. In the case of a person aged 55 or more, the choice of annuity for life or annuity for a fixed period should depend on life expectancy.

After 60 or so, the ability of an investor to manage his portfolio without help would have diminished considerably. In such a backdrop, an investor who does not have a family set-up to fall back on would be better off assigning a higher weight to a policy that pays annuity for life. The particular percentage would, again, depend on the investor's profile and preference.

Debt schemes and other options

At this point in time, the returns offered by fixed maturity options from top-rated corporates are much lower than that offered by the government small savings schemes. Adjusted for risk, the returns are downright unattractive. They figure in the universe of investment opportunities only to achieve a degree of portfolio diversification.

*In this backdrop, investors would be better off investing in debt schemes of mutual funds to get exposure to top-rated corporates. By investing through funds, investors could get the benefit of any portfolio churning that the flow of funds necessitates. Investing in debt schemes of mutual funds is anyway essential for diversification.

*The exposure to such floating rate schemes partially protect the investor from the reinvestment risk that an investment in a fixed-maturity scheme exposes him to. The feature of liquidity that a mutual fund offers is also a powerful factor in their favour.

*For getting exposure to fixed maturity schemes, investors can generally restrict themselves to government small savings schemes and a few bank term deposits that offer attractive returns. Bonds of fixed deposits of corporates can be considered only if they offer attractive returns. *The PPF is suitable for an investor who would like to cumulate his investments over a fairly long period. Tax considerations alone need not dictate investments in PPF. The post-office monthly income schemes are, on a risk-adjusted scale, the best monthly income option available to an investor.

*For exposure to fixed maturity schemes, investors can generally restrict themselves to government small-savings schemes and a few bank term deposits that offer attractive returns, including bonds or fixed deposits of medium-term cumulative investment option.

This is the second and concluding part of the two-part article, the first part of which was published on January 28.

Pic.: The State Bank of India local headoffice at Chennai.

Picture by Bijoy Ghosh