Retirement Planning- Start early, Stay cosy

The famous fable of the ant and the grasshopper has an important economic message. The ant worked hard during summer and stored food for winter. The grasshopper, always playing, unmindful of the coming difficult times, made fun of the ant for not enjoying the present. And then, winter came. The ant, which had well stocked food, was comfortable. The hungry grasshopper froze to death. Human beings should learn from this fable.

The environment in which we live is crucial in financial planning. Now, we are living at a time when life expectancy is increasing at a steady pace. In 1950, only 4.9% of world population was above 65 years of age. Presently, this is 22% and is projected to reach 39.5% by 2050. Clearly, the world population is aging fast.

Why retirement planning?

In India, our life expectancy in 1947 was a mere 32. Presently, it is above 65 and is showing a clear increasing trend. All these point to the importance of retirement planning. The developed countries have comprehensive ‘cradle to grave’ social security system. Developing economies like India are not resourceful enough to provide such social security to its citizens. In India only 10% of the working population employed in the government and organized private sector has pension and retirement benefits. 90% of the labour force, working in the unorganized sector, is faced with an uncertain future in their old age. Therefore, it is important that we plan for retirement.

When should I start planning for retirement?

The simple answer is: ‘earlier the better.’ It is ideal to plan for retirement right from the early days of one’s career. The more the time given for Accumulation Phase, the better it is for Maturity / Annuity Phase (retired life).

Starting early will give the advantages of longer term compounding of investment returns. Also, there are the advantages of starting with an affordable amount and discipline in savings.

Accumulation phase is that part of the retirement plan, during which you invest gradually (monthly for example) towards building the retirement corpus. Maturity / Annuity phase is the period post retirement, when you start withdrawing from the Accumulated Retirement Corpus (eg: invest and withdraw the interest) for meeting the expenses.

Where should I invest?

The simple answer is: invest in instruments that have the potential to generate returns that can beat the average inflation. Historically, equities have delivered the best returns beating inflation. Also keep the diversification part in mind. One of the time-tested routes of equity investing is Systematic Investment Plans (SIPs).

What is a SIP?

Under SIP, the investor invests a particular amount of money regularly, say every month. This regular investment done through the ups and downs of the market helps in reducing the average cost. Investors don’t have to bother about timing the market and the long-term investment helps in reaping the benefit of the power of compounding.

There are debt funds that invest in debt instruments, equity funds that invest in equity and balanced funds that invest in a combination of both. Systematic Investment Plans may ideally be done in equity mutual funds since equity funds give excellent returns in the long run. In equity funds, large cap funds give stable and steady returns while mid and small-cap funds, though risky in the short run, might give higher returns in the long run. Balanced funds, which invest 65 percent in equity and 35 percent in debt instruments, are also desirable.

How much should I invest for retirement?

Deciding how much to invest for retirement requires multiple number crunching.  The following guidelines would be helpful:

1. Ascertain your current monthly expenses

Consider those expenses that would continue post retirement as well like the monthly groceries, bills, etc. (Eg: exclude school fees, home loan EMI, etc., which would stop after certain years).

1. Calculate the number of years left for your retirement?
2. Assign an expected inflation figure to to findout your cost of living after your retirement.
3. Assume an expected rate of return on investments during Accumulation Phase.
4. Assume a conservative expected rate of return on investments post retirement since the investment will be in fixed income avenues.
5. Assume that you are likely to live long, say up to 90 years.
6. Anticipate a sum which might be required for meeting the regular medical and health check-up costs.

Following the above steps will help you decide the amount to be invested for retirement planning.

Let us consider an example of a 40 year old person planning to retire at sixty. His present expenses that will continue post retirement is Rs 20000 per month. Assuming an inflation rate of 6 %, he will need Rs 64120 per month on reaching 60 to meet these expenses. Assuming an expected return of 12 % post-tax during the accumulation phase and 10 % return in the post-retirement phase, he will have to invest Rs 7870 every month for 20 years to get an income of Rs 64120 per month post-retirement. Therefore, the minimum monthly investment for retirement planning should be 7870. Ideally, it should be higher than that since he should be saving / reinvesting a part of the income to compensate for inflation in the post-retirement stage.

New Pension Scheme

Another option for retirement planning is the New Pension Scheme (NPS). NPS introduced by the government is open to the public. Any Indian in the age group 18 to 55 can join this scheme. The subscriber has to make at least 4 contributions a year, with a minimum contribution size of Rs 500. There is also a condition that the minimum contribution during a year should be Rs 6000.The amount so mobilized will be invested by professional fund managers regulated by the PFRDA. The funds will be invested in 3 different schemes: E, G and C. E class will invest mainly in equity; G class in government securities and C class in PSU/ corporate bonds, bank deposits etc. The allocation among different schemes can be decided by the subscriber. At 60, the subscriber can withdraw 60% of the accumulated value. 40 % is used for buying annuities which ensure pension for life.

Plan for the rainy day through SIP or NPS.

Posted: September 2017