Retirement planning involves setting up a financial plan for the post-retirement period & drafting a strategy to achieve those objectives. This involves estimating the future costs, future income sources, & thereby investing accordingly to build a retirement corpus for a financially secure future. Understanding the Types of retirement plans available assists in making informed decisions & a stable income source. Hence, mutual funds help you accumulate the funds to meet future expenses, such as medical or healthcare costs, maintain the desired lifestyle, at the time when there is no income source.
Mutual Funds Categories Suitable for Retirement
The following are the categories of mutual funds that best suit starting with investing for retirement:
- Equity Mutual Fund Schemes
Under this type of mutual fund, the investment is done in equity-linked instruments, i.e. small, mid, & large-cap funds, depending on your mutual fund scheme.
- Debt Mutual Fund Schemes
Under this type of mutual fund, the investment is made in money-market & debt-market instruments. They can be further divided into categories depending on the nature of the fund & its maturity.
- Hybrid Mutual Fund Schemes
This scheme includes a combination of debt & equity funds, including the features of both fund types.
- Solutions-Oriented Mutual Fund Schemes
This scheme contains two types of funds, namely retirement funds & children’s funds, which include a lock-in period of 5 years or retirement age, whichever is earlier.
- Other Mutual Fund Schemes
Other mutual fund schemes include Index funds, fund of funds, or exchange-traded funds.
Things must be considered before investing in a mutual fund for retirement.
The following are the things that must be considered before investing in a mutual fund for retirement:
- Invest in Funds Giving Higher Returns than other investment options
It is always advised to invest in funds that offer higher returns and help you beat inflation and create long term wealth.
- You cannot Receive Equal Returns Every Year.
Mutual funds do not offer equal returns every year;if it provides 8% returns this year, they may generate 2% next year.
- For Higher Returns, Invest in Direct Plans
It is advised to invest in direct plans, as they offer higher returns because of their low expense ratio. This low expense is due to brokerage not being charged.
- Try SIP to Create Investment Discipline
SIP allows an investor to invest a certain fixed amount in mutual funds consistently. It inculcates the habit of disciplined savings & helps deal with market fluctuation via the rupee cost averaging technique.
- Focus on Asset Allocation Process
Diversify your investment by allocating it across different asset classes to avoid losses.
- Periodic Rebalancing to Earn More Profits
This means when an asset class is instated in the portfolio, the profits earned get reinvested in a different asset class that is part of your portfolio only.
- Not All Mutual Fund Categories Have the Same Risks
There cannot be any comparison between different categories of mutual funds, as they may pose different levels of risk.
How to select a Mutual fund for retirement planning?
The things to be kept in mind while selecting mutual funds for a Retirement Plan are as follows:
- Financial Objectives
Assess your financial objectives before investing in mutual funds in terms of expected returns. Once your financial objectives have been defined, an investorcan diversify their portfolio in mutual funds.
- Risk Tolerance Level
The risk tolerance level of an individual depends on multiple factors, such as age, medical, financial, etc. By assessing the risk tolerance level, one can find an appropriate mutual fund scheme.
- Expense Ratio
The expense ratio is calculated as the annual maintenance cost divided by the actual asset value. It is basically the commission charged to ensure profits from investments, where a low expense ratio is always advisable.
- Liquidity
Consider the liquidity of funds before selecting an appropriate mutual fund scheme. The liquidity of funds mainly depends on the type of mutual funds chosen. This means if you want to withdraw funds sooner, invest in liquid funds, else in equity mutual funds if funds are to be withdrawn later.
- Taxes
One should have a good knowledge of taxation on mutual funds while choosing an appropriate mutual fund. This can be understood as mutual funds with long-term capital gains offer an exemption of up to INR 1 lakh, & the balance amount @10%. On the other hand, short-term capital gains do not offer any exemption & are taxed @15%.
Pros of Investing in a Mutual Fund for Retirement
Provided are the benefits of investing in a mutual fund for retirement planning:
- Risk Diversification
Mutual funds allow you to diversify the risk of your portfolio across different asset classes, such as equity & gold, thus helping to reduce the risks.
- Management by Professionals
This fund is managed by a team of expert professionals who guide you through the investment process.
- Affordability
Mutual funds are quite affordable due to high economies of scale & low expense ratios.
- Liquidity
Under open-ended mutual funds are highly liquid & let you manage financial emergencies. Hence, if you want your funds sooner, opt for this plan.
- Tax Exemptions
This fund is eligible for a tax deduction of up to INR 1.5 lakhs u/s 80C of the Income Tax Act, 1961.
Cons of Investing in a Mutual Fund for Retirement
Provided are the disadvantages of investing in a mutual fund for retirement planning:
- Fluctuating Returns
These funds do not assure guaranteed returns, hence no stability in returns.
- No Self-control
There is no control under this scheme on the investments made due to funds being managed by a team of professionals.
- Profit Dilution
Diversification can be beneficial, but it restricts growth as well if funds are scattered in too many mutual funds.
- Fund Management Costs
An investor should consider management costs as they may not be fixed & might not assure better returns.
Conclusion
Mutual funds are an effective financial tool that can be used for retirement planning, considering their long-term nature & consistency in mind. It is always advised to start early &remain invested to build a robust financial future.