September 14, 2009

Retirement planning – III

I have written earlier on retirement planning here and here. There were several comments on both the posts and so I have decided to start this post with a Q&A

Q1: I think gold/ commodity (put any asset you like) is good and I do not agree with your point that one should avoid it

My response: If you know what you are doing and have the knowledge and the skill to invest, then please go for it. My specific point is that if you are a know nothing or a newbie in these asset classes, then play around a bit with small amounts of money till you get a hang of it. The market will not forgive you for your ignorance.

Q2: Are the asset allocation percentages fixed. Should one not vary them based on market condition?

My response: Asset allocations are not set in stone. However one should remember that asset allocation will play a big role in determining the return on your portfolio. So one should fix the asset allocation based on one’s risk tolerance. Translation of this mumbo jumbo – In my own case, I will only invest as much in equity in which I can tolerate a 50% temporary drop. As a matter of fact, the market dropped by almost 50% last year and most of us got a taste of how much drop we could tolerate without losing sleep.

Q3: There is no mention of insurance, ULIP and other hybrid schemes

My response: Pure risk insurance is important and one should always have an adequate insurance cover (more on that in another post). However I completely and totally hate ULIP and such unit linked plans. They are a
complete rip off and one should stay away from them.

In my own case, I said no to a close relative who was pushing this kind of scheme. I told him that I will give you the incentive you get from the company for free as long as I don’t have to buy the scheme from you (that way he benefits and I don’t lose money for the next 20 years). You can guess how happy he is with me J .

Please do not invest in such schemes unless you have analyzed them in detail. It is far better to buy the insurance and the fixed income/ equity piece separately than bundling it via unit link schemes, pay the high commissions and expense loads and lock the money for a long period of time.

Asset allocation and rebalancing
I have written about how asset allocation drives you portfolio returns. All of us think we can tolerate risk and can afford to have a high equity component. My suggestion is to keep it lower than the level you think you can maintain without losing sleep.

Let’s say you are looking at 11-13% returns and are planning to keep around 50-55% of your portfolio in equity. I would suggest that one should start with a 30-35% allocation and go through a bear market and see how one is able to survive it. If you are able to avoid the gloom and doom and still able to invest during the bear, then go ahead and start raising the allocation. It is easy to maintain a high equity allocation during a bull market. We are all geniuses during bull runs. The test of patience and risk tolerance is during a bear market.

Finally if one is not actively managing his or her investment, then it makes sense to start reducing the equity holdings during a bull run to bring it to the target allocation. For example, if you target is 40% and the equity components goes up during the bull market to 60% of your portfolio, then it makes sense to start liquidating some equities to bring it to around 40%. In contrast, if your allocation drops to 30% during the bear market, then one should start buying equity to bring it up to the target level.

The above suggestion is easy to understand and very difficult to execute. I have personally gone through this last year. It felt like quick sand. I was constantly adding money from March 2008 to my equity portfolio and the market kept dropping at the same time. So at the end of the year, the absolute value of the equity portfolio stood at the same level as the start of the year, inspite of pouring money into it. It is not easy to constantly lose money in face of a bear market.

One can further split the allocation between different instruments in each of the categories. One can split the debt component into Bank FDs, Debt funds, Post office deposits etc. In a similar manner the equity component can be split between mutual funds and shares. The actual numbers need not be precise and you do not have to get very scientific on it. As long as you are close to your target levels, it should work out fine.

Administrative effort
This is an ignored, but important component of portfolio planning. It does not make sense to invest in an option where there is a lot of documentation and other risks and costs involved. In the past, shares could be bought and sold only in the physical format and there was always a risk of bogus shares and the headache of paperwork.

In a similar manner mutual fund investing also involved a decent amount of paperwork. Luckily most investment options (except Post office schemes and Bank FDs like that of SBI) are now convenient and easy to manage. However one should keep in mind the paperwork involved in the specific investment option. My own preference is to look for option which requires minimal paperwork, allows online mode of investing – preferably automated, and does not require me to track payments and receipts on an ongoing basis. I also prefer investment options which would allow me to pull an electronic statement at the end of the year for tax purposes.

Most of the investment options and firm providing them are focused on making it smoother and easier for the investor. However we still have some options such as the post office and public sector banks which believe in torturing you, even when they take your money.

Scratched the surface
The entire topic of retirement planning which is a subset of personal finance is a vast topic. One could write a book on it and could easily update it on an annual basis. I have tried to scratch the surface here and just provide some initial thoughts or factors to look at when developing your portfolio for your or your parent’s retirement.

If you have to take one point from my posts, it should be this – Invest with full knowledge and understanding of the investment option and always focus on the risk or downside.

Please feel free to leave me any questions on the above topic in the comments section and I will be glad to answer them.


rmathew said...

What are your views on Unit Linked Pension Plans (ULPP) from vendors such as HDFC Standard Life?

They don't link insurance to retirement planning and seem to allow easy switching between, for example, equities and bonds according to market conditions without the associated transaction costs that you'd normally incur.

Ranjith said...

Hey Rohit

Been Following your blog regularly though this is the 1st time am commenting. Its an awesome blog and I have benefited from you. But then am sure that the sheer number of people following and participating here is ample testimony to the fact.

I ll wholeheartedly agree that ULIPs in most forms found in India are a total rip off... I myself have faced solicitations from kith n kin with ULIPS. Once I get into the nitty gritty of why I dont want this product is when both me and the solicitor realize that he doesnt know sh*t about it apart from the fact that there is huge commissions involved lol.

I have been investing for a few years now and apart from a 6 month living expenses corpus everything else I have is in equities. And I was not too bothered during last october to march. Now I have inherited a considerable amount of real estate which puts my asset allocation at 20% equity and 80 % realty. While I have beaten the broad indices by a decent margin since 2003(2003 to 2005 was not too difficult as my base was small) I would like to reallocate my assets. What proportion do you recommend?

Thanks in advance


sachin8778 said...

Hi Rohit,

Could you please share your thoughts on holding companys from value investing point of view?

Is it's nature makes them not a suitable candidate to consider by value/conservative investor?

Not sure if you came across this link on moneycontrol, something interesting or may be not to you :)

sumi said...

Hi Rohit,

paperwork can be a headache when it comes to investments. I am glad that I have been warned against ULIPs at the very beginning of my career will stay away from them.

Rohit Chauhan said...

Hi rmathew
i had a 5 min look at the personal pension plan for HDFC. for sum assured of 5 lacs , they want you to pay 12475 for 30 years
now 12475 invested annually at 8% in an FD will give you 15.26 lacs. now i have not taken bonus in the above calculation, but i dont think they plan to give bonus of 10 lacs at the end of the term period

also in event of death the beneficary get premium+8% interest compounded subject to limit of sum assured.

unless i am missing something big time, and as i cannot use curse words ..i can only consider this policy as a daylight robbery

the problem with all these policies is they are structured in a complex way and the costs are all hidden


Rohit Chauhan said...

Hi ranjith
diffcult for me recommend a % as i dont have all the details. at the same time moving from realty to equity is not a quick thing. there are transaction costs as far selling realty is concerned and then you have to find some good ideas in equity too.

again it depends on what kind of real estate u have and if you can derieve income from it


Rohit Chauhan said...

Hi sachin
i have seen holding companies in the past and they seem to have value. at lot of time you can get good returns if the underlying company recovers and the gap closes ..however a bear market is good time for it. if you buy at the wrong time , the drop in underlying co and increase in the valuation gap can hurt too


Rohit Chauhan said...

hi sumi
if you analyse the ULIP schemes, you will come to the same conclusion. unfortunately people ignorant of the nature of these schemes are targeted.
it is truly a scam in case ulips


Sachin8778 said...


I fully agree with your views on ULIPs. I have burned my fingers in one of such plan.

Unfortunate part is good public sector banks too are being party to these day time robberies. If you have not heard of it, I know for sure that one of the public sector banks 'suggest' to their housing loan customers to buy ULIP products from totally different insurance company. And you know what is the outcome if you don't follow this suggestion. They are the official agent for this insurance company. Better to be away from ULIP at any cost.

Hope the recent IRDA regulations (cap on difference between gross and net profit, etc) will clean this mess from insurance industry.

Rohit Chauhan said...

Hi sachin
very true is daylight robbery. unfortunately all the top banks and financial institutions are robbing the investors on this. they usually structure the ULIPs in such a way that the lay person will never realise that they have been robbed.

rmathew said...

Rohit, thanks for your response.

You seemed to have looked at the "Personal Pension Plan", which I agree is totally unexciting.

I was talking of the *Unit-Linked* Pension Plans (e.g. see brochure, PDF, for ULPP-II). Here all the investment risk is borne by you. You have the flexibility of moving between money-market funds and equities depending on your outlook and risk-appetite. The transaction costs here *appear* to be lower to me than what you'd have to pay otherwise.

I would also like to point out that comparing something like this with a 30-year FD with 8% annual compounding rate might not be fair - do you actually get FDs like this? (The maximum I could find on a quick look around is a 10-year FD at 8%.)

This kind of rate might be sustainable now when India is growing rapidly and is still a relatively closed economy, but not when the economy opens up further and the growth plateaus out.

PK said...


I have an investment in one such Pension Plan ( No insurance). The allocation charge was 50% in first year, 99% from second year. When i started the plan, entry load free investment into MFs was not possible. That scheme also has a low fund management fee of 0.8% for equity fund. A rough calculation showed it to be better than a regular equity MF (cost Wise) if I regularly invest for more than 10 -15 years. you can also reduce the cost by investing the minimum amount in the first year, then increase your investment in subsequent years.
This was my first major investment decision after I started to earn, about 3 years ago.
I am a professional without a permanent job. I also liked the fact that this money cannot be easily withdrawn. I feel one major drawback of using MFs as the sole vehicle for pension planning is the ease with which the money can be withdrawn.
The option of switching funds is unnecessary for me for two reasons: 1) I am investing the money for 30 years, So it will be in 100% equity.
2) Switching funds is trying to time the market. I never try to time the market because I do not want to guess.
I shall switch to a debt fund 3-5 year before I want to terminate the plan.

Rohit Chauhan said...

Hi ramthew
let me have a look at the plan you mention.
you are right on the 8% FD assumption. my biggest issue is that other than the explicit cost, the implicit return of these schemes is around 5%. i think that would barely cover inflation in the long run.
so in effect most of these ulips are skimming away the extra returns into their pocket


Rohit Chauhan said...

I looked at the example you have given/ invested and the difference between the scheme you mention and any mutual fund starts at a high of 30% and narrow to around 3% after 20 yrs.

assumption - start with investment of 1000 in both, 50%+.8% charge for the pension plan and 2% management fee and 2% entry load for a mutual fund.

even in the above scenario, the mutual fund is ahead for 15 odd years (lets assume returns for the time being).

ofcourse if the pension plan you mention has done much better than the market due to the long term nature, then it is better than any run of the mill mutual fund.

your example seems to be an expection, from what i have seen till date


PK said...

@ Rohit
Beating the MF is not the only target that I had in mind when i started on that plan. A very long term plan will instill discipline into investment. This is hard to achieve when markets are falling by the day.
I consider myself a learner investor. However I have no intention of becoming a direct equity investor with my limited knowledge. I try to read up on matters related investment in an attempt to minimise mistakes. Your blog is quite helpful for me, for your excellent articles and the learned reader's comments as well.

Anonymous said...

Hi Rohit,
With reference to Ur posts on 'retirement planning' can you give Ur comments on NPS scheme newly launched by GOI? Is it really worth it? Who should go for it? Its Pros & Cons? Comments on Defined Benefit and Defined Contribution type of retirement plans.