personal finance: Retirement planning: What is the right equity-debt mix in a high-inflation environment?


We all often consider retirement the golden period of our life, a time to sit back, relax, and enjoy the fruits of hard work. However, a comfortable retirement requires careful planning, especially since you will no longer have an active source of income. You may also have family responsibilities and other expenses to consider, and with life expectancy post-retirement averaging between 20 to 30 years, securing yourself and your family financially is crucial.

In today’s high-inflation environment, saving for an adequate retirement corpus requires efficient asset allocation, with equity investments being a key consideration.

Equity has historically outperformed inflation in the long run, making it an attractive option for retirement planning. However, deciding on the right equity portion can be challenging. Here is how to determine the ideal equity-debt mix to achieve your retirement goals and secure your financial future.

The importance of investing in equity to beat inflation
Inflation is a hidden tax on your investment and erodes the value of money over time. Failing to account for inflation when planning for retirement can lead to a significant shortfall in your retirement corpus.

For example, imagine you need Rs. 1 cr today for retirement. After 20 years, at a 6% inflation rate, you will need around Rs. 3.20 cr.

To ensure that your retirement corpus keeps pace with inflation, it’s important that your investments earn at least inflation returns for the most conservative allocation. 1%-2% should be the target and 2%-3% above inflation is desirable. On average, the inflation rate is 6%. Thus, the return should be at least in the range of 7%-8% post-tax and fees to preserve the purchasing power of your savings and compensate for the increasing cost of living.

Equity is a valuable asset class that has the potential to outpace inflation in the long run. This is because equity investments generally yield higher returns than inflation rates, making them a compelling choice for retirement planning.

For instance, over the period of 2003-2022, the Nifty50 has delivered an impressive average Compound Annual Growth Rate (CAGR) return of 11.9%. This exemplifies the significant potential that equity investments can offer investors over the long term. By investing in a diverse range of equity instruments, such as stocks, mutual funds, ETFs, and more, you can create a comprehensive portfolio that has the potential to outperform inflation and deliver long-term growth.

Nevertheless, it’s important to acknowledge that equity investments carry inherent risks. As such, when determining your asset allocation strategy, it’s crucial to factor in your investment goals and risk tolerance levels.

How to choose the right equity mix?
Choosing the right equity mix is essential for saving a retirement corpus. It requires considering individual goals, risk tolerance, and time horizons while keeping the inflation rate in mind.

The right equity mix is about including equity instruments in a way that creates a balanced portfolio and delivers expected returns while mitigating risks. For this, you should consider a mix of equity and debt for different times to maturity as shown below.

The above table assumes a fixed inflation rate of 6% and shows the expected return and real return for each equity mix. The earlier you start investing, the more space you have to include equity, earn better real returns, and beat inflation.

For less time to maturity, you should focus on getting stable returns rather than higher returns. If the time to maturity is long, you can skew your portfolio more towards equity and can still navigate through short-term market noise while achieving better inflation-beating returns.

This also indicates the importance of saving for retirement as early as possible. Also, remember that there is no one size that fits all for selecting an equity mix. It depends on individual goals and preferences. The aim should be long-term wealth creation.

When it comes to retirement planning, efficient asset allocation is crucial, with equity investments playing a significant role. Equity has a history of outperforming inflation in the long run, making it an appealing option. However, selecting the appropriate equity mix is vital for saving a retirement corpus, which should be based on your individual goals, risk tolerance, time horizons, and inflation rates.

(The author is Anup Bansal, Chief Business Officer, Scripbox)



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