Waiting for pension reforms? Invest in mutual funds for better retirement planning

What has helped steady the overall balance for average Indians is their holding in real assets, largely real estate and gold, both of which have done well in the past few years. Despite a high 30% savings rate, the low allocation to equity-related assets indicates that India is largely a nation of savers. There is a need to make it a nation of investors.

However, if one analyses the investment pattern of the average Indian with that of the high net worth individuals, those with more than Rs 1 crore in financial assets, the difference is stark. This segment invests over 40% of their funds in equities and another 9 % in alternate assets, apart from high investments in real assets.

Little wonder then that the rich keep getting richer since they invest in the high return assets, which undoubtedly have a higher risk but give positive post-tax, post inflation returns. Add to this the magic of compounding and you can understand why the average Indian who holds fixed deposits is ravaged by rising prices, while the luxury segment seems to be largely unaffected and is actually showing growth that is greater than the nominal GDP growth. Take the example of the US, where pension reforms were initiated in the 1980s.

By the end of 2011, the US retirement market stood at a massive $17.9 trillion for 82 million citizens. Mutual funds accounted for $4.7 trillion or 26% of this amount, which in turn represented 40% of the entire mutual fund industry in the US. Retirement saving accounts comprised 48% of the long-term mutual funds across the industry. Interestingly, funds held in retirement accounts were 51% of the entire household's long-term mutual fund holdings.

The investment pattern was also revealing. As much as 54% or $2.53 trillion was invested in pure equity mutual funds, both in domestic and global stocks. Another 21% or $1 trillion was invested in hybrid funds, which invest in varying combinations of equities and bonds. The remaining 25% was in bond and liquid funds.

The US has seen a virtuous circle, with dynamic pension reforms leading to over 50 million households investing in mutual funds, which, in turn, invested in the stock market, leading to both market depth and entry of long-term funds in the market. Today, over 66% of households in the US have more than 50% of their savings in mutual funds.

This is in stark contrast to India, where a very small number of households invest in mutual funds and the total allocation of household savings to these is less than 5%.

With the increase in financial literacy and better marketing, the benefits of mutual funds can be brought to the attention of the under-invested Indians, who are clearly ill-prepared for retirement. This could start a virtuous circle of long-term funds coming into the capital markets, funding critical needs for infrastructure building and creating compounding assets that are tax-efficient and give returns that can beat inflation. Targeted retirement funds, with a set number of years and varying asset allocations that become conservative closer to the goal can make retirement planning simpler and the average Indian independent.

This would be a simple, actionable solution for which no further legislative support is needed. However, investor education and widespread distribution, along with dedicated, client-centric fund managers is essential.

The writer is the head of Private Wealth Management at Deutsche Bank India. These are his personal views.