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Can you bank on debt mutual funds to create a retirement corpus

Most investment advisors advocate investing in equity mutual funds to create a retirement corpus.

, ET Online|
Jan 17, 2019, 02.45 PM IST
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Most investment advisors advocate investing in equity mutual funds to create a retirement corpus. They reason that equity or stocks have the potential to beat other asset classes over a long period. They also point out that only equity can produce inflation beating returns over a long period which is crucial for any long-term financial goals. However, there are some investors who wouldn't touch equity; these ultra conservative investors bank on safest options like bank deposits and government-backed investment options like Public Provident Fund (PPF), etc. to create a corpus for their retirement fund. Does that make sense?

“If someone is completely risk averse and wish to stay away from equities, they may go for debt schemes,” says Joydeep Sen, founder, wiseinvestor.in.

Mutual fund advisors believe extra conservative investors who do not go beyond fixed deposits should look at debt mutual funds for their retirement kitty. They point out that investors in the highest tax slab can enjoy better taxation on their returns from debt mutual funds, especially if invested for more than three years.

“Those falling in the 30 per cent tax bracket can enjoy better long term taxation in debt funds if they stay at least for three years,” says Dinesh Rohira, founder and CEO, 5nance.com.

Bank FDs are taxed as per the tax slab applicable to the investors. Short term capital gains on debt mutual funds held for less than 36 months are taxed as per income tax slab of the investor. However, long term capital gains on debt mutual funds held over three years are taxed at 20 per cent with indexation benefit. Indexation allows inflating the cost of purchase and it helps to bring down the tax outgo, especially in an inflationary scenario.

Now, the big question: what kind of debt mutual funds should an investor choose? Joydeep Sen says the investor's risk tolerance level should dictate the debt mutual fund category he or she should invest. “If a person is completely risk averse, s/he may go for short duration or corporate bond or banking and PSU Funds. Those who can bear some amount of risk, may opt for long duration funds or credit risk fund,” says Sen.

Will this strategy help them to earn extra returns to secure a large retirement kitty? “Investors can expect a 50 bps higher post tax returns in debt funds than FDs. They should keep their expectations reasonably lower as compared to equity funds,” says Rohira.

Most mutual fund advisors use this point to emphasis the premise that those investing only in debt instruments will struggle to beat inflation.

“Totally conservative investors, must understand that their post-tax returns from debt mutual funds will not be enough to beat inflation in the long term and they might end up having a lower than the desired corpus when they retire, says Hemant Beniwal, CFP, director, Ark Primary Advisors.

Let’s understand this with an example. Assuming a 30-year-old investor starts investing Rs 10,000 per month in mutual funds for her retirement and she continues to do so till she turns 60. At 12 per cent returns, she would create a corpus of Rs 3.5 crore in 30 years. At 8 per cent returns, she would have only Rs 1.5 crore at the time of her retirement.

A difference of 2 crore rupees is very hard to match.

In order to match the corpus created with equity funds (Rs 3.5 crore in the above example), she will have to invest Rs 23,500 per month at 8 per cent.

Mutual fund advisors say when you are saving for your retirement, you should aim for an adequate corpus to take care of your living expenses till death.

“What if you fall short of money to take care of your living expenses? No one would even want to think about that situation as it would be devastating. Also, what if you outlive your expected life? You should be prepared for that as well,” says Sen.

Thus, the need of equities, say advisors.

Mutual fund experts believe people who have at least 10-15 years to retire should look at equity funds if they want to earn inflation-beating returns on their investment and build a sizable retirement corpus.

“If you have time by your side, equities are very important to earn alpha post tax and post inflation. Even those, who start a little late at around 45 will have ample time. Post retirement also, generally, no one would need the entire money in one go. So, factor in those 20-25 years as well,” says Beniwal.

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