Why Retirement Planning is called the ‘Nastiest Problem’ in Finance?

Our personal finances can be full of tough questions. And one such tough question is:

How much money do I need to retire in India?

Most people are yet to start planning properly for their retirements. The reason is obvious. In terms of chronological order, the goal of retirement comes last and hence, gets postponed for as long as possible.

This is the reason why many young people who are early in their careers tend to ignore the importance of retirement planning.

Coming back to the question of how much money do you really need to retire?

You may be able to find out a decimal-accurate answer using some retirement corpus calculator. But that may not be as accurate as you think. I will explain why in a bit.

Fact is that it is not easy to determine how big a corpus do we need to save up to call it a day. And that is the reason why the Nobel Prize-winning economist William Sharpe has called retirement planning for people as the nastiest and hardest problem in finance.

Before I explain why this problem is so nasty, there are a few things that we need to be aware of to understand the problem in real terms.

Planning for retirement is a fairly new concept.

In earlier decades, people used to retire at 60 and then not survive much due to low life expectancies. So, practically there was no need for such a planning as most people did not live long after their retirements. And a large number of Indians had government jobs that provided a pension after retirement. So some risk of running out of money before dying was taken care of by pension.

But things are changing now.

Life expectancy is increasing day by day. Here is what the data from World Bank suggests about our increasing life expectancies. The graph below shows the life expectancy of Indians at birth in years between 1960 and 2015:

Life Expectancy Indians Year

So for example, someone who was born in 1980, their average life expectancy would be about 53-54. On the other hand, the average life expectancy for the kids born in 2015 is expected to be about 68.

It can be safely said that future generations would have even higher life expectancies. Assuming medical advancements keep helping our species’ case.

What these data points clearly indicate is that the number of years we will live after our retirement will be much higher than what our previous generations did!

Imagine joining a job productively at 25 and retiring at 60. And then living upto a 100. So that means you work for 35 years and don’t work for 40! Interesting.

This is good as well as bad news.

Good as you will live longer. Bad as you need to ensure that your retirement corpus lasts for more number of years. So you may need a bigger corpus! And this means saving more.

So if you ever had the question that how much money is enough to live comfortably in India?

Then a simple answer is … MORE. 🙂

Plain and simple.

A similar risk comes from the possibility of forced retirement. We don’t know when we will be forced out of jobs due to some reason or the other and with little possibility of joining back the workforce.

So for many, the (forced) retirement might be closer than what they think. They too will be having a very high number of years in retirement.

Many believe that basic salary deductions (via EPF, NPS, etc.) made by their employers are enough. But sadly, that is not true. Many know this and also understand that they need to do something about this. But the case of most people is like this that when you ask them they would have enough money to retire some day, they will tell that they don’t know exactly… but they hope that things will work out somehow.

But ‘hope’ and ‘somehow’ are not great strategies to have. And ideally, you would not want to become dependent on your children in retirement.

I get a lot of emails asking me how much to save for retirement and how much money is enough to never work again in India(!) and how to do early retirement planning?

On receiving such mails, I feel satisfied that atleast some people are giving importance to retirement planning that it deserves in the current scenario.

In very simple terms, retirement planning is done to accumulate a retirement corpus sufficiently large enough to replace the retiree’s income and sustain a stable standard of living throughout the retirement.

So coming back to the accusation of retirement planning being one of the nastiest and hardest problems in finance.

Why is it so?

That is because when forecasting what you will need in retirement, there are just too many things that can change. There are several interrelated sets of variables to be considered to reach an optimal answer to the question – How Much Money Do You Need to Retire?

And to be fair, none of the factors is especially complex. But when you have to combine all of them to build a mathematical model, the dynamics goes into another orbit! Seriously!

Here I am listing some of the factors:

  • How long will you live?
  • How long will your spouse need support?
  • What will be the inflation?
  • What will be the returns from debt investments?
  • What will be the returns from equity investments?
  • How much will your basic expenses be?
  • How much will be your lifestyle-related discretionary expenses?
  • Will you need additional health care support?
  • Do you want to leave some corpus as a gift for your children / grandchildren?

That’s not all. Below factors also play a big role:

  • How much longer do you plan on working before retiring?
  • Your current and future income levels until retirement?
  • What are the expected investment returns until the time you retire?
  • Your ability, willingness and need to take risks?
  • How your perception of risk will change over time?
  • Future tax rates?
  • Your current and future savings rate?
  • Severity and timing of bear markets
  • Magnitude and timing of bull markets
  • The sequence of returns during retirement years
  • What are your other financial goals (use this excel download to find out) and how much you need to save for those goals?

With so many factors at play, I am sure you now know why there are so many uncertainties involved with retirement planning. 🙂

Each of these factors has an enormous range of potential outcomes and each single factor outcome must be considered in light of every other matrix outcome.

The results are a vast range of choices. Selecting the proper one as the final retirement investing strategy is as challenging as it is important.

Uncertainty in life is a reality.

We need to acknowledge the fact that by just putting a series of assumptions about the future on paper or excel sheet does nothing to eliminate the uncertainty.

Nevertheless, it brings a sense of direction no doubt. And this is something that the best retirement planning advisors accept and build financial plans around.

Many advisors use rules of thumb (like 30x of your annual expenses, 4% withdrawal rate, etc.) and call it retirement planning. But these thumb rules can be helpful as a baseline for setting expectations but they require context and nuance to be effective in the real world.

And this is especially true for something as complex as retirement planning.

All online retirement planning excels and calculators also carry this risk. If you are using retirement savings calculator or how much do I need to retire calculator, then you need to understand their shortcomings. Else, get in touch with an investment advisor who can work out a solid financial plan for you which will take care of retirement planning as well.

Many people fail to notice but retirement planning is a mathematical problem quite different from investing for all other financial goals.

The problem has two basic parts:

  • First is that you need to estimate the corpus that you need to fund your retirement. Among several other factors, this depends on your expected expenses in retirement, the years you expect to live in retirement and the rate of return that your corpus will generate.
  • The second part is more about now. It is to determine the periodic contribution that you have to make between today and the day of retirement to create this corpus. This depends on the target corpus, the years that you have to build it and the expected rate of return.

Another interesting dynamic is the play between the two durations in the retirement equation. 1) Years TO Retirement and 2) Years IN Retirement.

The longer is the ‘years to retirement’, the lower will be the monthly investment that you need to make. This also means that if you start early, you have a longer time to save enough for your retirement. On the other hand, the longer the ‘years in retirement’, generally larger will be the retirement corpus needed. And generally, this means having to save more on a monthly basis.

I feel that it is essential to get a reasonably correct answer to “how much money I would need to retire?”

Why?

Because targeting too much would compromise your lifestyle today. And having too little is not something you would want to think about.

As for the nastiness of the problem at hand, we must do what we can do.

We should make intelligent and reasonable assumptions without trying to be too adventurous. We should try to account for as many variables as we can. Once the financial plan is created and put into effect, we need to continuously monitor it and update it with new information as and when it becomes available. Eventually, real life events and data points will replace the plan assumptions in years to come.

This is why retirement planning or financial planning is a process and not an event.

We can do all the retirement planning calculations and use excel models for retirement corpus estimation and what nots. But it’s possible that some of the assumptions will not work out as expected and hence, we will have to do course corrections.

This is the reason why financial plans should be open-ended (and not water-tight) to allow for corrective actions, updates or changes in strategy.

Now before I end, I will like to address another question that many people have.

At what age should one begin planning their retirement?

Or let’s say…

Who should plan for their retirement?

To be honest, retirement planning is for everybody as retirement is not optional. 🙂 You may call it something else in initial years. But ideally, everybody should have started yesterday itself!

If you are not in a pensionable job, then you are in any case on your own. This applies to all of you in the private sector atleast.

And please don’t think that you can retire with just Rs 1 crore.

I see a lot of spam emails and articles with catchy headlines like Retire with Rs 1 Crore, etc. For most of you who are fairly young, this won’t work. It just wouldn’t!

A crore is nothing in today’s retirement scenario context.

Having said that, is Rs 2 crore enough to retire in India? Or is Rs 5 crore enough to retire in India?

There is no perfect answer here. Everyone’s answer will be different depending on the values of factors (mentioned earlier) that drive retirement planning calculations.

Starting early will mean your money will have longer to grow and benefit from compounding as well as participate in market upturns.

Retirement Planning is not rocket science. But it isn’t as simple as what many people think it to be. If you have your doubts, then feel free to contact for professional advice.

In absence of any proper social security system in India, the importance of retirement planning increases a lot more. We Indians, in general, are under-invested when it comes to planning for our retirements.

It might seem that the issue of retirement is not urgent, but the fact is that it is very important and delay can cost you a lot of money. And let me tell you something. Do you know what is the biggest worry for people who are nearing retirement or are in retirement?

It is the concern of outliving their money!

And you really don’t want to be in that situation. Isn’t it?

In developed economies, the concept of reverse mortgage is prevalent. In this, the borrower receives money against the mortgage on his/her self-owned house. The amount that can be borrowed depends on factors like the value of property, age of the borrower, interest rates, other costs, etc. and can be easily calculated using reverse mortgage calculator tools. This idea of reverse mortgage is beneficial for senior citizens as it provides them with an additional source of income or lumpsum amount in their retirements. The idea of reverse mortgage has been floated in India too but its yet to find too many takers.

But to cut a long story short – Retirement Planning means saving enough money to provide for a comfortable and chosen lifestyle after retirement. That’s what it really is. It can really answer the question of “How much money do I need to retire?” for you.

If you are in your 30s or 40s, please don’t think that it’s too early to plan for your retirement.

If you are financially smart, you can actually aim for an early retirement and get out of the race that you don’t want to run for long.

In fact, if you are able to talk to a decent investment advisor, you can get some really good pointers to your questions like how much money is enough to never work again in India? Or how much money is enough to retire at 40 in India? Or how much money is enough to retire at 50 in India?

I am sure many of you reading this are looking for some real answers to these questions.

So think about it.

The need for retirement planning is as real as the whole idea of retirement itself. Don’t delay too much or you will repent when it’s too late.

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Your Parents are not your Emergency Fund. Your Children are not your Retirement Fund.

Your Parents are not your Emergency Fund. Your Children are not your Retirement Fund. Strong and thought-provoking statements. Isn’t it?
Parents Children Emergency Retirement Fund

I am sure many of you will be having gut-wrenching experience right now after reading the title of this post.

And many of you will also be feeling scared about your financial unpreparedness. But if that is not the case, then you are a lucky person who is doing just fine. You are not dependent on your parents for handling emergencies. And you are also well on your way to create a big-enough retirement corpus, which will not make you dependent on your children for post-retirement expenses.

But if you do depend on your parents for getting out of financial emergencies and you think of your children as your retirement funds, then I have only one advice for you.

You need to do something about it urgently. And you need to do it now.

If you are young or middle aged, and if you still need to ask for money from your parents to get over financial emergencies, then something is wrong somewhere.

Isn’t it?

Now when I say financial emergencies, I am not talking about taking money from parent’s to invest (generally people do so to buy real estate / property). I am talking about instances like regularly running out of money before month-ends, being unable to pay credit card bills, car loan EMIs, etc.

If these things happen once in a while, it is fine. But if such occurrences are regular, then you know that there is a problem. Either your expenses are exceeding income unnecessarily or you are not planning your future expenses properly. The situation can go out of hand very quickly. I have seen it happening with my well-earning friends. They earn well. But they are still broke for all practical purposes.

Creating an Emergency Fund is one of the first things any young person (or anyone who hasn’t done it) should do. A good target for this fund can be to accumulate 6 month’s worth of expenses (including EMIs if possible). It might sound tough to do. And I will not mince any words here – The fact is that it is not easy. And when someone has a habit of spending a lot (even more than his income), it is all the more difficult. But it is the right thing and it has to be done.

Also, even if your parents are financially capable of helping you in your financial emergencies, don’t build that thought into your financial planning assumptions. Stand on your own feet. Your parent’s have already done a lot for you in last few decades. Why treat them as Emergency Funds now?

That was about parents and taking their help for current expenses.

But what about your retirement plans?

Are you doing fine? Are you not sure about it? Or you know that you are not doing fine?

If your idea of retirement is that your sons and daughters will (happily) take care of you in your non-earning days, then frankly speaking, I don’t know what to say.

I just hope your children do as you expect them to do.

And I pray for you. 🙂 Because if they don’t, then it’s will be a very scary situation to be in.

No one wants to end up in an old-age home. I have been there many times as we regularly donate a part of our family income for helping old people. And what I see there is unexplainable. One can only feel the pain of senior people when one visits these homes. My suggestion to readers is that atleast once, everyone should visit an old-age home. You will only realize what I mean when you are there.

But coming back to our main discussion – if you are not preparing well for your retirement, then that is wrong on your part. Plain and simple.

See… I am sure you have full faith on your children. But not doing anything on your own is a clear case of inviting trouble.

Now I may sound wrong here, but if you are spending every rupee you earned on your children’s education and marriage, and are not planning to save much for your retirement, then you got it all wrong.

Helping your children is your responsibility. And so is helping your own older self in future when you are earning ‘0’ active income. There is absolutely no justification for not doing everything in your power to ensure that your retirement is comfortable.

So to cut a long story short, if you think that your children are your retirement fund, then you are neither being fair to yourself, nor to your children.

And you need to do something about it urgently. And you need to do it now.