Index Outlook: Time for reality check :: Business Line

On Federal Reserve’s track :: Business Line

Love it or hate it; but you cannot ignore it. That is the Federal Reserve for you. Words like taper, QE, Fed are peppering most stock market conversation these days and are also the perpetrators of huge doses of volatility in recent times. Here is a brief introduction to “The Fed” and how it moves the Sensex and Nifty.

The Federal Reserve or ‘The Fed’ is the central bank of United States, much like the Reserve Bank of India (RBI) tasked to control interest rates, money supply, oversee the banking system, control inflation and so on.

The Federal Open Market Commission (FOMC) is the committee of the Fed that meets around eight times in a year to take monetary decisions on — reserve requirement (how much a bank to hold in reserves), discount rate (the interest rate charged by the Fed to commercial banks and other depository institutions on loans they receive from the Federal Reserve Bank’s lending facility), open market operations (used by the Fed to purchase US government bonds in the open market as a means to adjust the Federal Funds Rate, which in turn controls the inter-banking lending rates) and other decisions.

Most of these have lost relevance post-2009 when Quantitative Easing came into play.

Quantitative Easing (QE): Usually central banks try to increase lending activity indirectly by cutting interest rates. Lower interest rates encourage people to spend and not save which, in turn, boosts the economy. But when the rates were already close to zero by 2009 and could go no lower, the Fed decided to print and start pumping money into the economy directly, which can also be called QE.

How this works is: The FED prints money and uses this money and its reserves to purchase government bonds from private sector companies or institutions such as insurance companies, pension funds and banks. With the increased demand for US government bonds, the value goes up thereby making them more expensive to buy and a less attractive investment.

The companies and institutions who sold the bonds then use the proceeds to invest in other companies or lending rather than buying more bonds.

With so many more companies and institutions having money to lend, the interest rates stay low, so more money is spent thus boosting the economy.

Tapering of QE (Taper): Presently as part of QE, the Fed is purchasing $85 billion in government debt and mortgage-based securities every month but the FED Chairman Ben Bernanke has previously indicated that they might start scaling back on these monthly purchases (tapering of QE) which has caused stress in the financial markets as investors fear lesser money in the financial system (liquidity).

How do the Sensex, Nifty and the rupee get affected by all of this: In the recently conducted FOMC meet, the broader consensus was that since the Fed Chairman had indicated tapering of QE, the monthly stimulus of $85 billion would be cut by $10 to $15 billion.

As that was not to be, the markets rallied by over 3 per cent the day after the meeting.

Foreign institutional investors with easy access to capital are expected to extend their buying spree in Indian stocks which might also help the rupee appreciate further.

Appreciated rupee would help reduce the current account deficit by lowering our cost of imports on crude, gold and others.

This would, in turn, help the RBI to start taking steps toward unwinding liquidity tightening measures.

(The author is Director, Zerodha and heads trading and risk management.)

Bridging shortfall in retirement portfolio:: Business Line

We recently met individuals who had 10 years or less to go for their retirement. All of them had the same concern — they were falling short of accumulating their desired wealth at retirement. The problem was that none of them had the choice of extending their retirement beyond the mandated age. This meant that they had to cut their desired lifestyle post-retirement. But should they?

In this article, we discuss what you can do to bridge the shortfall in your retirement portfolio, when you do not have the choice of postponing your retirement.

Bridging shortfall

There are two ways by which you can bridge shortfall in your retirement portfolio. You can either increase your equity allocation in the hope that your investments earn higher return. Or you can increase your capital contribution during the last 10 years of your working life.

Now, increasing your equity allocation close to your retirement would be risky. What if the equity market declines? You will have limited time to recover your losses. In your effort to reduce your shortfall, you might just as well increase the gap! You could, of course increase your capital contribution during the last 10 years of your retirement. And even if you invest that additional capital in fixed deposits or such interest-bearing investments fetching 8 per cent return per annum, you can double your capital by the time you retire (applying the rule of 72).

But all of you may not be in the position to increase your capital contribution during the 10 years leading to your retirement. This could be due to other obligations such as having to pay your mortgage or funding your children’s college education. So, what should you do?

You should give yourself more time to bridge the shortfall without postponing your retirement! How? You can consider the 10 years before and after retirement as a single investment period and adjust your portfolio accordingly. In other words, you should manage your portfolio through your retirement risk zone.

Portfolio morphing

To understand this, divide your post-requirement expenses into three buckets—living expenses, leisure and health-care. Now, funding your living expenses immediately after retirement becomes your priority. But you are unlikely to incur major health-care expenses until you are 70. So, you do not need to accumulate at 60, all the wealth needed for your post-retirement living. Therefore, any shortfall in your retirement portfolio can be recovered during the 10 years after retirement. How?

First, sell bonds in your retirement portfolio to buy a lifetime annuity to fund your living expenses. You should do this during the 10 years leading to your retirement. Why? It gives you time to shop for annuity. Remember, annuity offered by insurance companies will be typically higher when interest-rate levels in the economy are higher.

Second, carry the equity investment in your retirement portfolio till you reach 70. Why? This investment can help you fund major surgeries in your old age. You can do this because your medical insurance along with your emergency fund offers you basic health protection during your retired years. By continuing your equity investments till 70, you give yourself time to recover shortfall in your retirement portfolio.

And third, despite the shortfall, if you want to spend on leisure, sell some of your equity investments at retirement and invest in short-term deposits. This will help you fund your leisure expenses during the initial years of your retirement.

Conclusion

You can bridge the shortfall in your retirement portfolio in two ways without increasing your risk. One, you can contribute additional capital into your portfolio during the retirement risk zone. And two, you should consider your retirement risk zone as a single investment horizon and adjust your retirement portfolio accordingly. We hope that these measures help you in bridging the shortfall. Happy retirement!