CHAPTER 2 : Monthly Income vs. Cumulative Growth

    In the previous chapter, we discussed the effectiveness of Bank Fixed Deposits to preserve wealth. Lately in falling interest rate scenario, monthly income schemes for Sr. citizens have become very popular. 

    The sovereign-backed saving schemes like Post Office Sr. Citizen Saving Scheme or Pradhan Mantri Vaya Vandan Yojana are offering around 7.40% p.a. with regular interest payout. Superior Rate of Return, Fixed monthly cash flow and Sovereign backing make these schemes the preferred choice for Sr. citizens. In a scenario where the economy is flushed with excess liquidity where banks are forced to slash interest rates on FDs, these instruments are proving to be beneficial for the Senior Citizens.

    The typical structure of these schemes is that initially the investor has to deposit Lumpsum amount in the scheme and then they start receiving monthly income or interest payout till maturity. In order to lock-in 7.40% p.a. interest rate, investors usually invest maximum allowed limit of investment which is Rs. 15 lacs in each scheme. Meaning, Rs. 30 lacs blocked for 7 to 10 years which will yield Rs. 18500 per month. In Current market scenario, it is difficult to find investment avenues that can guarantee such returns along with promised cashflow in regular income space (PMVVY comes with additional insurance cover and also offers surrender value of 98% of purchase price).

Thinking Beyond 7.40% p.a. and monthly calculation:

    Having discussed the relative superiority of these schemes, there are certain challenges which need to be addressed as under:

    1.  Immediate Liquidity

    Typically, these schemes have a longer Lock-In period which deprives investors from short-term/immediate liquidity. Here, Liquidity is limited to Monthly cash flow only but the hefty initial lumpsum amount deposited is locked-in. It is advised that the investor (irrespective of age and risk appetite) makes a provision for certain amount of liquidity for ‘Rainy Days’. There is an option available to arrange liquidity in PMVVY where one can surrender the scheme with a penalty of 2% and; any alternate measure or leverage to arrange liquidity will carry an extra cost.

    2.  Maturity Amount and Notional Loss

    This is the most significant aspect. These schemes offer the entire principal amount or purchase price at the end of maturity. Technically, money will not grow above cost price since investors receive monthly income against the initial investment made. Assuming that an investor has invested 30 lacs collectively in both the schemes, he will receive an entire sum of 30 lacs on maturity. But assuming inflation to be at 4% for the next 10 years, the worth of Rs. 30 lacs will stand at Rs. 20,26,693/- on the date of maturity. So, there is a notional loss of around Rs. 9,73,307/-. Inflation has been the invisible devil.

    Summarizing the above factors, it is evident that in order to avail the optimum benefit of such schemes, an investor should calculate their monthly cashflow requirement and then conclude the final amount to be invested in monthly income schemes. In this way, one can earn the required income and simultaneously invest the remaining corpus in options where investments will grow at a compounding rate and beat inflation. The effect of ‘compounding’ is usually missing in products structured on the premise of regular income.

    Presently these schemes stand out in terms of rate offered and cashflow frequency but at the same time the challenging factors impacting the funds' effective maturity value should not be neglected especially, with age progression and narrowing down choices of high-risk investment avenues to invest post 7 to 10 years keeping limited options to no option. These two schemes promise a Superior rate of interest and monthly cashflow till maturity only and it is not a lifelong arrangement. Another option in the debt space is government-backed NSC or Corporate FDs. Unlike Monthly Income, these products capture the cumulative effect at a steady interest rate and also help to achieve desired investment goal. This strategy can complement the long-term equity allocation.  

    A Debt Mutual Fund is one more option but one has to be informed about the category and product to be chosen. There are about 16 categories of Debt Mutual Fund and it is very important not to go by just 3Yr and 5Yrs returns (past performance). In Debt mutual funds, past performance is less relevant. One has to assess the technical aspects like Liquidity in the system, Average Maturity, YTM, Duration, Credit spread, Credit quality for which it is prudent to seek advice from professionals.

    There is no theory or fixed formula for asset allocation pattern which one could follow since the needs, requirements and risk appetite of every individual is different from one another. Senior Citizens should carefully calculate monthly cashflow requirements and then allocate funds in monthly income schemes so as to avoid notional loss incurred by not availing cumulative or compounding growth investments.

Note - The Content is for informational / study purposes only and should not be used to construe investment decisions. 

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