Let’s get serious about Retirement Planning
How do millennials view savings or investments? This is a reasonably common topic of discussion in today’s world of financial planning.
If there’s one activity that we all tend to postpone and defer, it’s retirement planning. Most of us tend to underestimate the perils of poor retirement planning or the lack of a meaningful corpus at the time of retirement.
30s to 40s is typically when an individual has achieved a certain level of stability in both their personal and professional life. There is a sense of rationality, balance, and maturity that an individual typically attains. The key step in financial planning is estimating post-retirement expenses. One mistake that most people make in projecting cash-flow requirements post retirement is visualising a downsizing in lifestyle and consumption needs in post-retirement life. Consequently, they project lower ‘real cash’ flow needs. This to me is the biggest mistake most people tend to make.
The golden rules of estimating post-retirement expenses
- Factor in inflation – that’s what ‘real money’ means – and factor in real inflation. Let your retirement calculations assume inflation at nothing less than 7% CAGR. It is always better to be on the higher side. If the inflation isn’t as high as you projected, you will have more funds in hand. However, if your projections are substantially lower, you will be in dire straits. Here’s a real scenario: To generate Rs.6,250 on a monthly basis, you would have needed a corpus of Rs.12,50,000 30 years ago. Today, you would need a corpus of Rs.1 crore to generate a monthly income of Rs.50,000. That’s the impact of inflation. (Inflation rate – 7.19% for 30 years computed based on Cost of Inflation Index, source: www.incometaxindia.gov.in; Monthly interest assumed at 6% p.a)
- Assume no clamp down in lifestyle and consumption needs. Human beings are inherently averse to accepting change. This is more so the case when it is a scale down instead of a scale up. Moreover, there will always be additional lifestyle expenses that come with age than you may think of as necessary now.
- Prioritise your expenses into three categories – must have, nice to have, and can do without. Try to live without the ‘can do without’ before you retire. This will help you address the previous point as well as give you a more realistic picture of what your expenses are like currently and what they could be like in the foreseeable future.
- Project your expenses into monthly payouts and annual payouts. Annual payouts include things like Car Insurance, Medical Insurance, home-care initiatives like pest control and AC annual maintenance. Factor in all the expenses you undertake on an annual basis.
- Build capex spends. For instance, you will need to replace your car once in 5 years, will need a TV once in 8 years, a mobile once in 3 years, and so on. These can be a major drain post retirement.
- Once you arrive at these factors, sum these up and back-calculate when you intend to retire. Project a realistic life span for yourself of at least 80 years at the minimum. Now use these numbers to calculate your corpus.
- Break this corpus into yearly and monthly expenses.
- The above computation assumes that you have adequate Medical Insurance. Medical expenses are a major expense, especially post retirement, and you need to have a comprehensive medical policy that covers you and your spouse in case of eventualities. This is extremely important as an ineffective policy or lack of a medical insurance can throw all your plans out of kilter since the need for medical intervention and scope of medical expense is very difficult to predict.
Where do I invest for retirement?
There are many options available in the market including dedicated Pension Schemes. But for now, I’d like to emphasise that every retirement investment portfolio must have a significant allocation to equity.
Equity is the best asset class to beat inflation in the long run. Equity mutual funds in India have generated close to 15% – 17% CAGR over the past 10 years. That’s about 8% to 9% above inflation. When you compound this annually, it gives you a significant amount of wealth over an extended period of time. Here’s a fact – Over the past 40 years, an investment of Rs 10,000 in the S&P BSE Sensex would have grown to over Rs 45,28,568 (data as of March 31, 2019)
The typical approach is, the longer the period for retirement, the greater the allocation to equity. Individuals who are less than 40 years of age should have about 80% of their investments in equity and the assumption is at least 40% of their income goes towards investment products. My observation is that anything less than these numbers will always lead towards a sub-optimal post-retirement corpus.
- Start early. Ideally, start from your very first year of work. The same old parents-to-children golden rule works in this situation as well – do not postpone important activities. Retirement planning is a supremely important activity and something that young India will do well to register on their priority list.
Project a realistic retirement age. Just because our fathers and grandfathers retired at 60 years does not guarantee that we will retire at 60 too. Be realistic about your retirement age