Podcast 10th April 2015
NPS (National Pension Scheme) has a retirement plan that invests in a mix of equity and bonds with weights determined by your age. For example if you are below 40, more weight is given to equity than bonds and as you approach 55, weight given to equity becomes less. Read our note on NPS to understand the schemes.
In a perfect world without market, economic and business cycles, you will gain from higher equity allocation in the early years of savings and then reap the benefits without taking higher risk on equities.
We all know that the world is not perfect. It could well be that your savings get invested more and more in equities when equity prices are bubbling over and after the bubble bursts your equity investments become less and less. You are actually buying high and selling low.
In case of fixed income investments, your allocation to fixed income could be higher when the government is running policies that stoke inflation in the economy. You are losing out real returns on fixed income investments, which will hurt you when you retire.
The world has given plenty of examples where market, business and economic cycles have worked completely against what we call “an outdated retirement investment theory” of allocating weights to asset classes based on age or time to retirement.
India has seen many equity bubbles and busts since 1990 and investments at bubbles would have proved really detrimental to retirement investments. India has also seen long periods of high inflation that has completely destroyed savings of retirees.
What is the right way to look at retirement investments? Dynamic asset allocation is one way of riding out market, economic and business cycles. Weights are assigned to equities or debt based on valuations, growth and inflation expectations. However there could be destruction and disruption in economies and businesses as well and broad asset allocations may not work at all.
The ideal way to look at retirement investments is to invest based on where you are standing at in terms of current and future expected market, economic and business cycles. Would you invest in bubbles that are frothing over? The answer is a clear no. Would you invest when markets are depressed but economic and business conditions are improving? Yes. Would you invest in change leaders if you spot it? Yes. Would you invest in businesses that are being killed by change leaders? No.
Government that is taking sound policies to contain inflation expectations would make you invest in long term fixed income securities. Political chaos would make inflation expectations rise and you would avoid long term fixed income securities.
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