From the hidden pitfalls of rental properties to the smart way to use mutual fund SWPs, we break down how to secure regular, sufficient, and safe income for your golden years.
Achieving superannuation or retiring from active work life is one thing but skillfully using the corpus to sustain you in your lifetime and your dependents, thereafter, is quite another. Here are answers to top questions on your mind regarding generating passive income:
What Are The Key Factors To Consider When Setting Up A Passive Income Source?
For many of us, passive income doesn’t become mainstream until we retire and look for ways to replace our monthly pay cheque. Three factors become important when setting up this income source:
One, regularity in receipt – preferably monthly; at best, quarterly
Two, sufficiency of the income – the return on capital
Three, safety of the corpus – the return of capital
Compromise on even one of these three, and the smooth life you expect post-retirement, is sure to get bumpy.
When Should You Start Planning For Passive Income?
As early as possible in your working life.
You need to make a quick start to ensure sufficiency of income in your later years. Otherwise, both inflation and a long post-retirement life can dwarf the passive income over the years, leaving you with little choice but to risk safety of capital for higher returns.
If your income does not cover the increase in the cost of living you will experience year after year post-retirement, you will have to compromise on your lifestyle and curtail your expenses. And, the longer you live, higher the risk of dipping into your corpus (instead of living off the returns) and even depleting it during your lifetime.
This is the reason financial planners consider inflation in the post-retirement years as well as life expectancy into the retirement planning calculations even when you are actively building the corpus. If you start early, the corpus you need to live your silver years comfortably is much easier to build.
I Have Invested In Another House Apart From The One I Live In. I Use The Rent I Earn From It To Generate Regular Income.
While rent is perceived to be safe and steady income flow, there are several hassles with let-out properties:
- Maintenance and other associated costs of ownership
- Finding a good and suitable tenant who will pay the rent regularly
- Making sure the property doesn’t lie vacant off and on
- Ensuring that you always earn the right rental value for the location and amenities provided
Even if all these things fall in place, rental yields on residential properties in India range in low to mid-single digits.
Yields tend to be better for commercial spaces. Lately, listed REITS (Real Estate Investment Trusts) has emerged as an alternative. REITS invest primarily in real estate which earn rental income (predominantly from owning office spaces/malls) and are mandated to distribute 90 % of their cash flows to unit holders at regular intervals. They can provide stable income at higher yields, but capital appreciation opportunities may be limited as they distribute most of their income. However, investing in REITS should best be a diversification strategy. It is not a practical idea to invest heavily in these instruments as the number of listed REITS are limited and it poses concentration risk.
Won’t Earning A Stable Income Flow By Investing In Deposits, Bonds Or Annuities Be A Good Strategy?
Interest or annuity income passes the regularity test, but sufficiency and sometimes, safety becomes questionable.
Fixed deposits with banks and finance companies, investment in post office schemes, government and corporate bonds as well as annuities of insurance companies are all regularly used to earn passive income on a monthly/quarterly basis.
But returns on these instruments are subject to cyclicality of interest rates. This means that you must be prepared for the real return (interest rate minus inflation) being negative for these products often.
There are three ways to cover for inflation:
One, by investing in long-term government securities when interest rates are at a peak. For example, the RBI retail direct platform offers G-secs with 20/30 years duration. Sovereign guarantee ensures absolute safety of capital here. For instruments with shorter tenures such as bank or post-office fixed deposits, you can cushion the impact of interest rate risk by choosing higher tenures when interest rates are high and opting for shorter durations when rates are low.
Two, by investing in floating rate bonds where returns move in tandem with the market rates. These instruments are again guaranteed by the government /RBI and hence risk free.
Three, by seeking higher returns for higher risk, but at the same time, not going overboard on the same. This is where NBFC deposits and corporate bonds come in. Prudence over greed or short-term benefits is what should govern the allocation to these instruments. Invest only if you will still be able to manage even if your capital is not returned.
What Are The Ways To Earn Passive Income From Stock Market Investments?
Dividend payouts as well as capital gains can be good sources of passive income for investors who have painstakingly built their equity portfolio during their working years. However, regularity and sufficiency of income in this route is not a given. A need to liquidate when the markets are in a downturn can trim your gains or even result in a capital loss. Hence, you need to book out when the markets are peaking and move the near-term needs to safer instruments.
Similarly, sustaining on dividend income will be a viable option only when the investments are made based on certainty of dividend as well as opportunity for growth in dividend over the years. Simply investing based on the latest dividend yield or based on special dividends being declared now and then will not be a viable passive income strategy.
Passive income from mutual fund investments is an option too. But regular dividends here again are not a given. Even when it is paid out, distributions could be both out of capital put in by you as well as the earnings/profits of the fund. This is why the dividend plan of mutual funds was renamed ‘Income distribution cum capital withdrawal plan(IDCW)’ a few years ago.
Instead, systematic withdrawal plans (SWPs) work well for passive income from mutual funds, provided you invest the retirement corpus in the right fund categories. The rate of withdrawal plays a crucial role here. It should ensure sufficiency of income as well as avoid total depletion of the capital. You can get the help of your advisor to arrive at the right working for you.
How Much Should I Have To Retire Comfortably?
A recent view that a whopping Rs 40 crore is needed to retire comfortably in India, went viral on social media. While this is a mind-boggling number for many, the real answer to that question is highly personal.
Your ideal retirement corpus should consider your monthly post-retirement expenses (including inflation) and money needed for healthcare and medical or other emergencies (outside of your insurance cover), assuming a certain span of life.
Many investors think of retirement only as they reach middle age and when they have met certain other goals like a home buy or funding a child’s education. But the secret lies in starting your savings for retirement early. Invest in equites (directly/ through mutual funds) to compound your money at rates higher than inflation. Once you retire, invest the corpus built in a combination of equity and debt instruments according to your risk appetite and expense requirements, to generate passive income.
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