Should EPF and gratuity be included as debt while calculating asset allocation?

Published: January 30, 2024 at 6:00 am

A reader writes, “I am a subscriber to the freefincal newsletter. They have been very insightful. Portfolio rebalancing is very easy to understand but equally difficult to implement, it needs a lion’s heart to move from equity to debt. I have one question about what can be treated as debt”.

“I have been investing in mutual funds through SIPs (equity funds like Flexi cap, Multicap and large cap). I also have some exposure to equity shares and gold. As of today, the proportion is:

  1. Equity MFs – 39%
  2. Equity – 30%
  3. Debt MFs – 26% (Short term debt, money manager and a PSU debt fund)
  4. Gold – 5%

So, the allocation is roughly 70% equity and 30% debt + gold.

I have been working in a private firm and contributing to EPF. I also have a gratuity scheme offered by my employer. Kitty in both these are considerable. Considering EPF and gratuity as debt, the allocation becomes 40% equity and 60% debt + gold.

In such a case, should I consider EPF and the gratuity portion as debt and move from debt funds to equity to make it 70:30 again? Or should I not consider EPF and Gratuity as debt altogether? My age is 45 for reference.

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At the outset, this might seem like a “trivial” question to some readers, but you would be surprised how many times I have been asked this over the years.

Any fixed income instruments meant for a specific goal (in this case, retirement) should be considered as “debt” and included in the asset allocation calculation.

At age 45, an asset allocation of 40% equity is quite reasonable. Most people have much less since they start investing late in equity, whereas EPF gets deducted from the day they start working.

What should be done now is entirely contextual.

In my case, I started investing in equity soon after starting work (within two years) and invested much more in the asset class than my mandatory NPS contributions. So at age 48, I maintain about 60% in equity and 40% in NPS, Gilt Funds and PPF. I have explained the reasons for this here: why are you holding 60% equity for retirement? My primary reasons are I have already achieved financial independence, and my retirement is far away.

Only a SEBI-registered fee-only advisor can offer you the necessary contextual advice after considering your circumstances. I can only offer you the following general recommendations.

I don’t see any need for you to redeem your debt funds and shift them to equity. You already have 40% equity, which is only about 10% less than a well-balanced portfolio. See: Will Benjamin Graham’s 50% Stocks 50% Bonds strategy work for India?

Assuming you have about ten years to retire, you can leave the equity allocation at 40% or increase it to about 50% with fresh investments in the next couple of years.

More crucial is how you intend to de-risk the portfolio before retirement. That is, reduce equity allocation, as shown in several illustrations based on the freefincal robo advisory tool.

From this point of view, 40% equity is a good number, provided your corpus is large enough, and you are investing enough for retirement. This happens if the amount you need to invest is lower than the amount you are investing. If this is not the case, then a 5% to 10% increase in equity should be okay, but keep in mind that it cannot be maintained at that level for long and should be gradually reduced, as shown in the above illustrations.

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