Over the last couple of years, one class of investors has been hit the hardest -- the retired individual. At the stage of life they are in, the needs of those who are retired can be defined clearly.
They need regular and steady income, without taking on much risk. Unfortunately, there are few investment options today, which can guarantee both.
What has brought about this situation?
There are several reasons for the same. One, when the current retirees were planning for retirement, interest rates were well above 15 per cent p.a.
The expectation was that on retirement the rate of interest on low risk securities would be about 12 per cent p.a. The savings were made with this assumption in mind. But the actual rate of interest has declined much more rapidly and is now about 8 per cent p.a. (the taxable GOI Bond).
As a result, the income post retirement is 33 per cent lower than was expected.
Two, some of the blame lies on the retirees themselves. They failed to plan their finances keeping in mind that at some point in time the government will ensure that there is some synchronisation between returns offered by government schemes and the rate of interest in the market, i.e. they failed to appreciate that to earn higher returns one must take higher risk.
Most individuals are used to earning high returns without taking on commensurate risk. Today, even the mention of taking on mild risk to earn better returns evokes a negative response.
As a result most retirees park a bulk of their assets in instruments like the GOI Bonds and post office schemes. Therefore, the returns they earn are way below what they had expected.
Three, government efforts to provide low risk investment opportunities to retirees have been disappointing. Schemes floated by government institutions like the Life Insurance Corporation have met with only lukewarm response.
In short, there is no meaningful dedicated scheme in existence today, which can meet the needs of the retired individuals (the GOI / Relief bonds seem more suitable for high net-worth individuals, but more on this later).
Now what?
There is no possibility for the retirees to shore up their savings to compensate for the decline in the rate of return. Given this constraint let us evaluate the investment options that are available to the retirees.
Investment avenues for retirees
| - | 6.5 per cent Bonds | 8 per cent Bonds | FD* | POMIS | PO Time Dep. | LIC Varishtha |
MIP- MFs # |
| Tenure | 5 yrs | 6 yrs | 3 yrs | 6 yrs | 5 yrs | For life | No fixed tenure |
| Min. Invt. (Rs) | 1,000 | 1,000 | 20,000 | 1,000 | 50 | 33,335* | 5,000 |
| Max. Invt. (Rs) | No limit | No limit | No limit | 300,000 individual / 600,000 jointly | No limit | 266,665* | No limit |
| Safety/ Rating | Highest | Highest | AAA | Highest | Highest | Highest | Moderate Risk |
| Interest rates | 6.50 per cent | 8.00 per cent | 6.50 per cent | 8.00 per cent | 7.5 per cent^ | 9.00 per cent | 7 per cent - 9 per cent |
| Frequency of interest | Half yearly | Half yearly | Monthly | Monthly | Annually | Monthly | Monthly |
| Tax Benefits (Income) | Tax free | Sec. 80L | Sec. 80L | Sec. 80L | Sec. 80L | Taxabale | Tax free |
| On Maturity | Principal | Principal | Principal | Principal + 10 per cent bonus on maturity | Principal | No maturity period, but exit option available after 15 yrs. | Principal |
| Collateral | No | No | Loan facility available | No | Yes | Loan facility available | Yes |
| Amount invested | 100,000 | 100,000 | 100,000 | 100,000 | 100,000 | 100,000 | 100,000 |
| Annual Interest | 6,500 | 8,000 | 6,500 | 8,000 | 7,714 | 9,000 - 9,381 | 7,000 - 9,000 |
Top of the list of course are the assured return schemes (which pay out interest atleast once in six months) floated by the government and its institutions. These include:
- 6.5 per cent Tax free GOI Bond
- 8.0 per cent Taxable GOI Bond
- Fixed Deposits of banks and institutions like HDFC
- Post Office Monthly Income Scheme
- Post Office Term Deposits
- LIC Varishtha Pension Bima Yojana
From the table it is very apparent that the monthly scheme that is being offered by the Post Office scores the best on all parameters -- its safe, pays interest at monthly intervals and offers a return, which is very attractive.
The return offered by the scheme, before factoring in the tax benefits and the bonus on maturity, is just a shade below 10 per cent pa compounded. The only constraint is that there is a cap on the amount of money that can be invested, i.e. Rs 300,000 individually and Rs 600,000 in case of a joint account.
Currently, among the most popular instruments for retirees are the GOI Bonds -- both the 6.5 per cent tax free and the 8.0 per cent taxable bond. After factoring in the tax benefit for the 6.5 per cent bond, both these options look attractive.
However, many investors overlook the fact that such bonds cannot be offered as collateral in case there is an emergency. Nor can these bonds be surrendered. Therefore, retirees need to invest in such instruments only to the extent they are sure they have sufficient liquidity to meet any emergency.
The other options include fixed deposits offered by companies and the post office. While the company deposits offer low returns, post office deposits are attractive but pay out interest only at annual rests. This could be a constraint for retirees who have few sources of regular income.
The LIC Varishtha Yojana is one other attractive option available to retirees, the only constraint, again, being a cap on the maximum amount of pension that can be drawn, i.e. Rs 2,000 per month.
Apart from a relatively attractive rate of interest, the scheme also offers an option to take a loan against the policy. The pension received, however, will be clubbed with income and taxed at your marginal rate of tax. On a positive front the schemes scores very highly on convenience.
Only a single premium is required to be paid by the subscriber and pension receipts are made available throughout the policy holder's life. In the event of the policy holder's unfortunate demise, the initial sum will be returned to the nominee / legal heir.
Another option available to retirees today is the Monthly Income Plans from mutual funds. Since MIPs do not offer assured returns, they are not very popular with retirees. But currently, such schemes offer tax-free dividends and high liquidity.
Moreover, market determined returns, over longer periods of time can possibly exceed returns offered by the other schemes discussed above.
Within the gamut of MIPs, there is a wide variety to choose from. MIPs invest between 10 per cent-30 per cent of their investible surplus in equities. The key lies in choosing the MIP that best suits your needs and risk-profile.
The importance of maintaining liquidity in investments cannot be overstated especially for retirees. Let's see how the instruments rate on this parameter. 6.5 per cent Tax free GOI Bonds offer a premature redemption option after a 3-year period, however the 8.0 per cent Taxable Bonds are required to be held till maturity, i.e. 6 years.
Fixed deposits offered by companies generally have a lock-in period of at least 3 months, beyond the stated period; deposits can be encashed with a loss of interest. On the other hand Post Office Time Deposits have a lock-in period of 6 months.
However, the attractive rates offered by time deposits coupled with the liberal exit terms give them an edge over conventional company deposits.
The LIC Varishtha Yojana scores rather poorly on the liquidity front by offering investors an exit option after 15 years from the commencement date.
However, POMIS offers a premature encashment option after 1-year but with a loss in principal (5 per cent of the initial deposit is deducted). If investors exercise this option after completion of 3-year period, there is no loss of principal, but they are not eligible for the 10 per cent maturity bonus either.
The above six instruments (actually five, if you leave out MIPs) in all likelihood form a significant chunk of a retiree's portfolio.
A uniformly balanced portfolio would give a simple rate of return of about 8 per cent pa. As mentioned before, this is much lower than what was expected.
So, if you are a retiree, and are risk averse, it is unlikely that your portfolio will earn a return higher than this. Here are some pointers for you to make the most of your money given these constraints:
- To the extent you do not fall under the income tax bracket, invest in schemes like the Post Office MIS and the 8 per cent Taxable Relief Bond. Also consider investing in the LIC Varishtha Yojana.
- If you fall under the tax net, and your section 80 L limit is exhausted, the 6.5 per cent bond is an option. Also consider MIPs.
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To make up for the short fall in return, invest about 5 per cent of your wealth in equities. Consider going in for equity funds. Over three year periods, these schemes could add disproportionately to your overall returns.
And finally, watch out for the Dada-Dadi bonds that are likely to be launched soon. This will be the first debt instrument of its kind to be launched specifically for this class of investors. So, don't just lock up your funds in the GOI Bonds as yet.
