Make a conscious effort to take charge of your retirement planning to secure your sunset years
The simplest formula for financial success is to start early!
As you move through your 20s, 30s and 40s, caught up with jobs and families, it is very easy to put off your retirement planning. For most people, retirement planning usually comes at the end of all their financial goals. According to Sundeep Sikka, CEO, Reliance AMC, we still have an old mindset about planning our retirements. "The 30-30 rule of thumb says an individual earns for 30 years, to provide for the 30 years of post-retirement life, where the individual's income would have stopped. Yet the need to maintain a similar life style exists," says Sikka.
People usually start saving for retirement when they are nearing the end of their work life. The focus, instead, is on intermediate goals, from buying a car in the near term and the house they plan to buy in the next 10 years. Most start saving for retirement after fulfilling other obligations, such as home loan repayment and saving for their children's education and marriage.
However, it is important to note that with changing lifestyles, India is transitioning from the traditional joint-family support system to a self-supporting arrangement. And, considering an aging population of 80 million, with a significant majority of this population not covered under any formal retirement income scheme, this certainly is the wrong approach.
"Procrastination and work pressures, often leads to people delaying their retirement planning," says Anil Rego, CEO and founder of Right Horizons. When compared globally, India's retirement assets (to GDP ratio) is 15 per cent compared to other countries, including the US (80 per cent) and Japan (65 per cent). The fact that average life expectancy has increased by 20-25 years, it is imperative to ensure your finances are in a good shape when you retire. Here, we talk about five most common excuses people make while planning for their retirement and how best can these be dealt with.
It's too soon for me to think about retirement
The simplest formula for financial success is to start early! When one is young one is not in the mood to save, especially at the start of one's professional career. Remember, the pay cheque may not be fat, but you also do not have many responsibilities. The urge to spend is high considering this is the first step towards financial independence. According to a report by HDFC Life, young Indians (between 20 and 30 years) score low on financial awareness and planning.
While this does not point to complete absence of financial planning, they are not completely aware about the merits of goal-based planning. But, this is the time to start building your corpus and assigning your surplus funds in a manner that you can fulfill whatever dreams you may have - your goals. However, do remember to keep retirement planning separate from short- and medium-term goals such as buying a care or a house. Be clear that the corpus you are building is to be touched only after you stop earning.
The most powerful aid to retirement is math and time. The longer you have until retirement, the more you can build your savings through compounding and the less you'll need to invest each month. Sample this: Rahul and Samir have been friends for a long time and are of the same age. Rahul started investing Rs10,000 every month at the age of 25 and Samir at 35. At 55 years, when both had planned to retire, Rahul's corpus had grown to Rs2.27 crore (at 10 per cent CAGR), while Samir's corpus was just Rs76.50 lakh. "This is the power of compounding; the eighth wonder of the world," says Nirmal Rewaria, Head, Financial Planning, Edelweiss. "A small amount invested over a longer period of time will have a large impact on one's portfolio, which cannot be compensated even with double the investment amount," he adds.
Saving around 10 per cent of the income in your early 20s would help build a substantial retirement corpus. The more you delay, the more you will have to save every month. For example, if your age is 20 and you want Rs5 crore by the time you are 60, you will have to save just Rs4,207 every month for the next 40 years, assuming that the rate of return is 12 per cent. If you delay till 25, you will have to almost double your savings (Rs7,698 every month for the next 35 years). "Starting early can help you build a larger fund and give you flexibility for taking up entrepreneurial or other pursuits close to your heart," says Anil Rego CEO and founder, Right Horizons.
An early start also gives you the freedom to take risks. For instance, equities, though risky, give higher returns than other assets such as gold, debt and real estate, in the long run. In the last 20 years, equity markets (the Sensex) provided a compounded annual growth rate (CAGR) of 13 per cent, which is higher than any other asset class. You can invest a large chunk of your money in equity or related instruments if you start early. For example, if your horizon is 25-30 years, you can invest 70 per cent in stocks, and as you near your retirement, you can start liquidating these high-risk, high-return equity investments to park your money in fixed income options. "One can also use dynamic asset allocation plans offered by mutual funds" says Rego.
Based on our interactions with a number of financial planners and investors, there are some ideal portfolios for four different stages of life.
When you begin to earn: This is the start of your career and you have no liabilities or dependants. Though your income is less, so are your expenses. You have time on hand and can afford high exposure to equities. You can put 80 per cent of your money in equity and the balance in debt. Generally, the older the person, the lesser the risk one must take. The thumb rule to decide one's equity allocation is "100 minus the age". But this may not work in many cases. "Having said that, investors are uncomfortable with such a high equity exposure, in which case the new thumb rule is 80 minus your age," says Rego.
When you get married: Your income increases but so do your liabilities. You are still far from retirement and can have high exposure to equities. Since you have more liabilities, you should allocate your increase your exposure to fixed income investments for a cushion against the volatility in equity markets. You should have equity, debt and gold in 70:20:10, respectively.
When you have children: Your liabilities increase at a greater speed than your income. Hence, higher allocation to debt through PPF, EPF and debt funds is a must. Equities can still form 50 per cent to 60 per cent of your portfolio, but you should go for large-cap stocks and equity funds. Debts and gold should be 35 per cent and 5 per cent, respectively.
Pre-retirement: You are 5-15 years from retirement and need to protect the corpus from volatility. We suggest a 50:50 debt-equity mix.
Post-retirement: You now have a sufficiently big corpus. The next step is to allocate it in a way that ensures both regular income and safety. After retirement, it is advisable not to have more than 30 per cent exposure to equities. Liquidity must also be a big consideration.
I don't earn enough to save for retirement
As Robert Kiyosaki says in his book Rich Dad Poor Dad: It is not how much money you make; it is how much money you keep! There is no minimum amount to start saving. You could start with as low as Rs500 every month, which if invested systematically over the next 25 years, could fetch Rs12.75 lakh at maturity at a modest growth rate of 12 per cent. The same amount for 15 years would fetch Rs2.85 lakh. A small amount invested over a longer period of time have a large impact on the portfolio which can not be compensated even with double the investment amount.
"When you are starting off young there is no thumb rule on the minimum amount you must save for your future, even 20 pe cent of your monthly salary is good enough," says Rego. Sure, you have a lot of competing uses for your money. Some spending is locked in every month, like paying your car EMI, and some goes to nice-to-haves, such as fine dining or taking a weekend trip to a 5-star resort. It may seem that nothing is redundant. Saving for retirement seems impossible given your current lifestyle.
However, there will be a day when you will have to get by without a salary deposit in your bank account. While your pension plan can provide monthly income, it is not likely to replace your salary. "If you retire at the actual retirement age of 58, you still have 20 to 25 years ahead of you and can expect that most expenses, like health care, will go up," says Rego. Unless you are independently wealthy or can count on family members to care for you, you can't afford to not save for retirement.
I have saved enough for retirement
If you retire with Rs1 crore, 30 years later it would be worth Rs13 lakh in today's values - a seven-fold erosion in value accounting for inflation at 7 per cent. In simple terms, this means that things will become costlier and, years later, you will be able to buy much less with the same amount of money. Ignoring inflation would mean that you will save much less than what you will need a few years down the line. If you spend Rs50,000 every month at 30, you will need Rs3.81 lakh per month at 60, assuming that prices rise at the rate of 7 per cent every year.
Investors generally miss out on factoring inflation when considering savings for goals, but since retirement is a long-term goal, it is important to understand its impact. As income increases over a period of time so do expenses. Inflation is the rate at which prices rise and reduces the purchasing power substantially. You may spend the first 30 years of your life earning sufficient income to live a good life, but how well you have prepared for the next 30 years of your retirement is what matters.
A recent report by Reliance AMC shows that Australians seem to have done quite well with an amount of $43,000 of assets per citizen to fall back on after retirement, followed by the UK at $35,000 and the US with $27,000. India falls way behind with only $128 of assets, that is about Rs8,000 per person.
To arrive at the number whether you have saved enough, you need to ask yourself a few questions. How many years are left for your retirement? How much money will you need at retirement? What is your risk-taking ability? What is the monthly income you will need to sustain your current lifestyle? Once you have answered these, only then can you ascertain what is the amount you need to sustain a retirement life you planned. As a first step, we explain how you can calculate the money you will need for your post-retirement years (see Calculating Your Retirement Fund).
EPF and PPF savings are enough for my retirement
After you arrive at the amount you need <SoftCR>to sustain a retirement life you have planned you need to work backwards and create an investment plan. "You need to invest in such a way that you beat inflation, that is, earn returns that are at least a couple of percentage points above the inflation rate," says Rego. Taking inflation into account will not only tell you how much you have to save but also help you decide on the most appropriate investing strategy (see Impact of Inflation on Costs).
For a long time, retirement planning meant investing in fixed deposits (FDs) and small savings schemes such as the Public Provident Fund (PPF), National Savings Certificate Scheme and the Employee Provident Fund (EPF). Some also bought traditional insurance policies. "Ten years ago investors earned interest rates of 12 per cent on their FDs. However, it went down to as low as 6 per cent and deposit rates are at 8 per cent now," says Rego.
With inflation at 5 per cent, your investment in FDs barely beats inflation. Hence, your real rate is extremely low, not to mention they score low on tax efficiency. Interest on FDs is taxed at your current tax slab, which brings down the returns even further. This is unlike mutual funds and unit-linked plans, wherein you are taxed on exiting the investment. Hence during the entire corpus accumulation phase you are paying high tax on the income earned. "Also, investors must understand that rates are likely to come down over the long term, like globally, where equities is the more preferred class of investment," adds Rego.
While you pay tax on the interest earned on fixed deposits, gains from the PPF account are tax-free but it remains locked in for 15 years, which helps build a long-term corpus. By investing Rs1.5 lakh every year, one can save Rs46.75 lakh in 15 years. In 30 years, the amount will be Rs2.10 crore. The 15-year lock-in ensures that you save just for old age without getting swayed by intermediate goals. "PPF is tax efficient and so are tax-free bonds, which are currently on offer at 7.5-8 per cent," says Rego.
According to him, a good retirement plan should have many instruments, including mutual funds. The MF investment route scores well in terms of cost efficiency, tax efficiency and ease of execution along with a peace of mind that the fund is managed by professionals. You can invest in equity funds for capital appreciation. However, they come with some amount of risk. Bond investments also carry risks but nevertheless deserve a place in every retirement portfolio. Especially for those nearing or entering retirement, bonds can offer a steady flow of income and often produce an attractive rate of return.
Gold funds too warrant a place in your portfolio as a hedge against inflation. In terms of risk, not only can you choose funds which are safe (liquid funds), you can also invest in funds that are highly risky (sectoral funds), or hybrid funds, which invest in both equity and debt and are less risky. Abhinav Angirish, founder, www.InvestOnline.in, says apart from versatility and convenience, MFs are the lowest cost option for wealth creation when compared to Ulips and structured products.
Investing in equities is too risky for building a retirement corpus
You cannot avoid risks when it comes to investing. Even stashing cash under your mattress does not relieve you of the risk of a fire destroying your savings or inflation nibbling away at your purchasing power. The risk of investing in stocks decreases over the years as the returns average out with rise and fall of markets. But, stocks and equity mutual funds that invest in stocks of various capitalisations, has the potential to beat inflation over the long haul. "Since 2000, on 35 occasions markets have fallen below 5 per cent in a day and on 15 occasions markets have fallen more than 10 per cent in a month, but the Sensex has still moved up from 5,000 to 26,000," says Sikka. What it means is that in volatility there is opportunity. Hence, do not refrain from equities.
For example, 20 years ago if you had invested Rs1 crore in the stock market, represented by the BSE Sensex, the amount would have grown to Rs11.5 crore - a twelve fold increase. On the other hand, while your money in an FD would have grown to Rs4.7 crore, and in Gold it would have grown to Rs6.1 crore. "Clearly, equity scores over other asset classes over the long run," says Sikka. Gold and real estate, which were the preferred investment avenues for sometime, also has the potential to give negative returns, adds Sikka.
"Also, the fact that real estate cannot give you regular monthly income in your retirement must be considered," adds Rego. The world over, equity MFs have been successful in creating long-term wealth. In fact, countries, including the US, have defined contribution retirement plans such as the 401K (equivalent of the EPF in India) which hold a large party of assets in mutual funds, especially equity funds. According to Gaurav Mashruwala, a certified financial planner, equity is the recommended asset class for any goal that is seveen to nine years away while debt works for those that are two to three years away. Anything in between could be a combination of both.
Aashish Somaiyaa, CEO of Motilal Oswal AMC, too is of the opinion that at any age investment in equities is a must. Even for those who have retired must have some exposure to stocks to support their cash flow as it is not possible to earn inflation beating returns with debt investments. "If you decide on a no-equity policy after 60 or 65 years and you happen to live up to 100 years, you are bound to have financial hardships and will have to depend on the next generation. To whatever extent that you are not dependent on your investments to fend for your daily expenses, you must allocate that to equities," says Somaiyaa.
The best equity mutual funds in India have a track record of delivering 10-12 per cent compounded alpha over the index on CAGR basis over the past 10 years.