Mr Sharma is getting retired. His responsibilities are over, children are settled abroad with their jobs and families. He is happy that finally after working for so many years, he is going to spend some time in peace with his wife.
Mr Sharma has total portfolio of Rs. 1 crores, which he thinks is enough to meet his retirement goals. The only issue is that financially he is grossly underprepared. The problem – he doesn’t know that!
It is important to note that he does not have any pension coming to him and has to generate income from the portfolio to meet the retirement needs.
He asks me, “how best to invest this money?”
But I ask him a different question.
“Mr Sharma, will this money be enough to last your entire post retirement life?”
“I think so. Dividends from Mutual funds should help me ” He is quite confident.
“Ah!” is my short reaction.
But given my work, I see problems. I am prone to ask questions and run scenarios with numbers. This is how it goes.
Me: What are the living expenses you will have per month?
Mr. Sharma: Rs. 60,000!
Me: Any other special needs such as traveling, medical, etc that you need to plan for? May be an yearly expense.
Mr. Sharma: No, 60k includes everything.
Me: What is the life expectancy you are planning for? I mean how long will you need the money coming in?
Mr. Sharma: I don’t think we will live beyond 75. I don’t want any more years.
Me: Sure. At what rate do you think inflation should impact your expenses?
Mr. Sharma: 6% inflation is a good rate. We have a very modest living.
Me: Finally, what is the expected rate of return on your portfolio?
Mr Sharma: (after some thought) 12% should be easy to get. What do you say?
Me: That sounds a bit aggressive to me.
Mr. Sharma: OK, then let’s keep it at 10%. (itna to hona hi chahiye!, This is the least expected.)
Me: OK.
I used the numbers to show him the retirement fund he required as of today and then added few more scenarios to show him “what can go wrong”.
Retirement scenarios – What can go wrong?
Mr Sharma was happy to see the first 2 scenarios. He had enough money to take care of his needs.
But I wasn’t. The first 2 scenarios were optimistic in my view. He was overestimating the upsides and under estimating the downsides.
I was looking at the other 3 scenarios, which had a higher likelihood of occurrence.
“Mr Sharma, while I understand that you have a view on how you see your lifestyle, expenses and portfolio working, I think they are quite optimistic.” I tried to put my point across without taking away the smile on his face.
“It will be good to understand the risks that can impact your finances and accordingly the plan has to be adjusted for the same.”
“Sure. Help me understand.”
The first big risk is that of life expectancy itself. You and I know that we don’t control it as much. Life expectancy is steadily rising and you are better off planning for a 90 kind of a scenario than 75.
Just with this change in life expectancy you will need 1.64 crores today to provide for all expenses in the retirement lifetime.
You are clearly underestimating the power of inflation too. 6% is a very conservative figure and looks good in government reported statistics.
For people like you and me, we are better off taking a minimum 8% rate. It can be higher based on the lifestyle you have.
With this change in inflation, the requirement retirement fund goes up to Rs. 2.1 crores.
Even on the portfolio returns, your expectation is similar to an aggressive portfolio. Since you are retired and need more certain income, you need more certain sources of income, which may yield a lower rate of return.
You want to invest your money in equity / hybrid funds with dividend option. Putting your money to risk with higher volatility and ups and downs of the stock market can lead faster depletion of your funds. Of course, the dividends are not guaranteed too. From this year onwards, there is also tax on dividends from equity funds at the rate of 10.4%.
I suggest that you work with an assumption that your portfolio will only cover for the inflation and protect the purchasing power of money. That is equal to an expected annual return of 8%.
If we adjust the expected rate of return, the amount comes goes up to Rs. 2.76 crores.
“But I don’t have that kind of money.” Mr Sharma was a tad worried.
Not to worry. We will have to figure out the best course of action to ensure that you are able to meet your needs.
“OK. Let’s do it.”
Sure.
Different people, different retirement needs
That was Mr Sharma.
However, different individuals have different needs which can change the retirement fund requirements.
Just for expenses, what if they are more? You may like to travel more often. Medical expenses can be unforeseen.
Or, you may need to take up senior care in a retirement home later in your life.
Here’s another set of scenarios that you can identify with. Assuming, you had expenses of Rs. 1 lakh a month and need another Rs. 5 lakh a year for special additional needs.
You see the difference.
Again, these numbers are relevant assuming you have retired today. A future retirement scenario will have a different set of numbers.
Now start planning and investing accordingly. Don’t let your assumptions derail your retirement plan.
How prepared are you for your retirement? Do share with me in the comments. Also, try out for yourself in the RapidFIRE calculator.
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