Value funds for retirement planning: Building a Rs. 5 crore nest egg

Value funds that invest in undervalued stocks can be a powerful tool for retirement planning and building a large corpus. With patience and discipline, value funds allow your money to grow steadily over decades. Read on to find out how you can build a 5-crore nest egg with value funds

Understand how value funds work

Value funds invest in stocks that have valuations lower than their intrinsic worth. The mutual fund investment manager identifies such underpriced stocks by analyzing financial metrics like price-to-earnings, price-to-book value, dividend yield etc. As the stock price rises to its fair value over time, the fund gains from capital appreciation. Value funds thus aim to generate higher returns at lower risk in the long run.

Why value funds suit retirement planning

Value funds are ideal for goals like retirement that are 15-20 years away. They tend to outperform other equity funds over such long periods as the benefits of disciplined value investing compound. While they may underperform in the short term, value funds create significant alpha over full market cycles. As per Morningstar data, value funds delivered 14% CAGR over the last 15 years, beating diversified equity funds.

Build a corpus of Rs. 5 crores for retirement

Assuming you have 20 years before retirement, you need to build a corpus of Rs. 5 crores. Assuming an annual return of 14% and monthly SIPs of Rs. 25,000, you need to invest for the next 240 months. In 20 years, your SIP contributions will total Rs. 60 lakhs. If the investment grows at 14% CAGR, the corpus will grow to over Rs. 5 crores.

Select the right value fund for your needs

When choosing a value fund, analyze the fund manager’s investing style and track record of navigating different market cycles. Opt for funds with AUM of over Rs. 500 crores and at least 10 years of operation. Check portfolio concentration in top stocks and sectors. Evaluate trailing returns over 3-, 5- and 10-year periods. 

Mitigate risk by diversifying across funds

Don’t put all your eggs in one basket. Diversify investment across 2-3 value funds from different AMCs to mitigate risk. This balances out fund-specific risk and style risk. Stagger your SIPs across different market levels to benefit from rupee cost averaging. Keep incremental exposure to mid-cap value funds limited to 20-30% of the retirement corpus.

Stay invested for the long term

Don’t get swayed by short term underperformance. Have conviction that the value fund will deliver superior returns over full market cycles. Avoid the temptation to stop SIPs or redeem during market declines which lock in losses. Value funds gain tremendously during market recoveries. With a long-term investment horizon, interim volatility gets ironed out.

Reinvest gains to benefit from compounding

Reinvest the dividends from value funds instead of payouts. This allows you to compound gains over the long term by purchasing more fund units. Opt for the growth option when investing in value funds. Switch to the dividend option closer to retirement for regular income. Capital gains from equity funds get the benefit of indexation which reduces tax liability.

Stay realistic about expected returns

Don’t have unrealistic expectations of 30-40% CAGR from value funds over 20 years. Equity returns will be more moderate in the coming decade compared to the past. Assume conservative returns of 10-12% CAGR for retirement planning. Have an adequate debt allocation and emergency corpus so you don’t have to redeem equity funds prematurely.

Conclusion

It is important to review your retirement portfolio at least annually when investing in value funds. Assess if the fund is sticking to its value investing mandate and not straying into momentum stocks. Evaluate the fund’s performance relative to its benchmark and peers. Replace underperforming funds after giving them 2-3 years to turn around their performance.