What should be the asset allocation for building retirement corpus? Find out

Arjun is in his mid-30s and his wife is a working professional. The couple also has a child. Arjun has been saving a part of his earnings from the time he started his career. He has opted primarily for tax-saving investments. He can now afford to increase his savings and focus on building his retirement corpus. However, Arjun is confused whether he should invest in bank deposits or take higher risk and invest in equity mutual funds. What should he do?

The first step towards retirement planning is to save and invest aggressively in the years before retirement. Arjun must realise that he is in the accumulation phase—starting from the beginning of his career till the age of retirement. The retirement stage is likely to be equally long, but his assets will have to provide the income. To fund expenses in the years after retirement, these assets should be enough to beat inflation.

This is why Arjun needs a large retirement corpus. Growth assets, such as real estate, equity and gold, are typically risky since their values fluctuate in the short term, but have the potential to appreciate in value in the long term. They offer no or little regular income. Bank deposits, bonds and small savings schemes provide a regular income, but do not appreciate in value. Growth assets tend to provide capital appreciation and inflation-adjusted returns over the long term. Arjun’s retirement portfolio must consist primarily of growth assets.

The higher the allocation to growth assets, the higher the potential risk and return. This asset allocation, however, should change as he grows older. This is because his risk tolerance will decrease with age as he approaches the period of drawing on the retirement corpus. So he should scale back on the growth assets in his portfolio over time and increase the allocation to income assets. Choosing income assets, such as bank deposits, in the accumulation phase can leave Arjun with a much smaller corpus, while growth assets can become much bigger with time.

(Content courtesy: Centre for Investment Education and Learning ( CIEL). Contributions by Girija Gadre, Arti Bhargava and Labdhi Mehta.)