“Planning for retirement is not something we can put off until a later date. The time to plan is now!”
Retirement is one of the most important events in life for many of us. Thinking about retirement conjures up images of days spent reading, relaxing, self-reflection, travelling, and other such pursuits. Though retirement means different things to different people, one thing is common- everyone wants to retire comfortably and enjoy the remaining years of life.
However, the irony is that a large majority of people in India are woefully ill-prepared for their sunset years. While most are unaware of the monetary requirements of retirement, even those who have some semblance of financial preparedness, it is inadequate to see them through their retired life.
The main reason for this situation is our sub-par social security system, which is clearly inept to provide for the financial and health care needs of the elderly. Another important cause of inadequate retirement finances among-st Indians is the lack of proper investment education resulting in poor retirement planning. We prepare enthusiastically for all significant events of our life (marriage, children, education, travel, etc.) but somehow fail to plan for our retirement!
Just like a solid foundation is critical for building a durable structure, starting early with a sound retirement financial plan—which clearly spells out post-retirement needs and goals is critical for securing a comfortable retirement.
Why Start Early
Life expectancy in India is on a rise and with further advancements in healthcare technology it is expected to only increase further. A longer life implies a longer consumption period during retirement, and if not properly planned for, your savings might not be enough to support your needs and goals after retirement. Thus, the earlier you start the better your likelihood of financially securing your retirement.
Most people at young age dismiss retirement as a very far-off thing. This is very risky behavior as people often do not recognize the value of starting early, only to realize later that they are short on time to build an adequate retirement corpus. Letting your money work for you is a smart retirement planning strategy. By starting early you have one of the most important tools of earning at your disposal- that is the power of compounding. Compound interest is the interest on your principal plus interest on interest you earned previously. In other words,your investments earn income, and further that income earns income and this goes on ad infinitum. Consider the following example:
Kabir and Neha plan to retire at 60. They consult their financial advisor who suggests a diversified portfolio each for both of them as per their needs and goals. Assume that the portfolio earns 15% annually. Kabir’s age is 35 years and Neha’s age is 25 years and both of them will invest Rs 10,000 annually until 60 years of age.
What happens to their portfolio at retirement?
By starting almost 10 years early, Neha’s portfolio will have a clear advantage of Rs. 75 lacs at retirement. The power of compounding works dramatically to your benefit the longer you stay in an investment or the earlier you start.
Start Investing Whatever You Can
The thought of not having enough money to invest should not hold you back. A large initial chunk of money is not necessary. Start making regular contributions however small. As the above example highlights that even a small annual contribution like Rs 10,000 if given adequate time to grow can provide a comfortable cushion for retirement. The key is disciplined and regular investing, and let the power of compounding take care of the rest.
Have a Plan: Understand your Needs and Goals
As the above illustration showed, starting early with whatever amount you can save and invest will go a long way in building your retirement corpus. However, to achieve optimal results from your investments, it is beneficial to develop and invest according to a sound retirement plan. A well thought out plan is the one which incorporates all your needs and goals and defines appropriate investment strategies to achieve them.
Whatever you think might be your post retirement requirements- maintaining your current lifestyle, travelling, buying a vacation home, gifting your children etc, clearly spell out all your post retirement needs and goals. Being diligent and detailed is necessary as it is critical to figure out just how much money you need at retirement. Under assessment of your post retirement objectives can lead to an improperly devised plan that might not provide for you adequately. If you are not sure of your objectives, it is advisable to seek professional assistance. A professional advisor can help you to assess your objectives, develop investment strategies, monitor the plan and make appropriate changes when required.
Understand Market Forces
Inflation- the most important consequence of inflation for investors is that inflation erodes the purchasing power of money over time. Because of inflation, a rupee today does not buy as much as it did 10 years ago. It is the single biggest risk that the retirement investors face. The following table shows what inflation does to the purchasing power of Rs 100 over a period of time:
Assuming an average inflation rate of 4%, a 100 rupee note will buy goods worth only Rs. 37.5 after 25 years.
The key to protecting your portfolio from inflation is to invest early and invest in asset classes which have a track record of beating inflation. Doing this ensures that the incremental return of your investment over and above the inflation rate compounds overtime, thus significantly enhancing the purchasing power of your money at the end of the investment period.
Volatility reflects the ups and downs in the value of investments. Certain asset classes like equities are more volatile as compared to fixed income instruments. Before you commit to making any investments, it is important to assess your appetite for risk and comfort with potential downsides. In investments, higher returns are often associated with higher risk. This means assets with potential for higher returns are also more volatile and may see temporary or permanent decline in value. However, by focusing on the long-term, regular investment and diversification you can easily mitigate the risk arising from volatility. Stock markets historically have trended higher over the long-term despite brief periods of extreme declines. When you diversify and invest for the long-term, volatility does not pose any major threat to your investments. This is because diversification ensures that you are invested in securities and assets which have low correlation with each other. So, all your investment constituents do not decline or increase in value at the same time thus lowering the volatility and hence riskiness of your portfolio. In the long term, this optimizes your investment results as you get higher return per unit of risk.
The Strategy to Beat Inflation and Volatility
Choose the right instruments: to lead a financially secured post retirement life, it is critical to earn a rate of return that exceeds the long term inflation rate. Traditional saving instruments like bank FD’s, PPF, life insurance schemes etc. offer modest post tax return which rarely beats inflation in the long run. Equity investing on the other hand is a good long-term hedge against inflation as it has historically compounded the money at a much higher rate. A higher rate of return also means that an investor has to invest a lower initial amount when investing in equities as compared to fixed income instruments to achieve the same retirement corpus.
Diversify: though associated with higher returns, equities come at the cost of additional risk and in short term may also lead to significant loss of capital. On the other hand, fixed income instruments safeguard your principal and provide a regular stream of income. The downside of investing in fixed income however is the lower rates of return that might not keep up with inflation over time. To balance the twin objectives of minimizing risk and maximizing returns, it is advisable to have a well-diversified portfolio. While equities provide growth and a cushion against inflation, fixed income instruments can help balance the risk by providing stability and regular income at lower levels of risk.
Asset Allocation
Though there are no fixed rules, how much you invest in a certain asset class depends on your time horizon and risk appetite. It is here that a professional advisor can add value by skillfully devising an asset allocation strategy taking these factors into account. Typically when you are young, allocate more towards equities and as you approach retirement you may steadily lower the allocation to equities and turn towards the relative stability of fixed income instruments. A simple rule of thumb for portfolio construction for an individual is to allocate 100 minus his/her age to equities while the remaining may be distributed amongst the safer assets like bank FD’s, investment grade bonds, PPF etc. For example if an investor's age is 32 years, he should allocate 68% (100 - 32) of his funds to equities and invest the remaining in fixed income products.
Conclusion
There will be a time in your life when you will return from work to home forever. At that time, what matters most is how well you are prepared to handle your life and finances independently. Given the sensitivity and importance of being financially secure during old age, we strongly advise investors to be aware of their post-retirement goals and start investing early with a clearly devised retirement plan. In case you do not wish to consult a financial advisor, a simple rule of thumb is to save 10-15% of your annual income for retirement.
Everyone has the right to reward themselves with financial freedom in the latter stages of life. Do something today that your future self will thank you for. Happy 2018-19!