Jul 10, 2006|
Retirement planning and stocks
In the long term, we all are dead, said John Maynard Keynes. But this is not a very good reason not to plan for your retirement! While the context of this article is going to revolve around why should one invest 'also' in equities for retirement planning, this has got nothing to do with the bull market now!
This is important to consider because the magnitude of returns that has one witnessed in the last three years is not likely to be repeated every year. And aligning return expectations to one's risk appetite is very important when one is financial planning after retirement.
Why equities? Now, coming back to how equities can help you in your retirement planning, here is a graph that highlights the returns on Indian equities (represented broadly by the BSE Sensex). As is evident, while the returns in the last three years has been 66%, looking at the last 10 years, the rate of return is more realistic and traces the Indian nominal GDP growth rates. However, it has to be mentioned that between February 1992 to July 2003, the BSE Sensex, on a point-to-point basis, was at the same level! While it has not been a one-way ride, surely, what the graph highlights is that equities can provide decent inflation adjusted returns in the long term. Since retirement planning also involves long-term planning, equities can be rewarding in nature.
How equities? With 'why equities?' cleared, now comes the critical question of 'how equities?' Conventional investment wisdom tells you that 'as age increases, the risk appetite decreases' and given the fact that equities are high-risk asset class, the proportion of equity exposure in the overall portfolio should reduce. But how much exposure should one have to equities is a function of your age and your goals (short-term and long-term). 'Your Asset Allocator Review' (or 'YAAR' as we call it in Personalfn), answers the 'how equities?' question with a pre-designed portfolio mix for various ages. The portfolio not only suggests how much equity exposure should a person have, how balanced should on be as far as stock selection goes i.e. at younger age, in the equity portfolio, one should have greater weightage to high-risk stocks/sectors and as your age increases, the weightage of low-risk stocks/sectors increases. IN equities, we suggest investors to have a mix of direct and indirect participating. Direct would involve buying a stock from the primary (IPOs) and secondary market (stock market) while indirect involves investing in mutual funds (who have the required skill set).
Which equities? This is the trickiest side of this article. To simplify this process for investors, we have listed various sectors based on our assessment of risks from a long-term perspective. Of course, sector identification is one part, but the more important aspect is to choose the right stock from the sector.
Key aspects while you invest in equities:
- Invest in a company whose business you understand.
- In the long-term, stock prices traces earning growth and also, the ability to generate free cash flow of companies. While there can be volatility in between (both in stock prices as well as the financial performance of the company), if one has the confidence a company can go the distance, invest.
- While mid-cap and small-cap companies can be exciting, it is always judicial to have a mix of both.
- If one does not have the time, leave it to the experts you trust viz. mutual funds, insurance schemes and portfolio management services.
- Lastly and more importantly, a bull market or a bear market does not change the fact that equities are a risky asset class. Do not blame the market for your losses.
Given the fact that the value of money reduces over time, it is important to generate adequate returns to sustain the desired standard of living, even after retirement. In our view, adequate and careful investing in stocks is one way to achieve this goal (of course, with the extra risk). As someone said “Life begins at retirement”.
This article forms part of "Money Simplified – Retirement Planning and YOU" - a free-to-download online guide from Personalfn. To download the entire guide, please click here.
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