How Can You Use Mutual Funds to Build Your Retirement Portfolio? – Forbes Advisor INDIA
Mutual funds have become popular asset classes for accumulating funds for various financial goals, one of them is retirement. Careful planning coupled with careful investment in mutual funds can help you build a large retirement body that can help you easily meet your post-retirement needs.
While you would have achieved most of your financial goals by the time you hang up your boots, you need a body of work that can outlive you. With improvements in medical science, your retirement life could well last up to 15 to 20 years and more. Therefore, your corpus should be large enough to help you get through this period without a hitch.
Here’s what you need to know about investing in mutual funds to build a portfolio for retirement.
Benefits of building a retirement portfolio through mutual funds
Mutual funds are among the most flexible financial instruments available. They give you the ability to increase your investment with increased income and withdraw funds as needed.
If you can keep up with market movements, you can invest in direct plans to save on commissions. You can also switch from a poor performing fund to a better one if necessary.
The Securities and Exchange Board of India (SEBI), the regulatory body guiding investment in mutual funds in the country, has introduced several measures to make investing in mutual funds more transparent and user-friendly. investors. Measures such as the categorization of funds and the introduction of the new risk meter aim to make investing in mutual funds more transparent.
Mutual funds are tax-efficient financial products because their after-tax returns are high compared to other financial instruments. Long-term capital gains (LTCG) of equity funds above INR 1 lakh are taxed at 10%. In the case of debt funds, a 20% LTCG tax is levied after indexation, which reduces the acquisition cost and thus reduces the final amount of the tax.
The universe of mutual funds is vast. You can invest in a variety of funds depending on your post retirement needs. If you start early, you can opt for equity funds to build your retirement corpus. As you get closer to your goal, you can switch from stocks to debt to protect the gains from erosion due to market volatility.
Mutual funds help you diversify your portfolio. Your money is invested in different companies in various sectors. Diversification is an important principle of investing and it helps balance the risk-return equation.
Factors to keep in mind when calculating the retirement corpus
This is the most crucial factor to consider. Inflation reduces the value of money over time, and what may seem good today may not be enough tomorrow. For example, suppose your monthly expenses are INR 1 lakh today and you have 10 years left until retirement. Even modest inflation of 5% will push this amount to 1.6 lakh INR.
Assuming your post-retirement expenses are 70% of pre-retirement expenses, your monthly expenses would be around 1.1 lakh INR. With an expected rate of return on investment of 8%, you would need a corpus of 1.7 crore INR to generate a monthly income of 1.1 lakh INR.
If your retirement life lasts 25-30 years, you would need a corpus somewhere close to the INR 3 crore to ensure you have enough in your cat to lead a stress-free retirement life.
This is another vital consideration. Often, after retirement, people want to leave an inheritance to their legal heirs. If you intend to do this, you may need a larger body of work.
Medical expenses are a large part of a retiree’s expenses. Therefore, it is essential to have enough provisions in your corpus to cover these costs. While a medical contingency can wipe out your savings in no time at all, the level of difficulty worsens in your retirement life as there is a break in working income.
All you have is the retirement corpus to build on and if that wears out due to a medical emergency, spending the rest of your life in retirement can be quite difficult. Therefore, it is best to create a separate fund to cover medical expenses or to make your cat large enough that they can absorb the shock of a large medical bill.
Steps to Building a Retirement Portfolio Using Mutual Funds
After calculating the amount you need as a retirement corpus, you can choose the systematic investment plan (PAS) route to accumulate the amount you want. SIP is a method of investing in mutual funds whereby a fixed amount is invested in the fund you choose on a specific date. The amount is deducted from your bank account and invested in the fund.
How many SIPs do you need?
The amount of SIP you need to build your retirement fund depends on the time horizon and the expected rate of return. Suppose you need to build a corpus of INR 3 crore and your investment period is 10 years. Assuming the rate of return is 8%, the SIP amount you need would be just over INR 54,000 per month.
However, if your investment horizon is 30 years, that amount would drop considerably to just over INR 6,000 per month. Thus, the greater the investment horizon, the lower the amount of the SIP. Therefore, it is prudent to start accumulating funds for retirement through SIPs as early as possible.
Starting early gives your money more time to grow and brings the power of compounding that has a multiplier effect on wealth.
Benefits of SIPs
The constitution of a corpus and a retirement portfolio guarantees a long-term commitment. In other words, you have to stay invested for a long period of time. As SIPs can help you start small, starting at INR 1,000 per month and the money automatically deducted from your savings account and invested, it imbues a disciplined saving habit. This is very essential to create funds for retirement.
- Average cost gain in rupees
This is another important advantage. SIPs help you buy more units when the markets are down and vice versa. It ultimately allows you to earn more units and average the purchase cost over time.
- Create wealth through the power of composition
A disciplined investor’s best friend, SIP is one of the most effective ways to beat market volatility. After a while, it brings into play the power of capitalization which has a huge impact on wealth creation.
Investing in stocks to beat inflation
When building your portfolio and your retirement corpus, you can first opt for SIPs in equity funds. Indeed, in the long term, investing in these products can help you generate returns above inflation. In other words, investing in equity mutual funds can help you build a large enough body to counter inflation, which decreases the value of wealth over time.
Go into debt when you are close to your goal
As you get closer to your goal of nearing retirement, you should slowly switch from equity mutual funds to debt funds to prevent the corpus from becoming depleted due to market volatility. Debt funds are relatively less risky than stocks.
You can do this by setting up a systematic transfer plan (STP). In an STP, you periodically transfer specific units from one mutual fund to another within the same fund company. Thus, you can gradually move from stock units to debt securities at regular intervals. STP helps you rebalance your portfolio from time to time.
Choosing mutual funds to build a retirement portfolio
Whether you choose an equity fund or a debt fund to build your retirement corpus and portfolio, there are a few things you need to consider. Some important factors are:
Check the underlying holdings of a fund and make sure they are strong enough. Check the sectors and companies in which the fund invests. There are many websites where you can find information about a fund and its underlying holdings.
Before investing in a retirement corpus building fund, consider its long-term performance. See how consistent he has been in delivering the returns. It will also help you understand how the fund may have contained the declines when the markets did not perform well. It is advisable to consider eight to ten years of performance before making the final choice.
- Performance against benchmarks
Another essential point is to check the fund’s performance against its benchmark. It is advisable to choose a fund that has managed to consistently outperform its benchmark. On the other hand, if a fund cannot do this for a long time, it is better to avoid it.
- Fund manager experience
The experience of the fund manager is important. Check how long the manager has been at the head of the fund. Among the many factors that have a direct impact on the performance of the fund is the call taken by the fund manager. Better to opt for a fund whose manager has managed it for a long time.
Building your retirement corpus and portfolio with mutual funds is a simple and easy process. Get started as early as possible, as this not only gives your money more time to grow, but also makes changes halfway through in case things don’t please you. Keep a maximum of three to four funds, as too many funds will make it difficult to monitor the portfolio and dilute returns.
Also make sure that the funds are different when it comes to their underlying holdings, as funds with the same holdings will only inflate your portfolio. They will not bring you real diversification. Get the help of a financial planner on your trip who will guide you with the right advice to make informed decisions.