Where Should You Invest Your Money – Gold, Life Insurance, Provident Fund, Fixed Deposits, Mutual Funds or Equities

Preparing for your retirement – Get, set…go

There comes a time in our life when we are settled into our jobs, with a decent salary and some additional cash on our hands. This presents a very good opportunity for us to save up some money for the future, especially for our retirement. But where to start from? There are myriad options, but which is for us. This and many questions start whirling in our head. Even if we manage to catch a financial planner, it is we who have to pick the right investment. So let us find our starting point:

The main objective of retirement planning is to amass handsome savings over time. So before making an investment, it is important to consider the rate of return on that investment. A profitable investment would be the one that beats inflation rate, by yielding a higher rate of return. Any investment made below the inflation rate would mean loss of money for an investor and vice versa. The table below explains this point.

We can see that over past five-ten years, the consumer price index (CPI) – an indicator of inflation – has shot to 4.33 per cent from 4.16 per cent. To ascertain the effect of inflation on the return by these investment options, we will consider them one by one.

Gold & insurance: Trust them blindly

Life Insurance: Though it is at the bottom of the table in terms of return, life insurance comes with a host of benefits. Maturity proceeds of an insurance policy are tax-free. Besides, premium paid towards the policy qualifies for a deduction under Sec 80C. This means that the effective post-tax return is close to 6.5 per cent, good enough to beat inflation at 4.33 per cent. A life insurance policy has dual advantages – it provides fixed returns and also an insurance cover. But there is also a flip-side: generally, it is not possible to liquidate a life insurance policy.   Gold: From time immemorial, gold has been trusted as the safe haven for savings. From return's point of view too the precious metal is a fairly safe bet. At the time of sale, capital gains on gold are taxable at the rate of 20 per cent but on account of the indexation effect, no tax will be levied on the 5-year or 10-year period. Gold generates a rate of return in the range of 9 per cent-11 per cent, surpassing inflation rate easily. The rate of return may not be high, but it is the safest investment option available. Gold can be easily traded at prevailing market prices. Gold price is typically less volatile than other commodity prices but more volatile than the prices of commonly-traded stocks. Gold is unique in the sense that it does not carry a credit risk – a risk that a debtor will not pay. Instead, it faces a much unrelated risk – that of theft.

PF means no risk, no tension

Provident Fund: Government-backed Provident Fund (PF) and Public Provident Fund (PPF) are considered to be one of the best investment options in India. Maturity proceeds from both are tax-free. In addition, the contribution made towards PF and PPF qualifies for a deduction under Sec 80C. Apart from tax benefits, PF comes with a unique advantage. For every rupee that we put into PF, our employer contributes an equal amount. This means that the effective rate of return from PF is doubled – a contribution of Rs 100 to PF from our side results into a corpus of Rs 206 (and not Rs 103) – which easily beats inflation.

PF has historically provided a relatively high, tax-free and zero-risk return. But, unlike life insurance, PF does not provide fixed return. The return is reviewed every year and changes with respect to a change in the interest rate. In an era of falling interest rates, the return on PF is also likely to reduce. So, if we are three or four years from redemption, we should continue to invest in the PF the same way. But if we are a long way from maturity, we can consider other risk-free avenues (such as the National Savings Certificates (NSCs)). NSCs have a shorter maturity period of six years, and they allow investors to lock into a rate of interest till maturity, which is not possible in PF. There is also usually a penalty on premature withdrawal from PF.

Fixed and steady, that's what an FD is all about

Fixed Deposits: Benefits of Fixed Deposits (FDs) – safety, liquidity and high return – make them the most sought-after investment option. The return on FDs has been 5.3 per cent over the past 5 years and 10 per cent over the past 10 years. The interest is taxable at the marginal income tax rate. For those in the highest income tax slab of 30 per cent, post-tax returns on FD fall to 3.7 per cent and 7 per cent, for the two respective periods. This means that we might end up losing money on an FD. But FDs have a fixed rate of return. So, whether a bank makes money or not, we still get the promised rate of return. Because of this feature, it is advisable to keep a certain amount of contingency fund in FDs.

Though bank fixed deposits are widely considered as a safe option, there have been instances when depositors have lost their savings. This is why we must check a bank's track record and credibility before investing. Also, banks usually charge a penalty on premature withdrawal, which might lead to a reduction in the overall rate of interest earned on the FD. Thus, one should choose the length of an FD carefully, ensuring that we can do without the money until maturity. Another disadvantage is even if there is an increase in the interest rates, it will have no effect on our return which will be fixed from the beginning. But if inflation rises, we might end up losing money.

Let's make money without being too cautious

Debt-oriented and hybrid funds: These two funds may be no match for equity-related funds, but they are good when it comes to offering consistent return, and there is also less risk involved. Long-term capital gains tax is levied on them at 20 per cent after indexation and there is also dividend distribution tax at 28.3 per cent. Assuming we had invested into growth funds and no dividends were paid, the 10 per cent-12 per cent return generated over the last ten years effectively reduces to 8 per cent-10 per cent, managing to overcome inflation.

Debt mutual funds have an equity exposure of less than 65 per cent. Though debt mutual funds are far safer than their equity counterparts, they do not offer a fixed return. Returns of debt funds are dependant on the prevailing interest rate. In an era of falling interest rates, there is likely to be a significant reduction in the return generated.

Stocks and equity-oriented funds: Investing in stocks and equity-oriented funds can be a risky proposition, but we also cannot ignore the fact that it is the most lucrative option of all. There is no capital gains tax on stocks and equity-oriented mutual funds held for more than a year. Also, the risk associated with them can be mitigated to a certain level by diversification of portfolio (as with mutual funds). However, the risk cannot be completely eliminated. Investment into stocks (and associated mutual funds) is thus recommended if one is ready to take exposure for a longer period of time.

Let us assume that the rate of return and inflation over the past ten years would be replicated for the next 30 years. If you invest Rs 100 today, the value of your investments after 30 years would be:

What we see is that stocks and equity-based mutual funds generate a significantly higher return than debt-based instruments, consistently. Does that mean we should blindly chase returns and invest in stocks, ignoring other options?

While deciding our investment mix, it is important to consider how much time is left before we retire. Our investment pattern should reflect our age. Stocks and to a certain extent mutual funds do generate higher returns but they also involve a greater risk. And the return may not necessarily be generated in the short run. If age is on our side, means if we are young, we can afford to wait and thus invest in more risky assets (hoping to get a higher return). A debt to equity ratio of 35:65 is considered to be good at the age of 35. It is generally a ratio of our age to 100 minus our age. As we grow older, our risk appetite reduces. During this phase, one should consider investing largely in debt-oriented instruments. A debt to equity ratio of 45:55 is considered to be good at the age of retirement.

What you need to retire comfortably?

• The golden rule says that one should not put all eggs in one basket. We must try to diversify our retirement portfolio by including those alternatives that best fit our short-term as well as long-term needs.
• Irrespective of our age, a certain amount of money should be invested in instruments generating a fixed return (e.g., fixed deposits). These funds form our emergency corpus and can be liquidated in times of need without significantly harming our portfolio.
• If we want to enhance our retirement corpus by means of investing in equity market then we must be prepared to remain invested for a longer period, say at least 5-10 years.