Personal Finance Musing 21: Is Your Retirement Corpus Large Enough
PERSONAL FINANCE MUSING 21
IS YOUR RETIREMENT CORPUS LARGE ENOUGH
I will begin this post by thanking you all from the bottom of my heart. My book, “Musings of a (financially) illiterate father- a common investor’s guide to wealth creation and retention which went live barely 20 days back, is generating a buzz and having great sales. I know that the help provided by all of you in form of sharing last week’s blog post as also my facebook and Whatsapp link has helped tremendously. I will urge you to continue to share this post too as my book has been specially written to teach the alchemy of wealth creation and retention to our children-they deserve to learn it. Please support this mission of financial literacy by reading and recommending this book. The link is given below.
The book continues to generate positive reviews- sample this. Brijesh B. Singh wears multiple hats. He is a senior IPS officer currently posted as Special IG Police Cyber, Maharashtra. He has earlier been IG of the Criminal Investigation Department and is considered a renowned expert in IT and security, where he has introduced path-breaking IT schemes[1].
An engineer, he also holds master’s degrees in psychology and public administration. Deeply interested in Indology and philosophy, and extremely passionate about computers, he holds technology patents too. He indulges in photography, classical music, and poetry[2].
If this long list was not enough, he is also an author with two books under his belt, “Dangerous Minds” and “Quantum Seige”, both published by “Penguin Books”. The quality of his writing is evident with the fact that his book “Dangerous Minds” was launched by film star Anil Kapoor and “Quantum Seige” by the superstar Amitabh Bachchan.
With his impeccable credentials, Brijesh sure has the perspicacity to differentiate a gem from a fake. After going through the book, “Musings of a (financially) Illiterate Father”, this is what he had to say.
“Anand has thoughtfully filled a major void in personal finance education in our country.”
These words of praise from an erudite personality and fellow author like Brijesh B Singh have indeed been a morale booster. I am sanguine that this book will provide a clear roadmap for investing for many common investors like us.
Let’s continue with our exploration of the all-important topic of “retirement planning” which we began last week. I had put across three models for retirement planning for your consideration last week. To ensure a seamless transition to this week’s post, the link is provided below.
Once we retire, obviously the steady stream of income in form of pay stops. However, expenses except for a few, very much remain to be taken care of. This is where a retirement corpus that you have so painstakingly built up over the years comes in handy. A normal person, who retires at 60, has to take care of nearly 25 years of retired life- either of the spouses may live till 85 or beyond. To put this long time period in perspective, remember you have to live for 25 years or so off a corpus which has been built over 35 years of earning lifetime- A tough task indeed.
The first step towards calculating the size of our retirement corpus is to estimate how much money will be needed per month (or annually) in retired life? Post-retirement, many expenditures do reduce- Children’s education, EMI towards home mortgage (yes, you must absolutely have a mortgage-free house when you retire), Office related expenses like commuting, dressing etc. and certain social obligations. But what will increase are your medical expenses. A good rule of thumb is that one would need approximately 75% of pre-retirement income after retirement. So, if you retire with an annual income of Rs 25 lac, you will require around Rs 18.75 lac annually after retirement. It roughly translates to a monthly income requirement of Rs 1, 56,000. We will revisit this rule of thumb subsequently.
The next step is slightly more nuanced i.e. to calculate the total retirement corpus. How to go about calculating that? One way could be to factor in the historic returns provided by asset classes in the past (last 10 years should be a good enough yardstick) and then extrapolate this rate of return to work out your corpus. So far as equity is concerned, diversified mutual funds have given a return of 11.8% in last 10 years[3]. So far as debt instruments are concerned, Benchmark 10 year G-Sec (Government Securities) is considered akin to Sensex for equity. The current yield is around 7.2%[4]. For ease of calculation, let’s say you invested your retirement corpus in equity and debt instruments in the ratio of 50:50, so the likely projected returns will be in the range of 9.5% ((11.8+7.2)/2). Again, for ease of understanding, let’s round this rate of return off to 10%.
By this back of the envelope calculation, your retirement corpus should be Rs 1.875 Crore, 10% of which should provide you with an annual income of Rs 18.75 lac, leaving the principal corpus intact. Before you start to do your calculations, let me categorically state that this methodology is faulty.
The above calculation suffers from a few fundamental mistakes, firstly, it doesn’t account for inflation which will keep eroding the value of money over time. Secondly, it assumes that the returns from your corpus will keep growing each year despite the size of the corpus decreasing due to regular withdrawals. Thirdly, it doesn’t account for market fluctuations over the next 25 years by assuming an average return. In actual, the market goes up and down and the sequencing of these fluctuations can prove catastrophic. So, what should be the correct way to calculate one’s retirement corpus?
The 4% Rule Financial advisor, William Bengen, in his research in the 1990s and subsequent follow-on studies at Trinity University opined that if one has to plan for a 30 year retirement and one’s corpus is split into stocks and bonds in a ratio of 60:40, one can withdraw 4% of the corpus in the first year of retirement and then keep increasing it by the inflation rate each year. So, if you need Rs 18.75 lac in the first year of your retirement, the size of your Retirement corpus must be Rs 4.68 Crore (18.75 Lac*25). The 4% rule thus caters to the market behavior, inflation as also other related contingencies. It also ensures that you will not only have dignified and peaceful sunset years but will also leave behind a sizeable legacy for your progeny and social causes.
The 4% Rule is a good yardstick to plan one’s retirement and has been recommended by most financial experts. Like all such thumb rules, it is only a guideline and hence a withdrawal rate of 4-6% should be safe enough for most retirees.
There is, however, a wide variation between the sizes of retirement corpus calculated by the two methodologies- nearly Rs 3 crore. Like all things in life, the truth lies between the two extremes that we have seen.
We will round up our exploration of retirement planning next week wherein I will give my recommended methodology. I will also factor in persons who get pension or annuity on retirement.
My book (paperback) is currently available domestically on Amazon.in, Flipkart, Infibeam and Notion press, and internationally on Amazon.com and Amazon.co.uk. The e-Book version, including Kindle, should be ready in another week. I will keep you updated in my next post.
For now, enjoy your Sunday while reading my book- you have earned it.
[1] https://www.bankinfosecurity.asia/brijesh-singh-new-ciso-maharashtra-cyber-police-a-8795. Accessed on 25 May 2018.
[2] https://penguin.co.in/author/brijesh-singh/. Accessed on 25 May 2018.
[3] CRISIL-AMFI Equity Fund Performance Index, 28 Mar 2018.
[4] The Economic Times, 09 Apr 2018.
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