Indian retirees missed out on equity wealth: How decades of pension-led retirement saving left portfolios stock-light

Investing habits, preferences and patterns don’t change dramatically because one lives in another part of the world. Equity stocks are still the primary growth vehicles, long-term investing is an undisputed virtue, diversification is still the only free lunch, and investors sincerely believe they can beat the markets with smart investing and trading techniques.

However, this shared knowledge doesn’t result in equitable wealth and welfare across borders, even if most investors swear by Benjamin Graham and Warren Buffet. What’s different is history and the regulatory and institutional practices that shape investment choices and attitudes. How does context shape equity investing? Let’s discuss the broad contours of retirement planning as an example.

Equity investing for retirement

When the US enacted the Employee Retirement Income Security Act (ERISA) in 1974, equity investing was already an established idea with thriving equity markets and verifiable history of stock returns. To ensure that ordinary investors access these benefits, three pillars were erected and nurtured over the years. First, your wealth is what you build over the years; there would be no promise of an inflation-adjusted growing pension based on your last salary. What you contribute in your earning years grows and becomes available when you stop earning. This puts retirement planning at the centre of the household’s long-term savings plan.


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Second, employers must offer a retirement plan and contribute to it along with the employees. These contributions will be managed in a diversified portfolio, as chosen by the investor, with the objective of long-term growth. To make it even easier to act, employees automatically enrol into the retirement plan unless they opt out of it. This redefinition of the default choice from opting in to opting out is an acclaimed case study in behavioural finance. Target lifecycle plans, that modify the asset allocation automatically with age, are the most preferred default choice. Long-term saving and investing, thus, happens sensibly, mostly facilitated by smart design choices.

Third, the tax benefits are clearly aligned to enable saving and investing for the long term in a retirement plan. Contributions are exempt from tax, while withdrawals are restricted and taxable. This deferred taxation serves to encourage contribution, while discouraging early exit as well as gradual utilisation of the corpus over the retired years.

While there are many variants to the retirement plan and the choices therein, these principles are the cornerstone to understanding how those choices work. For example, one can contribute post-tax dollars to a retirement plan and withdraw them tax-free when needed. The idea is to defer taxes as an encouragement, while not taxing the same money twice over. Whether the retirement portfolio should have equity investments is not a question. The trustees will be accountable if they did not consider an asset class that would offer better long-term return and diversification. Why not equity would be the question, rather than why equity. We have Harry Markovitz, William Sharpe and other Nobel laureate academics to thank for showing this path to long-term wealth through a diversified portfolio with equity and other asset classes.

Delayed pension paradigm shift

In India, the centralised welfare model placed retirement planning in the hands of the government. For the longest time, before the new National Pension System (NPS) was the norm, we had a defined benefit plan. Even today, we have around us many retired government and public sector employees (and their widows and dependent children as applicable) earning a lifetime inflation-adjusted monthly pension that is way beyond their contributions during their earning years. The retirement income security model that we had earlier approved this entitlement as a state-sponsored welfare measure, until we recognised there wasn’t enough money in the budget for this indulgence. Our pension reforms and NPS took time to arrive because the mind shift from defined benefit to defined contribution took very long.

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Secondly, we focused on the rigor of saving more than on investing. The idea of employer and employee contribution has been around for a long time since the enabling acts and rules for provident fund were created. We also have the public provident fund for the self-employed. Provident funds run by the government or employer had many rules for compliance and for protection of the long-term funds until retirement. However, the enabling institutional infrastructure for investing these funds actively was absent for a very long time. We did not have an equity market index before the 1980s; the debt markets were dominated by the government until the early 1990s. We, thus, made a severe design error due to the lack of developed capital markets. A board of trustees that oversaw the investments complied with specific rules for investing, and the objective was declaring an annual income every year.

So, this long-term retirement portfolio was income-oriented and invested in debt and was not growth-oriented to include equity—a classic misalignment of investment objective and portfolio construction. Despite years of modernisation and evidence of the growth opportunity in equity markets and the rise of mutual funds, it remained tough to get Indian retirement savings to be invested in a diversified portfolio that included equity stocks. Equity was seen as too risky to stake long-term retirement income into, even if data didn’t support that fear.

Missed head start

Even after NPS, simplifying the investment portfolio to include low-cost index funds or permitting investors to determine their asset allocation and product choices, remained elusive. This hurt both the investors who missed the opportunity to hold a diversified portfolio with growth potential, and the Indian mutual fund industry to get a head start by accessing long-term retirement funds. The lowest-cost diversified equity portfolio—index funds—are not the default choice of Indian households for retirement planning. The popular statistic about how households in the US have mutual funds as their dominant holding comes from the simple fact that everyone holds a retirement account and everyone’s retirement account holds mutual funds.

As for the third pillar of taxation, the rules in India had an EEE (exempt-exempt-exempt) proposition for many investments, including provident fund savings. This meant that contributions are exempt, income is exempt, and withdrawal is also exempt from taxes. It took many years to recognise that this system was again denying the government its fair share in taxes and also not effectively deterring early withdrawals from the retirement corpus. We have had many modifications with respect to the retirement corpus, the product choices, its accretions and income, product choices and withdrawals.

What works for one country won’t work for another because of these issues of history, institutional structure, rules and regulations, process of design and oversight, and the broad objectives for welfare and financial security in retirement. In America for example, individual investors can open a stock trading account within their retirement plan and utilise a portion of their contributions, to buy and sell stocks. Their capital gains are not taxed, as long as it is not withdrawn. This flexibility ticks all boxes - long-term investing, contributing the gains and income to the retirement portfolio, deferring taxes on these heads until withdrawal, and actively building corpus. Consider the debate and discussion if this were to be proposed in India!

The Author is Chairperson, Centre For Investment Education and Learning