One evening, Anita's financial advisor Raj called her to discuss about her impending retirement. Raj discussed the importance of debt funds and how it can help maintain capital during the retirement days.

Anita was puzzled. "I am not interested in debt funds. My equity funds have performed so well."

Raj explained, "As you near your retirement years, you must save your wealth from market volatility. Equity markets may be unpredictable in the short term."

Anita hesitated, remembering the returns she had enjoyed. Raj continued, "If there's a huge market crash just before you retire. You might have to postpone your retirement or have to compromise with your current lifestyle."

This struck a chord with Anita. She agreed to gradually shift her portfolio to debt funds over the next two years.

In this article, we will talk about how you can shift from equity mutual funds such as index funds and Equity Linked Savings Scheme (ELSS) to debt mutual funds. So, let's start planning and aiming for a worry-free retirement for you!

Step#1. Review and Reassess Your Financial Goals

First, Evaluate Your Requirements during your Retirement

The first thing that you need to do is write down all the essential expenses such as your living costs, healthcare, and leisure activities. These basics shape your retirement lifestyle.

For example, your estimated living cost is Rs. 10,000, and you spend about Rs. 5000 for healthcare, and Rs. 3000 for leisure activities, you need at least Rs. 18,000 every month. Now, you can use any retirement planning calculator to calculate the amount that you will need after retirement after considering your time left for your retirement and the rate of inflation.

Next, Define Your Time Horizon

Check how many years are left for your retirement. This number is important while planning your investment shift.

If you’re retiring in five years, you must start transitioning to protect your savings from market volatility. If you have more time, you can shift gradually.

Understanding your time frame helps you plan better and reduces stress.

Step#2. Pick the Appropriate Debt Instruments

The next step would be to select the right debt instruments.

Here are a few options:

Fixed Deposits

It is one of the preferred investments since some time. In Fixed Deposit (FD), you can deposit a fixed amount in a bank for a fixed time, and in return, you get fixed interest. However, if you compare FD interest rates with other investment options, it gives you much lower interest.

Government and Corporate Bonds

They seek to offer a middle ground between safety and returns.

- Government Bonds

These may be inferred as the safest, backed by the government, and provide regular interest income.

- Corporate Bonds

These are issued by companies and seek to offer higher returns, though with slightly more risk.

It can be one of the investments for regular income and saving your capital amount. However, it can be difficult for retail investors to invest and exit from these bonds.

Debt Mutual Funds

Debt mutual funds can be one of the investment option for retail investors looking for a relatively stable investment option.

Debt mutual funds seek to provide a balanced approach by combining stability with reasonable returns. There are different types of debt mutual funds that invest in different securities. As a result, the risk and return of the debt mutual funds will also vary.

You can tailor them to match your risk-taking ability and investment horizon.

While the debt mutual funds taxation has undergone a change, it is still tax-effective than other debt instruments as the tax on debt mutual funds is applicable only at redemption. In case of other traditional debt instruments, the interest income earned in that financial year is added to the overall income and taxed as per the income slab.

Currently, debt mutual funds that have more than 65% in debt securities and redeemed after investing for 24 months, 12.5% tax is applicable on the capital gains. For redemptions before 24 months, the income is added to the tax slab and taxed as per the income slab.

Step#3. Choose Suitable Gradual Reallocation Strategy

There are two aspects of reallocation strategy. Let’s discuss each in detail.

1. Bucket Withdrawal Strategy

This strategy divides your money into three “buckets,” each with a specific purpose and timeframe.

Bucket 1: Easy Access Funds for Daily Needs (Debt Heavy)

This bucket is for your daily expenses. It’s filled with liquid, low-risk investments like fixed deposits and short-term debt funds. The goal is to have easy access to money right after your retirement for your everyday needs without worrying about market fluctuations.

Bucket 2: Hybrid (Mix of Equity and Debt) for Medium-Term Needs

As the name suggests, this bucket is a mix of equity and debt investments. It’s mainly to cover your needs in the coming 5-10 years. This mix provides some growth potential from equities while seeking to maintain stability with debt investments.

Bucket 3: Growth-Oriented Investments (Equity Heavy) for Long-Term Needs

The third bucket focuses on long-term growth. It’s heavily weighted toward equities to maximize returns over time, also the risk associated is very high. This bucket seeks to ensure that your money continues to grow, and helps you in fighting against inflation and saving your retirement funds for 10+ years.

You must start planning at least five years before your retirement, especially if you have an equity-heavy portfolio. This timeframe gives you the leverage to gradually shift your investments by reducing risk and avoiding any sudden market downturns that could affect your savings negatively.

2. Systematic Transfer Plan (STP)

“So, how should I shift my equity mutual portfolio towards a more balanced portfolio?” asked Anita.

Raj introduced her to STP which can be an effective tool to steadily move her investments from equity to debt.

How STP Works?

With an STP, you systematically transfer a fixed amount from your equity funds to debt funds at regular intervals (monthly or quarterly). This gradual shift helps in reducing market volatility risks and allows you to average out the transfer costs.

What are the benefits of STP?

The primary benefit of STP is that while you’re moving a portion of your investment amount to debt funds, the rest of the amount in equities keeps growing. This dual approach seeks that capital is maintained and also helps it grow.

Let’s Check Things You Must Consider While Shifting From Equity to Debt

Amount to be shifted from Equity to Debt

There is no right answer to this. The amount of money that you need to shift depends on your risk tolerance and requirements. For example, Anita is frugal and she doesn’t need a substantial amount in the near term. In this case, only a portion of her investments gets shifted to debt while the rest of her investments continue to remain invested in equity funds.

Increasing Lifespan

People are living longer due to medical advancements, so your savings should also last for many years. Keep some equity exposure to ensure your funds don’t run out. Equities aim to offer higher returns to help grow your money over time.

Inflation

Inflation reduces your money’s buying power. So, you must choose investment options that outpace inflation and also maintain the value of your savings. This ensures you can cover future expenses.

Emergency Fund

Set aside an emergency fund with at least six months of living expenses. This fund should be easily accessible and cover unexpected costs like medical bills or home repairs, which protects your long-term investments.

Consult a Mutual Fund Advisor

Seek professional advice for personalized planning.

Tax Efficiency Considerations

Be mindful of capital gains tax when shifting investments. Debt mutual funds are more tax-efficient than other traditional instruments since tax is applied only on gains at withdrawal.

For example,

• In Fixed Deposits, Interest is taxed yearly.
• In Debt Mutual Funds, tax is applied on gains at withdrawal, often resulting in lower taxes.

Conclusion

After listening to everything, Anita is now fully aware of the importance of debt investments and the role they play in retirement planning. She understood the importance of planning early and having a stress-free retirement.