Start investing early in life to build a retirement corpus. Equity
is the best bet in the longer run as it offers inflation-adjusted return
With better medical
facilities resulting in higher life expectancy, it is important to plan and
work towards accumulating a healthy retirement corpus that could sustain us for
at least 20 years after we retire. Remember that you might be without the
comfort of regular income from a job.
Our children may or may not support us. While all of us would like to live a
tension-free retirement life, the success of it depends on starting saving
early and investing the right way. Here is an outline on how to plan for
retirement.
First, decide your retirement age. Then calculate your current monthly
expenditure. Ask yourself if you want to maintain the same lifestyle or are
ready to compromise on it during retirement.
Adjust the money required with an inflation rate of 6-8 per cent per annum till
your retirement life. This will tell you the corpus that is needed to give the
monthly income you require in retired life. The next step is to know the
investment avenues available to achieve your retirement goal.
Three scenarios have been worked out to give you insight to investment needs
for tension-free retirement life — someone who would retire after 10 years,
after 20 years and after 30 years. All the three situations are based on
retirement age at 60 years, an inflation of 8 per cent, a current monthly
expenditure of Rs 25,000 and assuming an equity return of 15 per cent.
Scenario A: Ravi Nair is 50-year-old. He has a monthly salary of Rs 50,000 and
has decided to retire in the next 10 years. His current monthly expenditure is
Rs 25,000 (annual expenditure Rs 3 lakh). At an inflation of 8 per cent, post
retirement Nair would require Rs 6.48 lakh every year to maintain the same
lifestyle, i.e. a corpus of Rs 1.18 crore for next 20 years. To achieve this
corpus, Nair needs to invest Rs 43,000 per month.
Nair’s goal is unachievable since the amount he has to invest is close to the
amount he is earning. Nair can achieve only 50 per cent of the corpus required.
Since he has 10 years to go, he could consider investing in a balanced fund
through a systematic investment plan. A balanced fund allocates 65-70 per cent
of the money in equities and the remaining 30-35 per cent in debt.
Says Pankaaj Maalde, a certified financial planner, “This example is a wake-up
call to all those who have been postponing working towards their retirement
goal. If Nair owns a house he could consider reverse mortgage of his house or
will have to postpone his plan of retiring at 60 years.”
Scenario B: Assuming Nair is 40-year-old, his household expenses post
retirement would be Rs 13.98 lakh a year. Thus, he would require a corpus of Rs
2.55 crore to sustain him till he is 80-year-old. For this, Nair needs to make
a monthly investment of Rs 17,000.
Scenario C: Presuming Nair is 30-year-old, he still has 30 years to retire.
Assuming inflation 30 years from now is 8 per cent, his yearly household
expenses would be Rs 30.18 lakh. To sustain himself till he is 80, Nair would
require a corpus of Rs 5.50 crore.
Since he has 30 years to invest, he should take an equity expose of 100 per
cent in a diversified equity fund through a systematic investment plan.
Accordingly he needs to invest Rs 8,000 per month to achieve the corpus assuming
equity investment would give a return of 15 per cent.
Investment strategy: Your investment strategy should depend on your age, risk
profile and the timeframe you have in meeting your goals. In India, majority of
the population save in debt such as bank fixed deposits, Public Provident Fund,
National Savings Certificate and bonds.
Most perceive equity as risky but if you invest regularly for a longer period
say for more than 10 years through systematic investment plans, equities can
give on an average return of of more than 12-15 per cent.
For instance, the Sensex in 2008 had a one-year negative return of 52.45 per
cent. A person, who had invested prior to a year at the peak of the bull-run,
would have seen his capital eroded. However, if the same person had invested in
the Sensex five years prior to the bull-run, his return on December 31, 2008
would have been 9.43 per cent while if he had invested in the Sensex for 10
years, his return on December 31,2008 would have been 14.47 per cent compounded
annually.
For a long time now, funds parked with provident funds have been high-yielding
instruments. The pie generated up to 12 per cent yields between 1990 and 2000,
primarily due to the historically high interest rates prevailing then. However,
since 2001, interest rates have declined and settled below 9 per cent. This
fixed income bias limits growth possibilities of the corpus, also given the
high inflation. Since 1990, the average consumer price index or retail
inflation has been 7.25 per cent. Compare this with an average yield of 10.39
per cent, which provident funds offer subscribers, thereby giving a real return
of about 3 per cent. Even though equity is prone to short-term volatility, it
is the best bet in the longer run, as it offers inflation-adjusted return.
Further, the risk of loss diminishes as the investment horizon expands.
If you have more than 10 years in meeting your goal, you should invest 90-100
per cent in equities through SIP and the remaining 10 per cent money in debt.
Once you are five years away from retirement, transfer all your investments
from equities to a debt fund.
Buy adequate insurance: It is very important that you have a pure term
insurance policy, health insurance, accidental disability insurance policy and
a critical illness policy. This is because in case you contract a dreaded
disease, not only your health will get affected but also your ability to work.
In case your income stops, you won’t be able to meet your financial goals.
Term insurance is the cheapest way of insuring that your family is financially
secure even if tomorrow you are no longer around to care for them. The premium
of a term plan is a fraction of what you would have to pay in case you buy a
money-back policy, a whole life policy, an endowment plan, or a Ulip policy
with the same cover. This is because a term plan does not have an investment
component and the entire premium goes in covering the risk.
A pure term insurance plan bought online is highly recommended while invest the
remaining investible corpus in instruments offering better returns.
How much insurance do you need?
Before buying a term insurance policy, it is always important to find out the
amount of life insurance cover you need. The following factors should be
considered before buying a term policy: Your age and number of dependents, your
annual income and annual expenses, your outstanding liabilities like home loan,
car loan, etc, your investments/savings, your lifestyle expenses and the money
your family would require in future to support the same lifestyle in case you
are gone.
Says Maalde, “As a thumb rule, people below 35 years of age could look at a
cover that is 15 times their annual income, those between 36-45 years of age
could look at a sum insured that is 12 times their annual income while those
above 45 years of age could look at a sum insured that is 10 times their annual
income. In case a person has liabilities such as a home loan, car loan then he
needs to add the proportional amount of cover to take care of the liabilities.”
Don’t go for mortgage insurance: In case you have taken a home loan, increase
the sum assured of the term plan in proportion to the loan amount. Do not buy a
home loan insurance policy as these plans are expensive and the benefits would
cease if you transfer your loan to another bank.
Increasing the sum assured of your term plan would help as your family would
not be burdened with the loan repayment in case of your premature death.
Another benefit of a term plan is that you could change your home loan provider
if interest rates shoots up. Also since home loan insurance plans are single
premium plans and remember that you cannot surrender the policy.
Don’t take insurance beyond your retirement age: Once you retire, your income
drops. Mostly, people clear their liabilities till their retirement. Therefore
paying a premium towards an insurance cover would be difficult. It is advisable
to choose a tenure that ends by retirement.
Don’t go for fixed deposits and traditional insurance policies: Fixed deposit
rates have been falling and in the last one year, banks have cut interest rates
one year deposit rates by an average 130 basis points. Similarly, for all other
tenures too, deposit rates have fallen in the same range.
Investing through fixed deposits will not help you reach your financial goal as
they do not beat inflation nor are they tax efficient. Similarly, if one looks
at traditional insurance policies including child plans or money back plans,
the internal rate of return (IRR) varies between 2 per cent and 6 per cent. One
should avoid fixed deposits and traditional insurance plans as they give lower
returns and come with high lock-in.
Reviewing your portfolio is equally important. Continue working towards your
goal and review the progress made on a monthly, quarterly, or within a
particular timeframe. If you’re not making satisfactory progress on a
particular goal, you can change the process to achieve the goal.
