etting a strategic orientation to investing is a tough task. Typically, investors become too ambitious about what they want: good return, low risk, capital protection, and access to money at any time. The quest for the best investment choices begins with this question: what is the one thing that cannot be compromised? This is the core investment objective.
After this, strategic investing demands to know the constraints in getting there. The resulting investment plan is a compromise solution because it recognises that one cannot have it all. However, it is strategic because it focuses on what matters the most and seeks to get there. The investors who are about to retire hold a corpus built through several years of work.
They are past their peak income and primarily depend on this corpus for their post-retirement income. Many of them recognise their primary strategic need as a steady flow of income and, therefore, choose fixed income assets.
Bank deposits, government saving schemes and bonds are the popular choices. They believe their decision is strategic and correct because they have chosen on the basis of what they need—interest income, protection of capital and low risk. However, they may have missed a critical point. The single most important objective after retirement is to earn an income that fights inflation.
The fixed interest income from these traditional investments might look good in nominal rupee terms, but inflation is a number that compounds year after year. So, Rs 9 lakh of interest income from a corpus of Rs 1 crore might look more than adequate today, but if inflation were 7-8%, the expenses will double every 10 years. The corpus should double to keep the investor afloat, but since capital protection was sought to earn the interest income, the corpus will remain unchanged.
If the investor lives for 25-30 years after retirement, penury will hit at an age when increasing the corpus in any manner would be impossible to achieve. Investment decisions for the retired investor should take on board this core objective: the corpus should continue to grow and compound in value so that it fights inflation, while the investor draws income from it as required. On the face of it, this is a complex problem to solve.
There are two broad types of assets—those that offer growth in value, but earn a limited income; and those that offer a regular income, but do not grow in value. Growth assets are typically risky since their value fluctuates in the short term, but they appreciate in value in the long term. Real estate, equity and gold are examples of growth assets. The rental yield and dividend yield is tiny, and gold offers no income. However, these assets hold the potential to appreciate in value. Deposits, bonds and saving schemes are income assets.
They provide a regular income, but do not appreciate in value. If the retired investor chooses growth assets, he would be able to fight inflation as his corpus would appreciate, but there would be no income to draw. If he picks income assets, there would be income without the ability to fight inflation. Assume that Rs 1 crore is invested at a fixed interest rate of 8% and the investor hopes to draw Rs 6 lakh a year as expense.
If you consider an inflation rate of 7%, the interest income will fall short of the expense in a short span of five years since inflation would have taken the Rs 6 lakh at the start well past the Rs 8 lakh of annual interest income. The reinvestment of the initial years' surplus will enable the investor to stay afloat for another two years.
There will be a serious shortfall if one considers 25-30 years as the post-retirement period. How does the retired investor attain the core objective of inflation-adjusted income over the years? He should consider the compromises. What can he give up to achieve his strategic objective? The investor should see his expenses as withdrawal from a corpus that is allowed to grow, rather than ask for a regular income and preservation of the principal.
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