Running out of money before running out of Years

Longevity risk retirement plan

Running out of Money before running out of Years.

Read that again.

It’s a big risk that many young people face today. But unfortunately, they are unaware of it.

Suppose you have done some bit of retirement planning and have been saving money for your retirement at 60. You expect the retirement savings to last until the age of 75 (just assuming). Now the money which you have saved up is enough to help you live from 60 to 75.

But what if you outlive that figure of 75?

It’s possible.

And this is exactly the risk I am talking about.

Outliving your savings. Or technically speaking, the Longevity Risk.

No doubt you would be lucky to live longer than your own estimates. But these estimates are exactly what all your retirement planning calculations are based on.

So in case you plan (or God thinks you deserve) to live longer than your expectations, you are in for some big trouble very late in life. 🙂

Think about it… having no or very little money when you are about to touch 80. Scary!

Of course many will die much sooner than their expected lifespans. But many others won’t. That’s how averages work.

But with medical advancements and better healthcare, living up to the 80s is increasingly becoming common. In fact, it’s possible that our generation (or the next one) will easily live up to the late 90s if not 100s. That’s not all. If you are from a fairly decent financial background and have good health, your life expectancy might be at least a decade or two more than the average Indian life expectancy.

So…what does it mean?

It means that…

You Need to Save More for Retirement

To avoid running out of money before you die, you need to save more. And here are some more points to help you realize this fact:

  • Unlike previous generations, our retirements are expected to last longer. Maybe 20 or even 30-40 years.
  • Previous generations also had the comfort of pensions. Most of us are on our own with almost no social security.
  • Many believe that when they retire, their expenses will go down. Easy in theory but very difficult in practice. And not correct unless the plan is to drastically downgrade the living standards. Changing yourself (and your lifestyle) once you have crossed 60 is not easy.
  • Spending doesn’t remain same throughout retirement. Initially, you might want to spend more money on travelling. But later on, as your health starts getting in way of your life adventures, you would be spending more on healthcare. So expenses are pretty dynamic and generally don’t go down much.
  • And please don’t forget inflation. Unlike us, Inflation never retires. 🙂 It will continue to increase the cost of goods and services that you would need in retirement.

Why do You need to be in Equities?

It’s clear that your retirement corpus has to last for 20 or 30 years. And with expenses not expected to reduce much, your savings and investments now necessarily need to earn better returns.

And when it comes to earning inflation-beating returns, there is just one option – Equity. You just have to take exposure to equity for your retirement savings. Even if you are conservative, you ‘need to do it’ as that’s your only viable option. Provident fund options like EPF / PPF / VPF alone would not be sufficient for your retirement.

Planning for Retirement Properly

Most people (till very late) keep saving whatever they can. Or if their employer is deducting something from their salaries (like EPF/EPS/etc.), they consider it to be sufficient for retirement savings.

But that doesn’t work in reality. And by the time such people realize it, it’s already very late.

If you want to do your retirement planning properly, you need to identify current expenses (that will be relevant in retirement) and those which might start later on – and then project them to the future. This will tell you how much you need to save for retirement.

See, the aim of retirement planning is to help you accumulate enough money so that you can maintain your chosen standard of living even in your retired life. If done properly, retirement planning takes care of various risks like the one discussed earlier this post too (longevity risk).

So “How much do I need to save for retirement?”

There is no one correct answer here.

Infact, the answer is different for different people. That’s because it depends on a number of factors like:

  • When do you wish to (or will) retire?
  • What are your current expenses that will remain applicable even in retirement?
  • What are expenses that will start in your retirement (ex – senior healthcare, etc.)
  • What is your current age?
  • Till what age do you expect to live on your retirement savings? What about your spouse? What if she outlives you?
  • Can you start saving for retirement from today itself or later?
  • How much can you invest periodically?
  • Do you already have some savings for retirement?
  • Do you expect some extra income in retirement from your side-projects or part-time work?

Since the answer to all these questions will be different for different people, the answer to “How much do I need to save for retirement?” will also be unique for everyone.

Proper retirement planning can really help in getting such answers.

And never make the mistake of taking random numbers (like Rs 1 Crore or Rs 3 crore) for your target retirement corpus. If the number is underestimated, you will only realize your mistake when it’s too late. If it’s overestimated, you will be saving extra money uselessly.

And you don’t want to be in either situation. 🙂

Suggested Reading – Your Children are not your Retirement Fund

Source –

Final Thoughts

If you are young (I mean up to the mid-30s), you might feel that it’s too early to start retirement planning.

But I can tell you it is not.

Had you started earlier, it would have been much better. Here is an interesting proof. But if you still haven’t, then please start as soon as possible. You really don’t understand what risk you are taking by delaying.

Having said that, there are just too many variables that can impact a retirement plan. Read this article on retirement uncertainties and why retirement planning is called the nastiest problem in finance to get an idea. But even though it’s impossible to plan perfectly everything in advance, it still helps as it moves you slowly towards a reasonably acceptable scenario.

And please remember that retirement planning is important because unlike other financial goals, you will not get a loan for retirement. So you are on your own.


Case Study – When investing for 10 years pays more than investing for 30 years

I started earning when I was 23. Pretty late I guess. Nevertheless, not everything is under our control.
But benefits of starting early cannot be matched easily by other reasonable approaches (like even investing more in later years). And I did some calculations that once again prove that as far as saving and investing are concerned, best advice is to START EARLY.

Next piece of advice? Don’t doubt the two words of the advice above. 🙂

Invest 10 vs 30 years
The calculations that follow are based on certain assumptions, which you might question. I have tried to address the concerns later in the post. But I suggest that you focus on the crux of the story here, which is – to start investing early.

Scenario 1:

Suppose a person who starts earning at 23, is able to save Rs 1.5 lacs every year for next 10 years. He then stops (at 33) and doesn’t invest anything till his retirement.
What will his corpus be at the age of 60 (i.e. retirement)?
I will bypass the discussion on expected returns and how resorting to better asset allocation strategy can increase expected returns. Instead, lets use a reasonable and constant return assumption of 8% per annum.
Calculations show that at 60, his corpus would be about Rs 2.02 crores.
Now remember that this person has contributed a total of Rs 15 lacs from age 23 to 32. And not a rupee more after that.
Scenario 2:

Lets take the case of another person who realizes the power of compounding a little late and starts at 31. He continues investing Rs 1.5 lac every year till his retirement.

In total, this person would have contributed Rs 45 lacs in 30 years.

And he will end up with a corpus of Rs 1.83 crores.

See the difference?
First person invests Rs 15 lacs in 10 years and gets Rs 2.02 crore.
Second person invests Rs 45 lacs in 30 years and gets Rs 1.83 crore.
Now we all know that its not possible to invest a very large amount at the start of our careers. The annual investments gradually increase with increase in income. And in reality, investments neither stop at 32 (like first scenario) nor they remain constant between ages 30 to 60 (like second scenario).
So this is indeed a theoretical exercise. But it serves the purpose of highlighting the importance of starting early.

Scenario 3:

Now lets take another scenario:
Suppose your parents decide to invest Rs 1.5 lacs for 2 years after you were born. Then from the age 2 to 60, neither you nor your parents contribute anything. Unreasonable assumption but lets stick to it.
Corpus of Rs 3.15 crore at the age of 60.
The reason for this astonishing outcome is that Rs 3 lac invested immediately after your birth had many decades to compound.

And by the time you turned 23 and were ready to earn your first rupee, your corpus was already in excess of Rs 18 lacs. That’s a good amount to start with. Isn’t it? A big snowball to start rolling for someone who is yet to earn anything. 🙂

Again the assumption of Rs 3 lacs can be questioned. An amount of Rs 3 lacs was huge 23 years ago. But again, this is a theoretical exercise. It only proves that starting early works. It just does.
Investing 10 years
But don’t get disheartened if you are unable to invest in line with either of the first two scenarios or if your parents did not do anything like the third one. 😉

When it comes to compounding, there is no amount too small to start investing.

And remember that in initial years, you will not notice the impact of compounding. Its only after years that compounding starts to show its magic.

Getting Your Personal Finances in Order

Getting Your Personal Finances in Order

There are people who struggle through their entire lives – just paying bills, loan EMIs and continuously doing things (or job) they don’t like. Lets aim not to be like those people.
There are people who have no idea how they manage to live paycheck to paycheck. Somehow, they are still able to save some money here and there. But that’s mostly because of luck and not their skills. Lets aim not to allow luck to play such a big role in our lives.
Then there are people who live under this constant fear of not having enough money for their short- and long-term goals. This is inspite having decently stable and regular incomes. Obviously, these people are doing something wrong. Lets aim not to be in the same category as these people.
Lets rather aim to become a person – who broadly knows how money works and he uses that knowledge to make it work for himself. This will make him prepared, confident and happy with his financial situation.
But the journey to become such a person will not be easy.
It will be tough at first.
Tiring in the middle.
But eventually, it will be worth the effort.
Now its my personal feeling that aperson who doesn’t appreciate the importance of personal finance, is unlikely to save or invest a lot of money. He will instead end up spending whatever he can. This might seem like the right thing to do now. But remember, that as you edge towards retirement and your regular income is about to be extinguished, you will have nothing left. Your kids might not be of much help too.
On the opposite end can be a person, who is quite frugal (doesn’t spend a lot) – but still does not understand the real meaning of personal finance. While he might have money stashed up in bank, his money might not be getting utilized to its fullest extent.
So understanding personal finance is absolutely necessary. And luckily for us, its not rocket science. But most people still get it wrong.
Get your + family’s life and health insured, save some money for emergencies, invest for long-term goals, spend wisely and more importantly, less than what you earn.
Its pretty simple.
As far as my own personal finances are concerned, I have a system that works for me. Its not perfect. But given my current circumstances and priorities, it works for me.
But the same system might not work for others.
This is the key point to understand here.
Here, there is no one size fits all.
You need to think for your own self.
Don’t worry if your financial life is still not where you wanted it to be.
But also, don’t keep waiting for the perfect personal financial strategy to find you. It really takes time to see what works and what doesn’t with money. Empower yourself with knowledge – read books, Stable Investor ;-), reliable online resources and take action.
Don’t just copy others or keep waiting as both can be financially harmful.
And be ready to ask yourself some tough questions…
If your aim is early retirement, then ask yourself – Am I doing something to retire early? 

Am I saving (or investing) more than regular people (who are scheduled to retire at 60)?
If you want to save money for travelling around the world, are you actually doing something for that? Remember, that just waiting (and ofcourse saving money) to travel when you grow old, doesn’t work. You travel a lot betterwhen you are young to middle-aged. Old age makes travel a not-such-an-exciting option for most people.
I specifically took up the points of early retirement and travelling because these are close to my heart. 🙂 Now talking of things close to my heart, let me confess something:

I don’t save and invest as much as I possibly can.
Yes. You read it right.
Because, I don’t want to keep saving without spending.
Sounds odd?
Read further…
I spend a lot of money on travelling. Continuously earning, hoarding and not spending is something that I don’t aim to achieve in life. Ofcourse, getting rich is fine with me. But being the richest man in graveyard is not my thing.

Richest Person Graveyard
Don’t get me wrong here.
I am not saying that I don’t save or invest.
I am also not saying that spend everything you earn.
All I am saying is that there should be a balance between the two.
You shouldn’t compromise the present by not spending at all. But you also shouldn’t compromise the future by not saving at all.
Warren Buffett once said:
Who is to say whether it is better to defer a dollar of expenditure on your family – on a trip to Disneyland or something that they’ll get enormous enjoyment out of – so that when you are 75, you can have a 30-feet boat instead of a 20-feet boat. There are advantages to spending money on your family when it is young – giving them various forms of enjoyment, education, or whatever it may be. But it’s crazy to be spending 105% of your income.
That’s so damn right! Isn’t it?
So unless you worship the act of hoarding money, having a balance between saving and spending is the key. I remember reading the below words somewhere:
Save enough money so that you’ll have enough for the future and for emergencies. But spend enough now to avoid looking back with regret.
A new financial year has started. And I think that it’s the right time for you to think about your personal finances.
Your personal finances might be in a mess. Accept the hard truth. And make a conscious decision to do something about it.
Its also possible that you might already be doing great. But there are always things you could have done better.
So take out some time to assess your networth, goal readiness, risk coverage, investment plans, etc. If someone is trying to stop you from doing it, do this to them. 😉
Strive to make your money decisions smarter, wiser and more efficient. Becoming wise is a slow game. But it is necessary if you have a long way to go. And I am sure you have.

Have a very happy financial year!! 🙂

Not Planning for your Children-Specific Financial Goals? You will screw up your other Goals.

Children Goal Based Investing

Retirement, Children’s Education, their Marriages and House. For most people, these are the biggest financial goals of their lives.

Now at the face of it, these goals seem unrelated to each other. But if you think about it, you will realize that not planning well for even one of these goals, has the potential to screw up your plans to achieve other ones.

To understand this, lets suppose that at the age of 50, you have Rs 50 lacs in your retirement corpus. Lets also suppose that you have not saved enough for your children’s education.

Now the day comes when your child needs to pay Rs 10 lac every year for his 2-year post-graduate course. You can very well take an education loan for that.

But it’s possible that you might consider dipping into your retirement corpus to help your child pay his fees. It’s possible that your spouse might push you not to go for such a big loan. Even you might think that since your retirement is almost a decade away, taking out Rs 10 lac from Rs 50 lac might not be a big thing. Since your income will only increase going forward, you can compensate for this withdrawal by saving more in remaining 10 years (to your retirement).

But unfortunately, it is a big thing. Dipping into your retirement corpus means that you will break the process of compounding.

To put it more simply, it means that you will not have as huge a retirement corpus as you might have, had you not taken money out from the corpus.

That is not all. Once you do it. You might consider doing it again when you need to pay for your child’s marriage. Isn’t it? It’s a possibility, which you cannot rule out. Marriage expenditures can go out of hand very quickly.

So unless, you make separate arrangements for each of your major financial goals, chances are high that it will have a negative impact on those for which you have made arrangements.

I once wrote that you can get loan for your child’s education and marriage, but not for your retirement and that you should never treat your children as your Retirement Fund. At the cost of sounding funny, the previous statement does send out an important message.

For most parents, child’s education is something that they will never compromise on. But despite recognizing the need to save for their children’s aspirations and education, most people do not take timely action towards it.

To an extent, same goes for children’s marriage.

Result is that these people either end up taking loans, sell land or worst, take money out of their retirement corpus.

Ideally, you should start investing for your children’s education and marriage (assuming you do want to contribute to both) as early as possible.

The more years you have before you need the money, the less you need to save/invest every month.

So lets say that if you have less than 10 years before you need the money, then you might have to save/invest Rs X.

But if you have more than 15-20 years before you need the money, you might have to just save 1/3rdor even 1/4th of Rs X.

It is simple maths and as you will realize, because your investments have more years to compound.

How to Plan for Child’s Future?

Step 0:

Once you do realize that you need to start making arrangements for all your financial goals simultaneously, it is equivalent of winning one-fourth the battle.

It is like you have realized that just like your kids, even you need to do your homework. 🙂 And that too, start as early as possible. Now to be honest, one cannot guarantee that the amount saved by parents will be sufficient to fund their children’s education and marriage.

Children might pick a career path, which requires multi-year high-cost education. But being prepared financially, to the maximum possible extent is what parents should target. It is better than not being prepared at all. So if you end up saving Rs 25 lacs for your child’s education, when the course costs say Rs 30-35 lacs, then you are still better than someone who has saved nothing for child’s education. Isn’t it?

Step 1:

Next you need to ascertain how much money you need for your children’s education and marriage. For that, you need to do some simple maths and take into account current cost of education and how much you would want to spend on their marriages.

Please don’t forget to take inflation into account.

So a course that costs Rs 15 lacs today (when say your kid is 5 years old) might cost Rs 50 lacs after 18 years (when kid becomes an adult of 23). This is assuming an inflation of 7%.

Now I can share from my personal experience that as far as education is concerned, college fees generally don’t increase every year. But every few years, the fee increases without warning. It might even double! So its better to use a higher inflation figure while doing the calculations. Atleast keep it more than 7% that I used in example above.

Step 2:

Once you know how much you need for education and marriage after many years, you need to calculate how much you need to invest every month to reach the target.

Keep in mind that money being saved for education will not be used in one shot. Fee is paid semester/year wise and might be required over a period of few years. As for the marriage, money required is generally used up within a year.

While calculating the amount to be invested each month, you need to make an assumption about the expected returns your investments will generate. If you are starting early, you don’t need to take a lot of risk and can consider investing a small part in debt options like PPF (assuming goal is atleast 15 years away).

But if goal is not that far off in future, then PPF might not serve the purpose. But you can still consider keeping a part in debt funds and if the goal is atleast 5-7 years away, then make sure that most of your investments find way into well-diversified equity mutual funds.

A reader once mailed his query where he clearly mentioned that though he did plan to save for his child’s education, he did not want to save for child’s marriage. Now every individual needs to take his own call on whether to support their child education, marriage, both or none. But idea of this discussion here is to highlight that it is wrong to dip into the funds saved for your Retirement, just because you were lazy to not save enough for other children-specific goals.

This brings me to the last point.

Step 3:

Lets assume you are a great parent saving for your child’s education and marriage. You have been honest about it and have never missed a monthly investment towards these two goals. This is in addition to your contributions towards other strategically (systematically) important goals like retirement.

Suddenly and unfortunately, you die.

Then what?

You fail to take care of your family’s financial needs inspite of working and saving hard when you were alive.

This risk needs to be covered too…

So make sure that you buy adequate insurance to cover planned expenses of your children (like education and marriage). Ofcourse this is in addition to coverage you need to have to cover for everyday expenditures of your family and to replace your income.

I know, all this sounds overwhelming if you are parent of young kid(s). It’s hard to understand the urgency of all this now, considering that your child’s major fund requirements are decades away. However, the sooner you begin, better off you will be when money is actually required. And just think of the respect your child will have for you when you tell him that you have made taken care of fund requirements for his higher studies. He will be proud of you and your foresight. That will be a pleasant scene to be a part off as a parent. Isn’t it? 🙂

If you are still not convinced, try talking to those whose kids are about to start college or about to get married in next 1-2 years. They will tell you how important it is to start saving early for all these goals.

2 Colorful ‘Periodic Tables’ of Asset Allocation – Useful Visualizers for Financial Goal Planning

One of the most important concepts in financial planning is Asset Allocation. And without doubt I can say that, majority of people don’t get it right. That is the reason, these people end up with inadequate funds, when the goal-date arrives. And that is inspite of having saved and invested diligently, for years.
I have been pouring over books, online resources and talking to many*, who have managed their finances well and have achieved majority (or all) of their financial goals. One thing, which is common across all financially successful people* and theoretical case studies, is the efficient use of a deep understanding of Time Horizons, to make smarter investments decisions.
* Actual people in real-life.

Asset Allocation Financial Planning

Now there is a clear link between your financial goals and your time horizons. Though I will write more about this linkage in a detailed post soon, I will share with you a Periodic Table for funding your financial goals. The original idea of the grid can be found here. I have adopted the model and used my understanding and risk appetite to customize it.
Beware: The grids below might not be applicable for everyone. Not everyone is comfortable investing 100% in equity linked instruments even decades before the goal. So go through this grid with that in mind.
Here is the first grid which deals with asset allocation for retirement planning:
Retirement Planning Asset Allocation
As I said above also, a person might not have the risk appetite to invest 100% in equities. Also, most planners suggest getting out of equities near retirement. I disagree with all of them. If planned properly, one can leave a significant part of corpus in equities, even after retirement and still do well. But that is once again dependent on one’s risk profile (moderately high in my case). You will see ‘X’s in last two columns – I am not suggesting any fixed combination of assets here – as its too far into the future to do any concrete, water-tight planning right now (assuming one is planning for a 25 year old, then we are talking about 55 years ahead!). So you can safely ignore the last two columns.
But as a personal thing, I will prefer to keep 30% in equities, even when I am old and ofcourse, my essential expenses are taken care off.
I know there might be many issues with such a thumb-rule kind of a grid. As already mentioned, it might not be applicable for everyone.
Here is another grid about non-retirement goals. Goals which have a fixed date and don’t require any money once the goal is achieved.
Financial Goal Planning Asset Allocation
What I would suggest is that you pick up a pen and paper, and create a similar grid for yourself. It’s a nice exercise to help you think through, how you want to achieve your financial goals. Since it’s only a small theoretical exercise, you don’t run the risk of losing any money here. 🙂

What are your Systemically Important Investments?

Just yesterday, RBI announced the names of Systemically Important Banks of India. To put it simply, these are those banks whose failure will lead to catastrophic consequences for the country and its people, that is, us.
This concept of Systemically Important Banks (or SIBs) gave me an interesting idea about our own personal finances. Now it may sound a little far fetched… but I request you to hear me out.

Important Investments

But before I move forward with my ideas, I guess there is a need to give a brief background about the concept of SIBs.
After the 2008 Credit Crisis, few smart* economists and financial wizards* decided to do something for the good of the global financial system. They announced a series of reformative measures, which were popularly referred to as the Basel III Norms, to improve the resilience of the banks and the banking systems.

* Sarcasm is intentional 🙂
However, it was felt that Basel III measures were not adequate to deal with the risks posed by systemically important banks. Therefore, it was decided that these SIBs should be governed by stricter norms.
Hence another committee of financial wizards, the Basel Committee on Banking Supervision (BCBS) came out with a framework for identifying the global Systemically Important Banks. This committee also recommended that all member countries (including India) should have additional loss absorbency requirements applicable to these SIBs.
Now I am not sure whether these norms are any good or not. Or whether adherence to these norms can prevent any future crisis or not. But nevertheless, these norms resulted in RBI coming out with its own list of ‘Systemically Important’ or ‘Too-Big-To-Fail’ Banks.
In yesterday’s announcement, RBI identified State Bank of India (SBI) and ICICI Bank as the 2 systemically important banks of India. According to RBI, the failure of these two banks has the potential to screw up the economy (something similar to what happened in US in 2008-2009).
So that was the short background about the Systemically Important Banks. Now lets come back from the world of big banks to the world of personal finance.
Once again, I ask you to hear me out completely and then throw bricks at me. 🙂
Now lets see how RBI defines these Systemically Important Banks:
A few banks assume systemic importance due to their size, cross-jurisdictional activities, complexity, lack of substitutability and interconnectedness. The disorderly failure of these banks has the propensity to cause significant disruption to the essential services provided by the banking system, and in turn, to the overall economic activity. These banks are considered Systemically Important Banks (SIBs) as their continued functioning is critical for the uninterrupted availability of essential banking services to the real economy.

Now I will adopt this statement to define something else.

In life, a few personal investments assume systemic importance due to their size, lack of substitutability and interconnectedness with other investments. The disorderly failure of these investments has the potential to cause significant disruption to the financial well-being of an individual, and in turn, to the overall well-being of his family. These investments should be considered as Systemically Important Investments as their continued growth is critical for the uninterrupted and timely availability of essential funds for the previously-identified goals of the individual.

I will suggest you read the above paragraph again.

I know you must be having some thoughts about what you just read. And I am sure that you already understand that few investments that you make, are more important than many others in your life.

So for someone who is around 30, a systemically important investment might be real estate (I am 30 and I am afraid that I don’t have much interest in real estate as investments).

On the other hand for someone who is around 45-50, retirement savings might be his systemically important investment.

For somebody else, it might be ensuring timely availability of funds for his child’s education.

Now just take a pause and think about your own Systemically Important Investments.A failure of these investments will lead to non-achievement of your goals – which in most cases, will be a big failure for an individual.

Just imagine what will happen if you retire with a retirement corpus which will only provide for your expenses for 5-10 years. After that you will have to depend on your children. Nothing bad about that. But even then, you will become dependent – a concept which I am personally not very comfortable with.

Now when you don’t have money to sustain yourself when you reach 70, then it also means that you will not have any financial legacy or portfolio for your children and grand-children. Doesn’t sound nice. Isn’t it?

For a moment, lets go back to the concept of Systematic Importance of Banks. So why is it that RBI wants to recognize these banks? It is to ensure that they can be further strengthened to make them more robust and less prone to failure. Right?

Same is my concept of Systemically Important Investments. We need to identify them to ensure that they are less prone to failure. And more importantly, help us achieve our goals.

Lets take retirement corpus as an important investment. Suppose for years, you have been investing diligently. But somewhere down the line, you had an emergency and you had to withdraw a part of your retirement corpus to pay for it. You did it because you did not have a sufficient emergency fund in place.

You might feel that it won’t matter much. But concept of compounding is not as forgiving as you or me. You have committed the biggest sin of personal finance. You have disturbed the process of compounding. Withdrawing a few lacs from the retirement corpus, mid way through your investment life (around 45), will result in you ending up with tens of lacs short of your target retirement corpus when you turn 60.

The above example clearly shows that your systemically important investment was not robust. You did not have a contingency plan to take care of unplanned expenditures. One small withdrawal from the retirement corpus resulted in shaving off a few years from your well-funded retired life.

Think of it. Have you stress tested your investments? How will you handle a sudden need of money when all of your money is invested in mutual funds or PPFs? Think about it when you are free and you will understand the importance of identifying important investments and stress testing them.

I have seen people withdrawing money from their Provident Funds to buy property or for other expenses. And many of these people don’t even have any other significant investments towards retirement. They might still lead a good life. But the keyword in previous statement is ‘might’.

That’s it for this post. I want to further explore this concept and see how it can be applied to personal finance and goal based investing. Do let me know about your thoughts on this one.
Suggested Reading:

Detailed write-up on Systematically Important Banks on RBI’s website (It is not as boring as it sounds. Believe me)

Case Study – How Wrong Assumptions Can Destroy Your Happy Retirement Plans?

So you have finally realized that it is high time that you start investing for your retirement. And to help you with your planning, you have decided to make use of free-online-retirement-calculators.
The beauty of online calculators is that it is very easy to input a few numbers and see the results instantly. But the ease and convenience of using an online retirement calculators, should never undermine the importance of retirement calculations.
What I mean to say here is that just because of it is easy and you are using a few text-bookish assumptions,it does not mean that the magic number thrown up by the calculator is sacrosanct. And in most of the cases, it might not even be correct. You should always question it. Always.

Think of it. Are you willing to blindly follow an action plan set up (for the next 25-30 years) by an online calculator? Are you willing to take a risk on something, which will give you money to survive for 20-30 years after you have stopped earning? Its a big bet and requires you to take a really big leap of faith. And ofcourse, it is very scary.
Just imagine that a calculator tells you to save Rs 2 Crores (Crs) by the age of 60 years. And you diligently save and invest and somehow manage to accumulate Rs 2 Crs by the time you reach 60. Feels great.

Now when you started investing in your 30s for this corpus, the online calculator had an inflation assumption of 5%. In reality, it turned out to be 6%. Another assumption made by calculator was earning 8% annual returns on the corpus after retirement. In reality, things changed and safe bank FDs, where you had decided to park most of your money started giving just 5% annual return. The result…is that you are screwed. And screwed when? When you hit the age of 70 or 75. You have exhausted your corpus, not because you did not stick to your investment plan. But because situations changed and assumptions in your retirement planning calculator, did not remain completely valid in future.

Seems scary to run out of money at 75. It’s just like you run out of oxygen when you are doing deep sea diving and are 100 feet deep in water!
I am not saying that one should not use retirement calculators at all. All I am saying is that it is very important to understand that ‘Assumptions’ play a very big role in all retirement calculations.
Now these assumptions are also of 2 types.
First are the assumptions about the ‘Uncontrollables’. Things you cannot control. Some examples of these are assumptions made for return percentages, inflation, etc. You can do nothing to control these factors. You can only hope that your assumptions remain as close to reality as possible over the years.
Second are the assumptions about the ‘Controllables’. These are the factors which you can control atleast partially (if not fully). Some examples are your starting investment amounts, yearly increase in investments, etc.
In this post, I will simply focus on the assumptions we make about the Uncontrollables. And more specifically, lets focus on assumptions about the returns we expect to earn from our investments over the accumulation phase of retirement planning.
Now do this small 15-second exercise:
Close your eyes and think of a number (in percentage), which you think is most popular when people discuss about the expected returns from MF investments.
Thought of it? Great.
Personally, I have heard numbers ranging from 15% to 25%. Though I would personally love to get 25% annual returns, the fact is that it is not going to happen. No matter what anybody says, earning 25% every year is impossible. An annual return of 25% means doubling your money every 3 years. We need to be realistic and stop listening to brokers and agents.
So if 25% is bull shit, then is 15% fine? Honestly, it seems achievable. And there have been funds, which have done even better than that in past.

So is 15% a good assumption to make when doing retirement calculations?
It might be. I personally think that it is manageable in the long run. But common sense says that when I am making assumptions for future, I should be cautious.
These days, many people are talking about margin of safety (MoS). But mostly these people are using the term MoS, when discussing about individual stocks and value investing. But I feel that margin of safety is something, which should not be restricted to investing in stocks alone. It should also be considered when planning for your retirement.
But what is happening is that when it comes to personal finance, there are many who just blindly expect MFs to deliver 15% to 20% for next 25-30 years! I am not saying that it cannot be done. But I can bet that it will not be achieved by 99% of those who claim that it can be easily achieved. And I can bet my entire retirement corpus on it. 🙂
So lets come back to our case study:
Now 15% can be done. But when calculating the corpus needed for my retirement, I will take a much lower number. Say 12%. This straight away gives me a buffer of 3% to be wrong. So even when I am investing with 12% assumption, it is possible that luck favors me and I manage to earn 14% return. Will I mind it? Not at all. I love positive surprises. And who doesn’t?
But if I start investing with a 15% assumption, and I end up with returns of 13%, I will have trouble in my retirement years. And that is what I don’t want.
So with assumption set at 12%, lets do some number crunching. I will only share the findings and not the exact calculations to keep it simple.
Also, I will be tweaking the 2nd and 3rd scenarios for different rates of returns within the investment life. This is to bring these calculations closer to reality. So for theory and comparative background, you can read the 1st scenario. But focus more on 2ndand 3rd scenarios.
Scenario 1:
Current Age = 30 years
Retirement Age = 60 years
Accumulation period = 30 years (60 – 30)
Starting yearly investment = Rs 60,000 (~ Rs 5000 monthly)
Expected Average Annual Returns = 12%
Planned Annual Increase in Investments = 3%
Simply put, the expected rate of return in this scenario is 12% for the entire 30-year period.
The result is a corpus of Rs 2.31 Crores at the age of 60 years.
But lets make this more interesting. Lets split this 30-year investment period into 4 sub-periods:
  • Period 1 – when age between 30 and 40 years
  • Period 2 – when age between 41 and 50 years
  • Period 3 – when age between 51 and 56 years
  • Period 4 – when age between 57 and 60 years

Now an important point to note here is that returns earned in each of these four periods can be different. But in this first scenario, the returns have been put uniformly as 12% for all four periods spanning 30 years. The scenario is summed up in table below:

Retirement Corpus Planning 12%
As already mentioned, this is a good theoretical scenario, which assumes that returns over a 30-year period will be about 12%. Though it is theoretically correct to assume an average figure across a long period, I still feel that later years (after the age of 50) are way too far in future to be predicted correctly.
So to create a more realistic scenario, it makes sense to reduce the return expectations in later years.
Lets try to do this in second scenario.
Scenario 2:
A slightly more realistic assumption in later years is depicted in table below. The impact of lower returns is that one ends up with a lower corpus at the age of 60.
Realistic Retirement Corpus Planning
You might say that this exercise is just like assuming a lower than 12% rate of return for the entire 30 year period. And you are right in saying so. But its tough to make people believe that even MFs can give lower returns than 12% in later years. Just try telling this to someone who is already convinced that MFs will help him reach his retirement targets with ease, and you will understand what I mean.
We need to understand that the situation after 30 years is very far off in the future. And we have absolutely no way of knowing what will happen then.
Today, a return of 15% might look like normal. But we can never be sure whether the same 15% will be a normal thing in 2040 or not. It’s possible that the new normal might be 20%. And it is also possible that the new normal might be 12%. No one knows.
But when calculating our retirement corpus in future, it’s prudent to make assumptions of returns on the lower side, and those of inflation on the higher side.
So this 2nd scenario stands as follows:
Current Age = 30 years
Retirement Age = 60 years
Accumulation period = 30 years (60 – 30)
Starting yearly investment = Rs 60,000 (~ Rs 5000 monthly)
Annual Average Returns = Varies in 4 different period as shown in table above
Annual Increase in Investment = 3%
Retirement Corpus = Rs 1.60 Crores
That’s a cut of almost Rs 70 lacs!! (Rs 2.31 Cr – Rs 1.60 Cr).
Is this it? Can it get any worse than this?
The answer is it might. Lets take up the 3rd scenario now.
Scenario 3:
I know you will abuse me for such a pessimistic 3rd scenario. But here it is:
The returns in future keep going down to 5%. So between 30 and 40, returns are 12%. The next 10 years see a return of 10%. And the remaining 10 years see 8% in initial years and 5% in latter years. And the corpus? It comes to a paltry(!) Rs 1.27 Crs.
Sounds horrible. Right? Just a few percentage points lower in later years and the portfolio (as well as you) end up getting screwed!
Can you take this risk? The risk of having lesser money than what you expected after 30 years of investing?
I would not want to be in such a situation. And for that, if it means lowering my expectations and investing more, then so be it. I will do it as much as I can within my limitations.
Another assumption, which I have made in the above scenarios, is that every year, I am increasing the annual investment by just 3%. Though I have done extensive analysis of how you can become really rich by increasing you annual investments by 10%, the fact is that it is easier said than done.
Our salaries might get a 10% hike every year. And assuming a 6% inflation, we should theoretically have no difficulty in increasing our investments by even more than 10% every year. But no matter how well we plan, there are bound to be unforeseen, additional and recurring expenditures arising every year. A big electronic purchase which was pending for last few years (though even such purchases can be planned wisely), foreign trips (Yes. Trips can be planned too), unnecessary luxuries, etc.
And that is the beauty of expenses. The expenses have a bad habit of beating income increases every year. 🙂
A 3% increase is not recommended and is in fact very low. We should target a higher percentage every year. But since the theme of this post is pessimism, lets keep the annual investment increase at just 3%.
So till now, we have discussed that it’s an interesting (and useful) exercise to expect lower returns in later years of investment lives. So what should one do?
Suppose we take the corpus accumulated in 1st scenario as the target. That is, we need to have Rs 2.31 Crs at the age of 60. And for returns, lets take the expected rate of returns from the 3rd scenario:
  • 12% in Period 1 (30 and 40 years)
  • 10% in Period 2 (41 and 50 years)
  • 8% in Period 3 (51 and 56 years)
  • 5% in Period 4 (57 and 60 years)

So assuming that we need Rs 2.31 Crs at the age of 60, and with above given expected returns, how much should be the monthly investment?
That is the question, which we need to answer to complete this case study.
Now here, there can be two ways of achieving it.
First is where you start with a higher initial monthly investment (>Rs 5000 per month or Rs 60,000 annually) and increase it at the above discussed low rate of 3%.
Second is to start with Rs 5000 monthly investment (Rs 60,000 annually), but grow your contributions at a higher rate every year.
Here are the details of the first option.

Scenario 4:
Retirement Planning Higher Initial Amount
As you can see the table above, you need to start with a monthly investment of Rs 9100 instead of Rs 5000 (as in Scenario 1) and then increase your annual investments by 3% every year to reach your goal of Rs 2.31 Cr.
But what if you want to start with the same Rs 5000 every month? That brings us to the second option.

Scenario 5:
Retirement Planning Higher Annual Increase
In this option, you can start with a monthly investment of Rs 5000. But then you will have to increase your annual investments by 8.5% every year to reach your goal of Rs 2.31 Cr, given the lower return expectations set in 3rd scenario.
Now lets try to take another view.

I know the post is getting quite long. But please hear me out for some more time.
I am sure many of you would be saying that as soon as we approach the last decade before retirement, we should theoretically start moving away from equity MFs (the only one capable of giving 12%-type returns). But problem with moving away from an equity biased portfolio by the age 60 is something related to medical advancements! Yes. Don’t be surprised. Please hear me out.
What I mean to say here is that our generation has a higher probability of living upto 90 and 100 years of age than any of the previous ones. So if you completely move out of equities by 60, you will still have 30 post-retirement years to earn something on your already depleting portfolio. Isn’t it?
And I am sure to hurt many retirement planners when I say that even after reaching 60, one should keep a significant percentage of overall corpus in equity MFs. But having said that, consideration also needs to be given to a person’s risk appetite and not just the logic of higher life expectancy, which I gave above. But I guess that discussion is best left for some other day.
So that’s it for this post. Hope I was talking some sense in this post. 🙂 Please note that I have made return calculations in straight line (using % mentioned as expected returns). In reality, stock markets and mutual funds have volatile returns. One year might give 40% and other might give (-) 20%. And there can even be instances where there is Zero growth for 5 straight years! Almost anything can happen. 

The impact of case studies like these is that I am slowly but steadily lowering my return expectations. And this consequently, forces me to increase my contributions slightly with every such lowering-of-expectations-exercise. So think about what you just read above. And if you have some really high Buffett-type returns expectations from your investments, its time to get realistic about it. It is your retirement after all, not Warren Buffett’s. 🙂