Debt is not enough since inflation will eat into the returns.
If you want to enjoy your retirement years, you need to think and plan for it now. The earlier you plan, the better. There is no social security system in India. All the taxes a person pays through out his life counts for nothing. But this fact is known from day one.
It is not just prudent, but necessary to take positive action to shore up one’s finances. Most people think, they already do since they save in fixed deposits (FDs), small post office saving schemes, government bonds, debentures and the like. These investments may have sufficed some decades earlier, when the life expectancy was lower.
Over time, medical advances and the general rise in the standard of living have ensured that many live decades into their retirement. While this is definitely good news, what follows is not. Since people live 20-30 years into retirement, they need that much more money to see them through their golden years. The amount one would need to set aside for any medical expenses today is much more given the high medical costs. Besides, with the general standard of living going up, one needs sufficient money to maintain it. Many also want to leave a legacy for their children.
GAINING FROM EQUITIES
* Benefit from dividend-paying companies
* Book profits in rising markets
* Set threshold limits / triggers on stocks
* Use systematic withdrawal plans to receive a steady income
In such a scenario, if a person has invested all his money in debt instruments like FDs and small savings only, his post-tax returns would translate to 5.5 per cent or thereabouts. This does not even come near the present inflation figures – which means his real returns from all his life long investments are in the negative.
Let’s understand this by way of an example. Ravi aged 45 years has a monthly expense of around Rs 30,000 today. He expects to retire by 60. He also estimates that his expenses after retirement will come down by 30 per cent. This is because, there will be no education, marriage and other expenses related to his children who will be independent by then. Assuming a seven per cent composite inflation over the period till his retirement, this translates into a requirement of Rs 57,950 per month in the first year of retirement. If he is to generate this amount without dipping into his corpus, he needs to have a corpus of Rs 1.26 crore (without adjusting for inflation), at the time of retirement. In case, this corpus is kept aside, it could earn the same amount (by way of interest) in perpetuity. But in case, he plans to use the interest and the principal amount itself over a 30-year period, then he needs Rs 1.02 crore at the time of retirement. This does not account for any major medical emergencies in this period.
Now, if some portion of his money is invested in equity-oriented assets which give a long-term return of 12 per cent, post-tax, and 40 per cent of the portfolio is allocated to such assets, then the corpus required at the time of retirement is Rs 78.25 lakh, assuming that he will use the corpus and the returns from the corpus in this period. But such a suggestion generally leads to the next question troubling investors. Isn’t the equity market prone to fluctuations? How can I put my retirement corpus into that and trust it to give me good returns? What if I lose my money?
LONG-TERM THINKING
Planning for the retirement corpus means planning for a corpus that will help a person sustain for over 20 to 30 years. That’s really a long period requiring a long- term strategy. When one has time on one’s side, he must use the benefits of equity-oriented assets that perform well in the long -term. This has been the case with stock markets within India and elsewhere in the world too. So, even though there may be fluctuations in the short-term, equity assets will give decent returns over time. There is no reason to panic about the erosion of capital when the market plummets. Given the long timeframe, it is bound to go down sometimes and climb upwards at other times. Staying invested, secure in the knowledge that what has gone down will eventually come up, is the crux of success here. Hence, a person readying for the retirement phase, needs to insulate himself for a few years from the fluctuations of the equity portion of his portfolio. Given time, the equity portion will do well enough to ensure decent returns.
EARNING FROM EQUITIES
How to get money out of equity assets in the retirement period is another question. One way to earn is through dividends. So stay invested in good companies that give out good dividends. However, one cannot depend on dividends as a regular income. One could also book profits when the market is doing well. Smart investors book profits in companies that may not be able to sustain the outlook (even if it is good currently). You can set a threshold limit for a stock’s rise, say 20 percent for a particular stock and book profits when it crosses the limit. In equities, it is possible to set triggers as is possible in case of some mutual fund (MF) schemes too. In funds, where setting a trigger is not possible, plain monitoring and profit booking will work. In MFs, there is a systematic withdrawal plan (SWP) option, too, through which one can set up a target to receive a fixed sum, for a specified period. This will ensure a steady flow to take care of the expenses.
For instance, if Rs 12 lakh were invested in an equity-oriented fund and the fund has given 12-plus per cent returns, it can potentially support Rs 10,000 per month. To be safe, one can draw down a lower sum per month, like Rs 8,000. A third option would be a simple method of weeding the non-performing ones from time to time and using the proceeds. That way, the portfolio will stay healthy and perform well.
Re-balancing is important. One needs to maintain an appropriate level of exposure between equity and debt assets. If the desired ratio is 40:60, one can look at the portfolio re-balancing every three to six months to preserve that. If these are done, the retiree can put up his legs and and smile like the happy seniors who grace the pension policy advertisements.
Published in Business Standard / September 19, 2010
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