How to plan for a wealthy retirement

Retirement planning is a relatively simple exercise that requires investing discipline and, regular monitoring. It is important to make a start; however small it may be.

Before we get on with discussing the case study on retirement planning, it is important to highlight what it is:

1. a very personalised process that is unique to every individual;
2. an ongoing process because what we are aiming at is not fixed (our standard of living, which we are aiming to secure will change over time).

Our aim therefore in discussing this case study is to understand how you can get started in planning for your retirement. For you to be able to draw up a personalised retirement plan, you will require the services of a financial planner.

In this note, we will discuss the retirement planning process of an individual, say Ajay. Ajay is 30 years old; he is married and has a two-year-old child. He is a professional, employed in a software services company. He draws a compensation of Rs 30,000 per month.

His wife too is employed, as a teacher. She draws a salary of Rs 15,000 pm. The present household expenditure is Rs 30,000 pm. Ajay is looking to retire at age 58 years.

Since we are focussing on retirement planning for Ajay and his wife, we need to look at the cost they incur in maintaining their present standard of living. Let's assume, Ajay wants to, as of today, maintain the same standard of living post retirement, i.e. he will need Rs 30,000 per month (pm), adjusted for inflation, on retirement.

Therefore, we have to plan Ajay's investments in a manner that they will yield an income of Rs 30,000 pm, 28 years from now.

Post-retirement, other than regular monthly expenditure Ajay will incur expenditure on travel and healthcare. Given that health costs are rising fast and we are traveling more for leisure, it is prudent to set aside some money for these purposes.

We have assumed Ajay will require Rs 500,000 per annum post retirement (Rs 125,000 p.a. in today's Rupee terms after adjusting for inflation).

Another head of information that will be required is Ajay's present savings and the rate at which they are expected to grow over the years. These savings could include balances with the Employee Provident Fund (EPF), mutual funds, savings-based life insurance policies and fixed deposits among others.

The house that Ajay owns and lives in will not be added to his existing assets for the purpose of retirement planning. This is because he lives in the house and will not be able to generate income by way of rent or sale of property at the time of retirement.

Finally, before we get down to the numbers, we will need to make two assumptions:

1. the average rate of inflation for the next 28 years;
2. the low risk rate of return you can earn 28 years from now; at 58 years of age your risk appetite will be low and therefore a bulk of your investments will be in very low risk securities that yield regular income.

While it is difficult to say with certainty what the actual inflation and rate of interest will be, we nevertheless need to have a starting point. In our view, an average inflation rate of 5% p.a. is a reasonable estimate. As far as the rate of return is concerned 28 years down the line, we think it will be about 5% p.a.

It is important to restate at this point that retirement planning is not a one-time exercise. As your standard of living changes and the investment environment evolves, you will need to regularly make adjustments to your plan so that you can achieve your objective.

Therefore, these assumptions too will change over time and Ajay will need to accordingly make adjustments to his saving and investment pattern. It should be understood that Ajay's financial advisor will have an important role to play in the reassessment.

Let's now take a look at the retirement planning solution for Ajay (see table).

We have taken three scenarios depending on the profile of the client. The third solution (Small Savings) has been included to show how any retirement portfolio that is almost entirely focused on investing in schemes like EPF, NSC and post office is likely to perform over time.

The methodology we have adopted is that Ajay will aim to accumulate a corpus which when invested in low risk securities on retirement will yield the desired income. So, the Rs 30,000 p.m. now is equivalent to about Rs 117,600 28 years from now (post-inflation).

To earn this income (Rs 117,600 p.m.) at a return level of 5%, the amount that is required to be invested is about Rs 3.82 crore (Rs 38.2 million).

In Case 1, we discuss a scenario where Ajay is 'aggressive' while making his investments, i.e. he takes on high risk with the hope of earning higher returns over the tenure of investment. A 15% p.a. compounded return is what we have assumed in this case.

If the money is invested in instruments which can yield such a return, then Ajay will have to either make a one-time investment of Rs 513,500, or a monthly investment of Rs 6,100 throughout the tenure.

In Case 2, the only difference is that the assumed return on investments is lower at 12%; so the investment required to meet the objective is higher at about Rs 1,350,000 (one-time) or Rs 13,400 (monthly).

Case 3 is not really an option but something what a lot of investors are unconsciously opting for. A lot of their savings are in such schemes despite the fact that returns have declined sharply over the years.

While the returns are attractive, from a long-term perspective of 28 years they do not compare well with the other options (like equities).

This is apparent from the table where a portfolio comprising predominantly of post-office schemes is a poor performer as compared to a portfolio that comprises other riskier assets.

Of course, returns offered by small savings schemes are guaranteed; but at the same time in case of PPF and EPF they are reset every year, i.e. the return is not fixed. Moreover, at the time of maturity, it is likely that the return offered by such schemes will be lower than what it is today.

Therefore the rate at which the money is rolled over will be lower, reducing the overall returns. Having said that, such schemes should form a small part of any long-term portfolio, on the basis of their highest level of safety.

Once Ajay has a fix on the amount he wishes to set aside to meet his retirement needs, he will need to identify exactly which assets to invest in. If he is opting for an aggressive portfolio, he will have to decide which stocks/equity funds/ULIPs to invest in.

Some ideas are discussed in this guide; we recommend that you finalise your portfolio only after discussions with your financial planner.

As is evident from the table, retirement planning is a relatively simple exercise that requires investing discipline and, regular monitoring. It is important to make a start; however small it may be.

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