The strategy is so simple that it almost appears unbelievable. All you need to do is set up SIPs in different types of funds based on your desired asset allocation. A young investor with an aggressive risk appetite can invest in a clutch of diversified equity funds to save for his golden years. As he grows older, and his risk appetite wanes, he can reduce the exposure to equities. As a middle-aged person, he can opt for less volatile balanced funds.
The problem is that this does not happen automatically. The investor needs to shift his investments from high-risk options to low risk avenues himself. A few mutual funds offer schemes that are based on the risk appetite of the buyer. The Advisor Series from ICICI Prudential Mutual Fund has five funds ranging from the Very Aggressive fund for young investors to the Very Cautious scheme for older buyers. “These funds can be used to save for any goal, including retirement planning,” says Chaitanya Pande, head of fixed income, ICICI Prudential Mutual Fund. Similarly, the Life Stage Funds of Funds from Franklin Templeton Mutual Fund offers five schemes starting from the 20s Plan right up to the 50s Plus Plan.
But as we have pointed out, the investor needs to take a call on the right time to shift. Not everybody has the discipline or understanding to do this when required. In developed markets, there are mutual funds that take into account the age of the investor and automatically reduce the exposure to risky assets. These target date funds (also known as lifecycle funds) progressively shift money out of equities into debt.
A similar arrangement is available in the New Pension Scheme (NPS). An investor in the NPS can choose his investment mix in equities (E class), corporate bonds (C class) and the ultra-safe government securities (G class) funds. But there is a 50% ceiling on investments in E class funds.
However, if the investor does not indicate his desired allocation, his corpus is put into the default option that is governed by his age. Till the age of 35 years, 50% of his corpus will be in the E class fund and the remaining will be split between C class and G class funds. After that, the fund will reduce the exposure to stocks and bonds. Every year 2% of the assets in the equity fund and 1% of the assets in bonds will be shifted to the gilt fund. In five years, by the time he is 40, the equity exposure of his NPS corpus would be down to 40%.
By the time he is 55, he would have only 10% in equities, 10% in bonds and 80% locked in the safety of government securities (see table). “It is an excellent arrangement that aligns the portfolio risk with the investor’s risk appetite,” says Dhirendra Kumar, CEO of Value Research. It is especially beneficial for lay investors who don’t understand or want to track their investments every closely. The only glitch is the assumption that everyone in the same age will have the same risk appetite. The ability to take risk is dependent on several factors and varies for each individual.
A young person with a low income and several dependants may have a lower capacity for risk than someone in his 50s who is earning well and has fewer liabilities. Some experts feel that the NPS is far too conservative in its approach and, therefore, not suited to someone with a high risk appetite. “Why should someone in his 30s not be allowed to put more than 50% in equities?” asks PV Subramanyam, financial trainer with Iris.
But he points out that it is far better than the traditional pension options which invested 100% in debt. Also, these schemes are funds of funds (FoF) and invest in a mix of equity and debt plans from the fund house. A typical FoF will have 5-6 schemes in its portfolio. This dual layer adds to the costs of the fund. The investor is charged the expense ratio of the FoF as well as the schemes it holds. “Low costs are imperative when you are looking at a long-term investment of 15-20 years,” says Dhirendra Kumar. Besides, FoFs are not eligible for the tax benefits that equity and balanced funds enjoy. The long-term gains are not tax-free even though your fund invested a large chunk in equities. This is a major drawback because the tax could erode your returns.
