This is why equity allocations work better for wealth creation in the long run

In part 1 of this series, we highlighted the importance of retirees having some element of equity asset allocation in their portfolios. In this article, which is a continuation of the previous one we will delve into how equity allocations work better for wealth creation objectives in the long run.For retired investors, it may be hard to move away from established patterns and entrenched investment notions that they may have in their pre-retirement years. Post retirement when the income apparatuses undergo a radical shift and risk-taking abilities also decline, investment strategies may become heavly coloured by an extra conservative approach which may deter wealth creation in the long run. Investments into asset classes such as gold, fixed deposits, real estate become dominant in the portfolio with little room for any equity component. While, retirees may have built a substantial reservoir for their post-retirement years by diligent investing in their pre-retirement years, many erroneously believe their wealth creation goals can take a backseat especially what with their children settled. However, with longer life expectancies, galloping inflation and mounting medical expenses, traditional investment instruments may not be able to provide enough returns to ensure enough financial legroom perpetually. This is where equities come into the picture and warrant weightage in the portfolio of retirees.Equity vs real estateFor retirees, investing in real estate post retirement may be a herculean task and generally real estate investments are made pre-retirement – rental income from real estate investments aid in supplementing income post retirement. However, from an investment perspective the biggest drawback with real estate lies in the fact that it is a long term investment that you would need to hold on to until the property prices rise to its potential. The returns would also depend on the choice you would have made when buying the property – the location would determine the returns and so will the concurrent market scenarios in the real estate sector. Should you find yourself in a position where the real estate market is going through a slump, you would have no choice but to either wait for the scenario to improve or liquidate it for a loss. You would also have to woo a suitable buyer who would be willing to pay the price you are seeking.Although equities also carry risks, what makes them fare better in terms of returns in the long run is the power of compounding. Investments spread across different market cycles over a long period of time helps you reap the benefit of rupee cost averaging and the ups and downs in the market averages out overtime. According to a report published by property portal 99acres.com citing data from the Reserve Bank of India’s House Pricing Index (HPI), the average home prices in India have risen by 10 percent yearly between FY 2010-11 and FY 2020-21.Equity vs goldEquities and gold as two asset classes serve two different purposes. While equities bring in returns higher than the inflation rates, gold act as a hedge in terms of uncertainty because gold prices typically do not move in tandem with the market. The presence of both these elements is vital for a sound portfolio building exercise. But, in the case of retirees, equity becomes an absent factor and the belief that appreciation in the prices of gold is inevitable in the long run and will be enough for sustained capital appreciation can create problems because gold returns have generally hovered in the 5% to 12% range in the last decade. Unlike equities where you can claim tax benefits if you choose tax saver funds, holding gold does not provide any tax benefits. Moreover, liquidating gold assets can be a challenge with returns being cyclical and constraints like loss of making charges. As a physical asset, gold also entails storage liabilities and insurance costs.Equity vs fixed depositsSimply put the biggest difference between fixed deposits and equities is that fixed deposits offer low to moderate returns with no risk. On an average the returns from FDs is typically in the range of 5% to 8% and when you take into account the fact that returns from FDs are taxable, the ability of these instruments to bypass inflation levels pales significantly. FDs also pose liquidity challenges because you have to invest a lumpsum for a certain tenure and should you choose to withdraw the investment before the maturity period, you stand to lose a portion of interest income. With equities, liquidity is rarely a concern as these assets can be converted to cash in a jiffy and neither do you need to accumulate a lumpsum to start investing in them.The expert takePreeti Zende co-founder of Apna Dhan Financial Services says, “There are 5 important asset classes for investments. Cash and cash equivalents, Debt, Gold, Equity, and Real estate. The usefulness of all these asset classes depends on your need and the financial goals for which you want to invest. For retirees, the most suitable asset classes are cash, debt, and Equity. The allocation of funds in these asset classes depends on a regular income, liquidity, and the need for inflation-headged return. Basically the primary need for retirees is regular income to meet day-to-day expenses and the safety of capital that can be achieved from keeping some amount in bank balance, FDs and liquid funds in the form of emergency funds.”Explaining the equity angle, she says, “But these investments lack in providing inflation hedged returns after taxes that’s why allocation in Equity is needed for the retirees. If you invest in equity in the initial years of retirement through equity mutual funds and keep invested for 10+ years then the accumulated corpus can be used for later years of your retirement. Equity MFs in the combination of hybrid funds, nifty index and flexicap can make sure that you are not taking the undue risk on the equity side. Gold and real eatate may not be suitable for the fresh investments post-retirement as they are illiquid as well as need huge initial investment. If you are already invested in them then you may continue, provided you get regular income from them as well major allocation of the portfolio is not concentrated only in these 2 asset classes.”Shalab Gupta Bibhab, founder of Bibhab Capital says, “MF’s offer a unique proposition in form of hybrid schemes, balanced or ESF category suits them well. This fits the bill for wealth creation and SWP’s in them serve the use of missing regular incomes. All this comes at low volatility only. 70-80% of the corpus should chase this category. 10-15% in growth oriented equity schemes for that additional kicker and remaining in debt funds to cater to any untoward expense. Real estate loses out to mutual funds when it comes to liquidity and uncertainty while gold and FDs have never been attractive options in terms of post-tax returns. If this sounds too overwhelming, taking the help of an experienced planner is advised.”Action pointsIf you have never dabbled in equities before, SIPs in equity mutual funds with underpinnings of large cap stocks can be a great way to make a headstart.Do not liquidate any existing investments in a jiffy should you be looking to test the waters with investments in new asset classes.This article is part of the HT Friday Finance series published in association with Aditya Birla Sun Life Mutual Fund.