It is not enough to just plan and save for your goals. You may do everything right on that score but still find yourself short if the money is not readily available to use when the goals have to be funded. Here are some moves to make at the end stage of the game—when you are near your goals—so that there is no slip between the cup and the lip.
Have an exit strategy
Not having a strategy to withdraw money from your investments to fund the goal is the biggest mistake you can make towards the end of your investment horizon.
This includes knowing when the goals have to be funded and the amount required at each stage, which becomes much clearer closer to the goal. Once this is known, assess the investments accumulated to see if they are adequate. If not, decide how you are going to deal with the shortfall. Your options include diverting investments from other goals, taking a loan or even delaying the goal, if possible, to give you time to accumulate the required funds.
Redeem in phases
Once the funding decisions are made, the next step is to decide how to sell or redeem the investments. Give yourself sufficient time to make the transition from accumulation to distribution.
If your investments are in growth assets like equity, then there is a price risk that you have to factor into the selling decision. Plan your exit over a period of time, so that you are not caught in a dipping market when you are ready to sell. Exit from financial instruments such as mutual funds, bonds and equity shares in a phased manner over a period of time.
One investment tenet that works equally well in the accumulation or withdrawal stage is that of cost averaging. Just as it is difficult to predict the lowest market levels to buy into an investment or asset, it is equally difficult to predict the high point in the market to exit that investment.
A better strategy would be to exit in a staggered manner over a period time to be able to take advantage of market volatility and get a good price when markets are high, to even out the lower prices at other times.
Physical assets such as gold are relatively easy to sell, while some others like real estate are less liquid and may take longer to liquidate. Some investments, especially debt products like deposits and savings schemes, come with a maturity date. These may not be exactly synchronized with the due date of your goals. When a maturity is earlier than the goal date, plan for the realized amount to be held safely till the goal is due.
Where to park the funds
Take time to choose the investment products into which the realized corpus will be channelled. If the money is to be used as a lump sum payment, say for down payment of a home, you will want to park it in a safe short-term investment product like a savings bank account or a short-term mutual fund scheme till you are ready to use it.
On the other hand, if this is the corpus that needs to provide a regular income in your retirement, then you need to select products that will generate the income that you require. Depending upon your need for safety, income and liquidity—in whatever combination—select the most suitable products to hold the funds as and when the investments are realized.
A rising market or a product with good returns may be tempting but unsuitable for your needs in the distribution stage. Focus on the goal and set the exit plan in motion irrespective of the level of market or new products available.
The effect of time, and compounding in reverse
Time and compounding benefits work against you in the withdrawal stage. The move—from higher-earning growth investments in the accumulation stage to lower-return investments with a focus on liquidity and income orientation in the distribution stage—will impact the portfolio’s returns. The opportunity cost is magnified by the compounding effect. Mitigate this impact by withdrawing only as much as you need for each stage of your goal instead of withdrawing all at once. In this way, some portion of your funds will continue to earn higher returns.
Unlike in the accumulation period, where an increase in the time available benefits you with more time to contribute to the corpus and greater compounding benefits, in the distribution phase it works against you. An increase in the distribution period may well translate into the corpus running out before the goal is fully met. For example, if you have provided for 4 years of education for your child but actually have to fund for a longer period then the corpus will feel the strain. If the period is expected to go beyond what was originally provided for, then you should consider practicing austerity measures right from the beginning to make the corpus last and augment the corpus with other income or loans where possible.
Make it tax efficient
Taxes eat into the corpus available to meet goals since they may apply both when you redeem or sell the investments and when you use the corpus to earn an income to pay for goals. Factor this into your calculations and selection of products and look for ways to minimize the impact. For example, in the accumulation stage redeeming investments made in equity-oriented products are currently exempt from long-term capital gains tax. Funds accumulated in the Public Provident Fund (PPF), Employee Provident Fund (EPF) and insurance products are also exempt from tax. If you are holding funds in the savings bank account before you use them for your goals, then don’t omit to use the tax benefit under section 80TTA of the Income-tax Act on interest income earned. Mutual funds allow you to structure your returns as dividends or capital gains, depending on which is more tax efficient for you, given your tax bracket.
You have multiple decisions to make as you move to the distribution stage. You need to plan and strategize to make sure that the corpus you have accumulated is adequate for your needs and is used in the best way possible.[“Source-livemint”]