Fixed Income Investment Options For Accumulating Retirement Corpus

Fixed Income Investment Options For Retirement

Published: October 10, 2019 at 11:58 am

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Everyone agrees that a good amount of equity exposure is necessary for building a retirement corpus capable of handling inflation when income from employment stops. This can be done via some mix of equity mutual funds and direct equity. What about the fixed income or debt part of the portfolio? Let us consider the investment options available in this space for accumulating a retirement corpus.

There are some considerations before we discuss the choices available. Many have a debt-heavy corpus.  That is most of the assets associated with retirement are locked in PPF or EPF because they did not start investing in equity for many years after starting work. This is an extremely difficult situation to handle and let us consider this first.

For such investors, if retirement is a good 15 years or more away, they should focus on quickly increasing equity exposure by investing only in equity going forward (aside from the mandatory EPF/NPS deduction). They should (everyone should) reduce the NPS equity exposure to zero and make it a pure debt mutual fund with a mix of govt and corporate bonds  (50:50 or more of govt bonds as per comfort).

Sadly, unless the income is significantly high, increasing equity exposure only from future investment alone will take years and years. They should also redeem from PPF (assuming it is 7+ years old) to get equity exposure as high as possible. One of the most important driving factors behind my financial independence is the equity exposure was quickly made higher than NPS (in my case it a debt fund from day one).

However, many are scared to do this. They would argue tax-free 8% return is more valuable than the risk of investing in equity.  The price you pay when you take on risk is obvious, but the price of sticking with fixed income can hit you hard late in life. So think hard about this.

For those who have just started their investing journey, this is a big lesson. EPF or VPF is a fantastic investment only as long as you stay within the necessary asset allocation. If 60-70% of your corpus is EPF and you only in your 30s or early 40s, you need to take quick action to ensure you can accumulate enough for retirement.

Assuming 60% in equity and 40% in fixed income in the initial phase of investing and gradual increase in fixed income allocation, later on, a good chunk of that fixed income can be EPF + VPF, NPS or PPF (esp for those who do not have regular income).  Learn more about the importance of the gradual increase in fixed income here.

List of Fixed Income Investment Options For Retirement (or any long term goal)

  1. EPF
  2. PPF
  3. Recurring deposits
  4. Fixed deposits
  5. arbitrage mutual funds
  6. money market debt funds
  7. gilt debt funds
  8. short to medium-term bond funds
  9. Bonds

It is quite possible with age and familiarity, an investor can graduate from FDs to debt funds to money market funds to medium-term funds. That is, our risk appetite increase (or decrease).

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Standard fixed income options like EPF and PPF are good for the initial few years of investing. Sooner or later there would be a bumper year in equity with a gain of 50%, 80% etc. When that happens, a resetting of the asset allocation is prudent.

That is, a partial profit book from equity into … where? If we add that to PPF or VPF, liquidity is lost. That is we cannot freely remove that money and add it back into the market when it goes down (and it will).  Even otherwise a freely redeemable fixed income solution is necessary.

Say what you may, debt mutual funds do make a big difference. So do arbitrage mutual funds but one should keep in mind that they too have credit risk like debt funds.

These arguments are also valid for any long term goal. For my son’s education goal, I have added an arbitrage fund (ICICI) as the debt component. It is tax-efficient and liquid. If there is a big dip in the stock market, I have the option to sell the arbitrage units and buy equity funds.  Having this choice is crucial. The primary reason for this is to lower risk. Higher returns if any is only an accessory.

Recurring deposits and fixed deposits can be terribly tax-inefficient for those in the 20% and 30% slabs. Primarily because the gains have to declared and tax paid each financial year.  A debt mutual fund is a natural choice.

There are three options with debt funds:

  1. Stick to money market funds like liquid, overnight or very short-term bond funds with reasonable credit quality. The risk of loss is low(er) but over the long term, returns will gradually head south.
  2. Avoid all credit risk and use only long term gilt funds. See for example SBI Magnum Constant Maturity Fund: A Debt Fund With Low Credit Risk for long term goals! The NAV here will be highly volatile and the investor must practice and mix of annual rebalancing (aka strategic) and tactical rebalancing as per bond yield movements. This does not involve much effort.
  3. Take on a mix of credit and interest rate risk. The management effort is less, returns can be higher than money market funds but there is always a risk of bond defaults. To negate that, choice of fund selection and monthly monitoring of the portfolio is crucial.

It is important for investors to understand that there is no escape from risk whatever choice they make. It is only a question of familiar risk vs unfamiliar risk. Comfortable risk vs uncomfortable risk. Sadly, when it comes to returns, we study the past and take it seriously. When it comes to risk, we ignore the past and assume what did not cause a loss is not risky (more on this coming up).

There is an important aspect of fixed income portfolios that many of us do not consider. Even if choose only PPF or EPF, I still need a liquid fund or overnight fund or arbitrage fund for two reasons : (1) booking profits and re-entering equity and (2) as we near retirement or the goal deadline a good chunk of the corpus should be in safe instruments.

Summary: Factors to keep in mind while building a fixed income portfolio

  1. Tax efficiency is crucial. However, if you choose tax-free then there will be a lock-in
  2. A liquid instrument is essential for rebalancing.
  3. Liquid fund or bond fund or gilt fund, there is always a risk. It is only a question of what is acceptable to you.
  4. Money should be shifted to a safe instrument (preferably with lower tax outgo) as the goal deadline approaches.  An overnight fund or liquid fund fits the requirement. Systematic transfer to these assets can reduce tax outgo.

What is your fixed-income strategy? Share below. Are you overweight on fixed income how do you plan to handle this?

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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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6 Comments

  1. Iam 37 years of age and in the 30% tax bracket. Have about 35% debt in my portfolio with remaining in equity. Plan to increase debt component slowly over the next 20 years. Close to 50% of this debt is in EPF and rest is in a combination of arbitrage funds & short term debt funds (majority) and FD & tax free bonds (minority). Emergency funds are kept in a 6% bank account.

    Post the experience of last year, have consciously started avoiding short term debt and fresh investments are in arbitrage and liquid only. Don’t plan on going back to short term debt as I don’t have the appetite for losses in debt. Unlike equity, I always have doubts about my debt part of portfolio and every year I seem to get/have a new understanding.

  2. Pattu,
    As always, thanks for your posts!!

    From the debt MFs/fixed income perspective and basically from a post retirement portfolio construction and withdrawal strategy – allow me to present a concept with one of the example scenarios:

    Using the bucket strategy, let’s say the amount needed for the first 15 years of my retirement is X. And so now, that needs to be in the safe on fixed income side (via debt mutual fund or equivalents).
    But with this requirement, also overlay my inherent bias for the Hybrid Aggressive category to this equation !!:)

    So instead, I allocate 2X amount in an Aggressive Hybrid Mutual fund for this first 15-year retirement period usage.
    Now essentially, what is being stated is that even with 70% down on the equity side of such a Hybrid Aggressive fund – the overall amount (that needed for the first 15 years) does not go down below X at any point.

    Please note: my desire in all this does _not_ emanate in trying to earn better return from such a strategy but simply because:
    1. Debt funds overall as a category look to be a very complicated (in fact I would say risky vis-a-vie returns much like the way it’s for gold!). And their management not being easy either (unless these instruments are used for profit booking from equity and asset re-balancing)
    2. Also, there does not seem to be a Debt Index fund or Index Hybrid Fund or Life Stage Funds (please read, low cost tax efficient options) out there yet
    3. So instead and if we can get to a 2X amount (and use Aggressive Hybrid both during accumulation and withdrawal phase), why not just pay the 10% LTCG on an Aggressive Hybrid and be happy!

    Well, this is just a concept, but the basic idea here is to consider an Aggressive Hybrid Equity fund either as
    1. A 100% Equity find with benefit of lower volatility than a Pure Equity Fund (in the accumulation phase)
    AND
    2. A Debt Fund but that is always marked as 50% of its value in our retirement portfolio (in the withdrawal phase)

    And the more I think about the withdrawal strategy problem in retirement , I am finding (2) is not a bad way to look at things, although it looks extremely foolish at outset 😊

    Thoughts/or even better, a post debunking all this theory – so that our heads stay in the clear…

    Thanks!

  3. I have an FD which i thought i will move to short term debt fund, thank god i didnt. Now i am scared after what happened with debt funds , so i plan to keep fd as is but invest interest into arbitrage fund. I plan to add additional investment to arbitrage as my income grows. Once i get a better understanding of arbitrage, i plan to split the fd among fd, ppf and arbitrage, so that fd is the energency corpys, arbitrage is the liquid part of the fixed component while ppf is for long term needs.

  4. Hello sir.

    I find your articles very informative. I am also currently under the dilemma of where should I park money w.rt Debt. The obvious options are PPF and EPF.
    I have started a RD recently around 40% of my savings at 7.3%. Post tax i know it would give me just 5.1% return. But i dont have the guts to invest 40% of my savings to a debt fund be it liquid or short term debt funds. My current investment horizon is of around 2.5 to 3 yrs with this RD.
    Do note that I have around 50% Equity exposure via pure equity mutual funds and pure equity investment and hence I am looking out at debt and went for RD.
    Alternatively I was thinking of buying a second home and invest in a under construction property as the area which I am planning to invest has appreciated the max in Pune.
    Can you please advice. Thanks in advance.

  5. I am revisiting some of the concepts now that I am 60 years old and trying to practise what I preached to others. Tax efficiency is important but at this life stage safety of principal is more important. So, I would recommend going in for SCSS, RBI Bonds, LIC Vaya Vandana as well as Bank FDs until 20% tax slab is exhausted. For the 30% tax slab, one could look at FMPs, or Short Term Debt Funds (since you get indexation benefit after 3 years). Keep contingency funds in Money Market funds.

  6. Pattu

    Your posts are an invaluable resource. As regards fixed income, I am using a combination of arbitrage, ultra short funds and credit risk (only Franklin for now) with 33% allocation to each for my fixed income portfolio. I have always wanted to add 10yr CMT funds to my portfolio but I don’t understand what you mean by strategic and tactical rebalancing. Can you please help me understand how to do that? Thanks.

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