India is facing a retirement crisis and it could become a lifetime financial headache for many. This crisis has been brewing for the last few years due to a combination of sub-par economic growth and poor salary increments inadequate to cover inflation. The crisis has, however, now come to a head following the Coronavirus (COVID-19) pandemic that has upended the entire economic and financial framework of savings and retirement.
There are three aspects to this crisis. First is the loss in income due to the pandemic, which makes it tough for people to save for retirement. Second, saving options are shrinking for those who are approaching the age of retirement, or have just retired, due to a sharp fall in interest rate on fixed income instruments such as bank & post fixed deposits and government bonds.
And third, there is a cash flow challenge for senior citizens who largely survive on the savings pot they had accumulated over their working life. Most of it is invested in fixed deposits but decline in interest rates means that the returns now fail to cover the annual rise in cost of living due to inflation.
Inflation is the year-on-year rise in prices of goods and services that we use, be it foodstuff, cloth, fuel & power, children’s education or health care. Historically inflation in India has hovered between 6 and 7 percent per annum on average.
Planning for this was a little easier until two years ago as the interest rates on fixed deposits and government bonds were higher than inflation. For example, the government of India now offers 5.8 percent interest on its 10-year bonds, down from 6.6 percent in January this year and 8 percent two years ago.
So what can be done in this macroeconomic environment? A lot, if one is willing to change track and become an active saver and investor.
1. Many of us will now have to raise the level of savings to ensure a bigger pool when we retire. This means cutting down on lifestyle expenses like holidays, travel, expensive gadgets and even fashion. This is the time to prioritise essential and truly living expenses over those that provide us pleasure or raise our self-esteem. This may mean some down trading in terms of brands and products that we usually buy.
2. Put money in savings and investment instruments that offer higher yields. Young people can opt for corporate fixed deposits that offer upto 8.5 percent interest on a 5-year deposit. These are mostly offered by non-banking finance companies that are riskier than plain vanilla bank fixed deposits. (Read: 10 Best FDs in India right now). Older people and those close to retirement are advised to opt for relatively safer options such as RBI Savings Bond 2020 or Bharat Bond ETF 2020.
3. Corporate Bond Funds by large mutual fund houses are also an interesting option for investors. Bond funds from popular fund houses such as HDFC, ICICI and Kotak Mahindra and Aditya Birla Sun Life have given 7-9 percent annualised returns in the last three years, which is quite attractive for investors who find equity too risky. However, unlike FDs, bond funds carry interest rate risks and returns fall when interest rate rises and vice versa.
4. Bond Funds are also more tax efficient compared to bank fixed deposits. Interest income from bank fixed deposits is treated as another income and taxed at the same rate as your regular income. Gains from bond funds are however adjusted for inflation, also called indexation benefits that reduce tax liability and provide higher levels of post-tax returns.
5. There is no escape from equity. As interest rates decline, an exposure to equity becomes important to push-up yields on your overall portfolio and beat inflation alongside. As a thumb rule, equity or stock markets do well when interest rates decline and vice-versa. And this has been the case in the last 5 to 6 years.
6. Younger investors can take risk with growth stocks in sectors such as banks and non-banking finance companies (NBFCs). Older investors and those close to retirement are advised to stick to cash rich companies with a safe balance sheet and good dividend-paying record. As we highlighted in the past, a good steadily growing dividend paying company is a neat way to earn steady cash flows if one is patient and can stay invested for 5 years or more.
According to a recent study by Business Standard newspaper, India’s top listed companies distributed nearly Rs 1.91 lakh crore worth of dividend for the year ending March 2020, up 6.5 per cent over the last year.
There are still many stocks with juicy dividend yields of 5 percent or higher. Many of them will also suit retired people looking for steady cash flows and moderate capital returns or at least help in inflation protection.
7. Lastly, have some exposure to gold as a hedge against inflation and economic uncertainty. Anyways, gold has outperformed all other asset classes in the last two years and most experts expect it to do well given the currency debasement by central banks and the global economic uncertainty. From a portfolio approach Indian investors are currently over invested in equities and under-invested in gold. The yellow metal should be 15-20 percent of your portfolio right now.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
Also Read: How to invest in gold for maximum returns