How Should You Move Your Mutual Funds As You Grow Old?

Investment planning is an ongoing exercise as it evolves with time and as per an investor’s age. Any investor’s investment strategy should ideally be in sync with his/her risk profile, which usually changes with age. Young investors tend to have a higher risk appetite and must, therefore, use an aggressive investment strategy. Middle-aged investors can take a balanced approach with a moderate-risk investment strategy. Lastly, investors nearing retirement or those who are retired should adopt a conservative investment approach. The stronger the investment base established at a younger age, the higher the benefits of compounding in the long run. 

Here, we will explain how investors can move their mutual fund investments as they grow old to ensure stability and depth of returns from investment.

How are age, risk appetite, and mutual fund choices related?

An investor’s risk appetite is inversely proportional to his/her age. As one ages, the capacity to take higher risks is less. When an individual is young, he/she has better earning capacity, and this allows the investor to constantly explore better earning opportunities and increase income levels. However, as one gets old or is nearing retirement, savings are generally the only source of income. This hampers the ability of an individual to take on risks with the available funds for investment.

An investor’s risk profile comprises:

1. Risk attitude
2. Risk tolerance.

Risk attitude is an investor’s mental comfort with market movements and corresponding changes in fund value. Risk capacity, on the other hand, is one’s financial capability to take on losses from an investment. Let’s understand this with an example:

Rahul is 30 years old and is working with a large MNC. He earns a decent pay package. However, he prefers to invest in debt funds and money market instruments. This makes him a conservative investor. While his age and financial capacity allow him to take on risks by investing in equity investments, his risk attitude does not permit him to do so.

How does switching mutual funds with age work?

Switching mutual funds can also be called shuffling. This involves periodic adjustment of a mutual fund portfolio with an objective to change the asset allocation mix. With age, as your investment strategy, risk appetite, and return expectation change, you should switch your mutual fund investments so that the exposure to various asset classes within your investment portfolio aligns with your revised strategy.

Moving your mutual fund investments should be done in a well-planned manner and on a periodic basis. This helps in booking profit on time while reducing the risk exposure. 

Here are some investment strategies for different age groups:

Young adults:

Young adults could include students who have just graduated and also those who have passed out of college and landed their first jobs. As young adults start their financial journey, the sudden financial independence can be overwhelming for many. An individual who has just started earning may want to spend on things that are not really required. To avoid financial wastage, it is best to start off with mutual fund investments. 

Young adults often prefer the SIP mode of investing in mutual funds, since there are a variety of options to choose from based on one’s risk appetite. With sufficient market research, one can explore equity fund options since these are high risk but also offer higher returns in the long run. This way, one can begin wealth creation for the future.

Mid-life adults:

People in the age group of 35-50 may see a decline in their risk-taking abilities. To measure the level of risk that one is prepared for as per age, the 100-age rule can be used. Under this, an investor can subtract his present age from 100. This number will be the percentage of an investment portfolio that can be invested in riskier mutual fund options. The remainder should be parked in risk-free investment avenues such as Bank FDs, NPS, PPF, etc.

The most important factor to take into account while determining mutual fund investment options during midlife is asset allocation. Opting for a mix of debt and equity funds can provide a healthy balance to the investment portfolio, such that one does not miss out on gains related to market upswings while also maintaining a healthy risk level.

Nearing retirement:

People who are nearing retirement or are retired prefer to have a stable source of income to cater to their day-to-day needs. As impulsive spending comes down, there are more savings at one’s disposal. However, switching from equity to majority debt funds within a portfolio is the right choice, as it offers stable returns. This is also the right age to use the STP or systematic transfer plan option in mutual funds. STP allows investors to gradually and automatically switch from equity to debt funds. The earnings from debt fund can then be redeemed using the SWP or systematic withdrawal plan to cater to daily financial needs. 

Conclusion

Every individual has a different financial goal. This is influenced by personal preference and also the age of the investor. Mutual funds offer a number of options for various age groups to maximise returns at any point. Each requires investors to invest for a certain time horizon. Thus, as age increases, to reduce the risk levels and maintain sufficient liquidity, one must switch from equity to debt oriented funds. 

FAQs

• What moved my market? (Issue #3: Fisdom Weekly Updates)
• Direct v/s Regular Mutual Funds
• What are direct mutual funds?
• Thumb rules for asset allocation by age
• Best investment plans for retirement