What are retirement portfolios made of? At a minimum, a retirement portfolio should contain a debt component for stability and to draw periodic income from, an equity component to allow the portfolio to grow and keep up with inflation, and importantly a rebalancing plan to optimise growth and stability. (we are not talking about physical assets here).
If this is the need, what if we use a balanced advantage fund, which invests in both debt and equity, and the fund manager takes care of asset allocation as well? Does that reduce your job to just coming up with a withdrawal plan? And are there any hidden risks in going with this seemingly ready-made solution?
In this article,let’s look into how a full-fledged retirement income generation plan from a balanced advantage fund stands against one from a managed equity and debt portfolio.
Portfolio 1: Balanced advantage fund
Balanced advantage funds, as an official mutual fund category, came into existence after SEBI’s classification of mutual funds in 2018. A typical balanced advantage fund has an effective equity exposure anywhere between 30% to 80% based on the fund manager’s perception of whether equity is overvalued or undervalued. It is important to note that each fund house will have different metrics to assess this.
Now, this category is officially in place only for the past 6 years. But we need longer data to assess the feasibility of balanced advantage funds as a retirement product. Therefore, we picked a fund that chose to be a balanced advantage fund even before SEBI’s category came into being, making it a pioneer in this category. We are talking of ICICI Pru Balanced Advantage (which was first launched as ICICI Pru Equity and Derivatives Fund) For the period we have chosen, from January 5, 2007, to July 5, 2024, the fund has given a CAGR of 11.49%.
Portfolio 2: Separate equity and debt funds
For this portfolio, we have selected funds with similarly long track records from the same fund house. The equity fund chosen is the ICICI Prudential Value Discovery Fund, and the debt fund is the ICICI Prudential Short Term Fund. We have used different asset allocations, which will be explained in the Analysis section below.
For the period from January 5, 2007, to July 5, 2024, the ICICI Prudential Value Discovery Fund delivered a CAGR of 17.04%. The ICICI Prudential Short Term Fund has achieved a CAGR of 8.19% for the same period.
Rebalancing plan
In an asset-allocated portfolio, rebalancing is done to take profit from inflated assets or to add to an asset that is available cheaply. This can be done on a rule-based approach, such as once a year, if the asset allocation has moved in either direction by a certain threshold, bringing it back to the original allocation. For example, in a 60-40 Equity-Debt portfolio, if equity goes up to 65% or above, you would sell part of the equity and buy debt to bring the total allocation back to 60-40. Similarly, if equity drops to 55% or below, you would sell part of the debt and buy equity.
However, since our two-fund retirement portfolio is quite minimalistic, we cannot allow selling debt to buy equity, as the debt fund is what we are counting on to meet future monthly withdrawals. (In an advanced retirement portfolio, there can be separate components to take care of periodic withdrawals and debt as part of the long-term portfolio to carry out rebalancing.) Hence, in our two-fund portfolio, rebalancing is done only if equity gets inflated. Redemption of equity is done when the equity asset allocation goes up by more than 5% from the original allocation, and this will be invested into debt.
Analysis
For our analysis, we started with an initial capital of Rs. 1 crore and tested initial annual withdrawal rates of 4%, 5%, and 6%. In each case, we applied an annual increment of 6% to the withdrawal amount to adjust for inflation, as typically done in retirement portfolios.
For example, with an initial annual withdrawal of 4% per year, the monthly withdrawal would be Rs. 33,333 (4% of Rs. 1 crore / 12).
In the second year, the monthly withdrawal would be Rs. 35,333 (106% of Rs. 33,333).
In the third year, it would be Rs. 37,453 (106% of Rs. 35,333). And so on.
The monthly withdrawal at the end of the period would be Rs. 89,759.
Please note that taxes have not been accounted for in this analysis.
Portfolio transactions
For Portfolio 1, the initial capital of Rs. 1 crore was invested in the ICICI Prudential Balanced Advantage Fund on January 5, 2007. Withdrawals began from the same fund starting from January 5, 2007, lasting till July 5, 2024.
For Portfolio 2, we considered two different asset allocations: a 50:50 equity:debt and a 30:70 equity:debt ratio. The initial capital of Rs. 1 crore was allocated to the ICICI Prudential Value Discovery Fund and ICICI Prudential Short Term Fund according to the chosen asset allocation. Monthly withdrawals were initiated from the ICICI Prudential Short Term Fund starting from January 5, 2007, to July 5, 2024.
Every January 5th, the portfolio’s asset allocation was reviewed. If the equity portion had increased by 5 percentage points or more from the initial allocation, it was rebalanced by redeeming from equity and reinvesting into debt to maintain the original allocation.
Here is how the results stands:
Metrics for evaluation
- Balance Capital: The remaining amount in the portfolio after all withdrawals have been made.
- Balance Capital Growth Rate: The annual growth rate of balance capital, after all the withdrawals in this period.If this rate keeps up with inflation (assumed at 6% in this analysis), the portfolio is likely to sustain future income generation. For example, in the case of Portfolio 1 (Balanced advantage fund) at an initial annual withdrawal rate of 6%, we started with Rs.1 crore and ended with Rs.1.57 crore. For a period of 17.5 years, that is a growth of 2.63% per annum.
- Final Withdrawal: The annual withdrawal rate in the last month under observation based on the balance capital. For example, in the case of Portfolio 1 (Balanced advantage fund) at an initial annual withdrawal rate of 6%, the final redemption is Rs.1.35 lakh, the remaining capital is Rs.1.57 crore. This is 0.855% per month or 10.26% per year.
- Withdrawal Risk: The percentage of observations throughout the income generation period (17.5 years in this analysis) where the annual withdrawal rate exceeded the initial withdrawal rate. For example, in the case of Portfolio 1 (Balanced advantage fund) at an initial annual withdrawal rate of 6%, out of the 211 months when a withdrawal was done, only 11 times the withdrawal was below 6% (annual rate) of the remaining capital. At 200 months, the withdrawal amount was above 6% (annual rate) of the remaining capital, resulting in a withdrawal risk of 94.8% (200/211).
Among the metrics, one needs to make the distinction between final withdrawal rate and withdrawal risk. Withdrawal risk points to the stress the portfolio underwent in generating retirement income during the period under observation. The lower the value, the less the risk. Final withdrawal rate points to future risk. A higher final withdrawal rate compared to the initial withdrawal rate indicates capital erosion in the portfolio, risking future income generation.
Findings
Case: 4% withdrawal
All three portfolios comfortably sustained the 4% initial withdrawal rate, as evidenced by the growth in remaining capital above the 6% annual increment in withdrawals. The final withdrawal rates were lower than the initial rate set for all portfolios. However, when examining withdrawal risk, the Balanced Advantage fund portfolio exhibited a higher risk (41.7%) compared to the asset-allocated portfolios.
Case: 5% withdrawal
In this case, the Balanced Advantage fund portfolio appears stretched in its ability to provide retirement income. The remaining capital grew below the rate of increase in withdrawals, and the final withdrawal rate exceeds the initial 5% withdrawal rate. The withdrawal risk is very high at 94.3%, indicating high stress in the portfolio to generate income in the period.
In the asset-allocated portfolios, the 30:70 Equity:Debt portfolio managed to maintain its sustainability for retirement income withdrawals. Its capital grew at nearly 6%, and the final withdrawal rate was slightly below the initial rate. However, with a withdrawal risk of 56.87%, there was notable stress in meeting income needs during the period.
Meanwhile, the 50:50 Equity:Debt portfolio has comfortably managed to withstand the withdrawals.
Case: 6% withdrawal
In this case, both the Balanced Advantage fund portfolio and the 30:70 Equity:Debt portfolio faced stress due to higher withdrawals. However, the Balanced Advantage Fund portfolio experienced more stress than the 30:70 Equity:Debt portfolio, as evidenced by a final withdrawal rate 2.5% higher than the latter. Additionally, the withdrawal risk of the Balanced Advantage fund portfolio was over 10 percentage points higher than that of the 30:70 Equity:Debt portfolio.
Meanwhile, the 50:50 Equity:Debt portfolio managed to withstand the higher withdrawals in this scenario as well, although its performance was not as strong as in the 5% withdrawal case.
It is interesting to note that the asset allocated portfolios fared better than the Balanced Advantage fund portfolio, even the one with just 30% Equity allocation. If we look at the weighted average return of a 30:70 ICICI Prudential Value Discovery Fund:ICICI Prudential Short term fund for the period of analysis, we get 10.85%, which is less than the 11.49% the ICICI Prudential Balanced Advantage Fund has generated. To see what worked in favour of the asset allocated portfolios, we looked further at the portfolio rebalancing for various withdrawal cases. The below are the years in which the portfolio was rebalanced, or redemption from Equity was carried out to add to Debt.
In general, in the two equity and debt portfolios we have given, withdrawals are from debt. But since they undergo rebalancing, given below are years when Equity was redeemed as part of rebalancing in the asset allocated portfolio.
There are some interesting observations here.
- Even an asset allocated equity debt plan can cause stress to the portfolio by way of high withdrawals. Take the case of 6% withdrawal for the 30:70 equity:debt portfolio - it saw a final withdrawal of 7.7% and in 83% of the instances the withdrawal was higher than the initial rate of 6%. Not a good thing. But here is the big positive. A rule based asset allocation strategy prevented redemption of equity at crucial points like beginning of 2009, during the global financial crisis, beginning of 2012, Eurozone crisis, beginning of 2017, post demonetisation, when equity markets were under stress. All these points were followed by a market rally, although to be known only in hindsight.The fact that withdrawals were from debt prevented unnecessary tampering of equity, allowing it to once again settle and grow. In any managed portfolio, periods when equity is available cheap is when we should avoid redeeming from equity and if possible, add to equity.
- In a balanced advantage portfolio too, it is likely that a fund manager will increase equity at this point and rightfully so (though we don’t have portfolio data for the older periods). However, if an investor has mandated a withdrawal from this fund, more equity will inadvertently be redeemed at this point, not allowing the same to be added/deployed (in equity). This has likely caused the balanced advantage fund portfolio to underperform 30:70 Equity:Debt asset allocated portfolio, despite having higher equity allocation, generating high internal returns, and having a fund manager oversight to assign equity and debt.
Simply put, not withdrawing from equity, when the market is low has allowed the equity:debt portfolios to outperform the balanced advantage fund. That leaves these portfolios with higher corpus for future income generation.
If you wish to do more analysis on this, by tweaking asset allocation, withdrawal rates etc; please use the spreadsheet below:
Conclusion
Here are the takeaways from this analysis:
- In a robust retirement plan, it is essential to implement checks and balances to avoid redeeming equity during unfavourable market conditions. Opting for a balanced advantage fund portfolio forfeits this flexibility available to portfolios with separate equity and debt components.
- Our analysis reveals that a rule-based withdrawal and reallocation strategy can potentially extend the lifespan of your retirement portfolio with lower risk compared to a simplistic portfolio solely reliant on balanced advantage funds.
When it comes to critical goals like retirement planning, it's crucial to develop a comprehensive plan that considers personal circumstances and market uncertainties. Consider seeking assistance from financial planners, where necessary, to ensure your plan is well-suited to meet your long-term financial objectives.
We have also separately written about the shortcomings of using balanced advantage funds for SWP (Systematic Withdrawal Plans) in an earlier article, Should you use balanced advantage funds for SWPs? - PrimeInvestor.
33 thoughts on “Should you use balanced advantage funds for generating retirement income?”
Dear Bipin,
Thank you for this insightful article. I have a general query. In all these scenarios , the balance corpus at the end of the period increased to a significant value.
In an actual retirement scenario, my objective is to live comfortably plus ensure that i do not run out of money in the following 20 years or so. So , i am looking at a strategy where i can withdraw more ( and live better) rather than look at how much i have ended up saving at the end of the period. Your thoughts will be helpful if i am naive here. Also, does your excel have parameters to tweak and check scenarios ? TIA.
Hello,
This analysis is about withdrawing more as time passess. We’ve used 6% as the ‘yearly increment’ in withdrawals. The balance corpus is after doing withdrawals with increments. About this being increased – this is used to analyse how the portfolio stands after 17.5 years (the period of analysis) to take care of future withdrawals. While increasing the balance corpus itself is not the primary objective of a retirement portfolio, prolonging income generation with higher withdrawals is. This depends on the corpus growing even after withdrawals, especially in the initial period of retirement income generation. If someone is looking for a shorter period of income generation, they can make higher withdrawals and/or increase the withdrawal amount by a higher percentage.
Some of the parameters in the Excel file can be tweaked. These are highlighted in green.
Thanks
Excellent analysis, this gives a clear planning strategy for retirement planning…I will think on these lines and have a similar portfolio for retirement
Thank you!
Please keep in mind that this is a minimalistic analysis meant to explain some of the core concepts of retirement income generation. Please consider personal circumstances, taxation etc when you design your retirement portfolio. Seek help from financial planners, where necessary.
Hi Bibin,
It was a great blog and a superb analysis. Was wondering since BAF returns are better than pure debt, would if be worthwhile to invest say 1/3 or 1/2 the amount intended for debt portion in a balanced advantage fund , do the SWP from debt part only. During rebalancing during favourable conditions, move from BAF to debt and from pure equity to BAF.
Hello,
This strategy should work logically. However, you may want to compare it against an equity-to-debt move only to see whether there are benefits and if it is worth the additional management involved.
Thanks
Thanks for the article. Detailed.
My option on balanced advantaged fund during retirement OR as 2nd trough of emergency funds (1st being liquid/short-term debt funds) would be: Secure your 3 year day-to-day run expense corpus in these funds and do SWP from there. If index does get low, use a %ge of these funds (% depends on your risk palette) into selected equity funds. With debt funds being taxed at higher tax levels, this could be a viable way forward?
Ofcourse this can hold good for most hybrid funds, but balanced hybrid being less volatile with equity taxation. Chose the right balanced fund though, which is not aggressive (One such e.g., DSP Dynamic Fund).
Nicely explained Sir, Why can’t we plan for Aggressive Equity Hybrid funds for this SWP, instead of going for separate 50:50 or 30:70. What are the pros and cons in setting up SWP with Aggressive Equity Hybrid Funds as this also will not require any rebalancing as this is being done by the Fund Manager.
Hello,
The key takeaway from the exercise is that unless equity and debt are separated, you’ll be forced to withdraw from equity, even when it is unfavorable to do so. This increases the risk of income generation. This principle also applies to aggressive hybrid funds.
Thanks
does this mean that the withdrawn units would be in same ratio (50:50 or 30:70) as the allocation in the fund (BAF) ? how can you be sure of that ?
No, it doesn’t mean that. Let’s look at an oversimplified example:
Portfolio 1: a hybrid fund with 50:50 equity: debt allocation
Portfolio 2: Separate equity and debt funds with 50:50 allocation
Equity markets goes down 20% from Jan 1 to Jul 1, recovers part of the losses and close the year with 5% losses from Jan 1
Debt markets goes up 3% from Jan 1 to Jul 1, ends the year with 6% gain from Jan 1
Let’s say an equity fund mirroring the equity markets has NAVs as below:
Jan 1: Rs.10
Jul 1: Rs.8
Dec 31: Rs.9.5
Similarly, the Debt fund’s NAVs will be:
Jan 1: Rs.10
Jul 1: Rs.10.3
Dec 31: Rs.10.6
The hybrid fund’s NAV, assuming it gives average of the equity and debt for both the periods Jan 1 – Jul 1 and Jan 1 – Dec 31:
Jan 1: Rs.10
Jul 1: Rs.9.15
Dec 31: Rs.10.05
We invest Rs.1 lakh in both the portfolios; plan is to redeem Rs.10,000 once a year at Jul 1st. The portfolio 2 will be rebalanced on Dec 31.
Portfolio 1:
Jan 1 purchase:
Amount: Rs.1 lakh
Hybrid fund NAV: Rs.10
Hybrid fund units purchased: 10,000
Jul 1 redemption:
Amount: Rs.10,000
Hybrid fund NAV: Rs.9.15
Portfolio value before redemption: Rs.91,500
Hybrid fund units redeemed: 1,092.896
Hybrid fund units balance: 8,907.104
Portfolio1 value after redemption: Rs.81,500
Dec 31
Hybrid fund NAV: Rs.10.05
Portfolio 1 balance: Rs.89,516
Portfolio 2:
Jan 1 purchase:
Equity: purchase amount: Rs.50,000
Equity fund NAV: Rs.10
Equity fund units purchased: 5,000
Debt: purchase amount: Rs.50,000
Debt fund NAV: Rs.10
Debt fund units purchased: 5,000
Jul 1 redemption (redemption happens only from debt fund:
Amount: Rs.10,000
Debt fund NAV: Rs.10.3
Debt fund value before redemption: Rs.51,500
Debt fund units redeemed: 970.874
Debt fund units balance: 4,029.126
Debt fund value after redemption: Rs.41,500
Equity fund NAV: Rs.8
Equity fund balance: Rs.40,000
Total portfolio 2 balance: Rs.81,500
Dec 31
Equity fund NAV: Rs.9.5
Equity fund units: 5000
Equity fund balance: Rs.47,500
Debt fund NAV: Rs.10.6
Debt fund units: 4,029.126
Debt fund balance: Rs.42,709
Rebalance:
Equity redemption: Rs.2,395.5
Equity fund units redeemed: 252.158
Equity fund units balance: 4,747.842
Debt investment: Rs.2,395.5
Debt fund units invested: 225.991
Debt fund units balance: 4255.117
Equity fund value: Rs.45,105
Debt fund value: Rs.45,104
Portfolio 2 balance: Rs.90,209
Here both the portfolios have maintained 50:50 allocation at the year beginning and year end, also did the same amount of withdrawals at the same date, yet portfolio 2 ended up having slightly higher value than portfolio 1, because it avoided redeeming equity when equity markets were down 20%; this is not possible with the hybrid fund as when we redeem from it, we ended up redeeming equity as part of it at an unfavourable time.
Nice example. Didn’t think from this perspective. Still the difference is not significant.
Believe that, (1) if you account for tax factor for debt funds (2) If Rebalancing is not done every year, but done only when Equity goes down significantly for e.g., 15% or more (which may happen once in 3 years avg?) — SWP from balanced/hyrbid funds may work out better?
Your thoughts, Mr.Bipin?
Thanks
Hello Sir,
Regarding tax: The issue is that tax can vary significantly depending on personal circumstances. For example, if a retiree with no other income has a debt fund that is sitting at a 100% gain, for a monthly income generation of up to Rs. 1.17 lakhs from this debt fund, there will not be any capital gains tax applicable, as the gains will be below Rs. 7 lakh, which is tax-free with rebates.
If the debt fund is sitting at a 50% gain, the threshold for monthly income for tax to be applicable is Rs. 1.75 lakhs.
Please note that if this is for a retirement plan in the future, the tax rates and slabs at that point will be applicable. If we look at trends, both the threshold for paying tax and the rates of tax are coming down for slab tax.
On the other hand, if another person with multiple income streams uses an income portfolio to generate more income, they will likely pay more tax.
I don’t understand the second point about doing rebalancing when equity is down significantly. Please note that in this analysis, a rebalancing in favor of equity is not done because that would deplete the debt balance for periodic income generation.
thanks for the detailed clarification
Thanks for this, very insightful. can you pl plot monthly Equity/Debt ratio of ICICI pru balanced advantage fund for this period….hope that data is available. I’m still not clear why balanced adv fund performed poorly compared to other two cases. does this mean that balanced fund on average had less than 30% equity for this entire period?
Hello Sir,
I am afraid we do not have data on the monthly equity allocation of the fund for such a long period. It is unlikely that the average equity allocation of the fund for the entire period was less than 30%.
As explained in the article, in our view, this happened because, with periodic withdrawals enabled, there is no option to preserve equity assets when the markets are down, which is possible with a separate equity fund.
Thank you.
Thank you. that helps!
A very good analysis.
Do you have a curated list of financial planners who can be of help?
He should be able to analyze individual portfolio in similarly lucid fashion suggest changes?
Fee paid financial planner who will not invest for investing through him.
Hello,
Thanks! While we do not have a curated list of financial planners, we can share contact details of potential contacts. You may then inquire if they are able to provide the services you are looking for.
Please write to us at [email protected]
Thank you.
I think this does not take taxation into account. Moving from Debt to equity and vice versa is way more tax inefficient compared to the other option
Hello,
You are correct; this analysis does not account for taxation. As explained in the reply of another comment, doing a generic analysis of retirement income with taxation is hard as the impact on tax can vary a lot based on the corpus and individual’s financial situation.
Thanks
Bipin very good analysis – How about HDFC Balanced Advantage or Edelweiss Balanced advantage fund.
The convenience of a single hybrid fund with equity fund is very valid.
I feel if we include taxation balanced advantage fund will stand out 🙂
Hello Sir,
Thank you! Regarding using other balanced advantage funds, both HDFC’s and Edelweiss’s funds do not have a long track record of being dynamically managed hybrid funds.
Regarding taxation, yes, it will make a difference. However, it will be very specific to the corpus, as both equity and debt taxation have elements that will be determined by the quantum of capital gains, which in turn depends on the corpus; and also on any other income the investor has. In a nutshell, this can be very specific for each individual. For example, capital gains on debt funds are taxed at the slab rate. If we assume a person is generating retirement income from the portfolio and does not have any other source of income, it means debt capital gains up to Rs. 7 lakh are tax-free (general taxation relief including rebate, available for everyone under the new tax regime). If the debt fund is sitting on a 100% gain, this means a redemption of Rs. 14 lakh from the debt fund in a year will be required for the debt capital gains tax to be applicable. If the debt fund is sitting on a 50% gain, the debt redemption threshold will be Rs. 21 lakh in a year.
Another point to note is that over 10 years or more, this Rs. 7 lakh limit will likely be revised upwards, adding another complication of including tax in the analysis for a very long period.
Thanks
Bipin ji, one of the best best analysis which Team PI has come up with.. Superb. It has really given me a very good perspective and clarity when it comes to choosing my retirement portfolio.
Thank you, Sir!