Are you a retiree who has parked his/her retirement corpus into investment avenues so that they can be used judiciously to supply you your expense each month ? If yes, read on to understand the negative impact of retirement portfolio returns.
Most of the way retirement calculation is done by novice investors is at the back of thumb rules – say I need Rs 50,000 each month after retirement which is same as Rs 6 lakhs per annum. Now to generate 6 lakhs each month at say 10% rate of returns, one needs a corpus of Rs 6 lakhs/ 10% = Rs 60 lakhs. Right ?
Well, if only it could that simple.
Negative returns can jeopardize your retirement portfolio
Note that you need to factor in the inflation monster in your expense calculation. So the Rs 50,000 that you need each month will escalate to a large figure as each and every year progresses, thanks to inflation. Assuming a constant expense from retirement till life expectancy is not a very practical approach, I am afraid.
So given a life expectancy of say 85 years, if you need around Rs 50,000 each month, then you will note that the nest egg needed is approximately Rs 1.4 crores. Inflation is assumed at 9% and rate of return on portfolio is assumed at 10%. Retirement age is obviously 60.
On the sidelines read how much money do you need to retire as well.
Now, here is where the fun actually starts.
To generate a 10% return on his portfolio each year, the retiree will in a very intelligent way deploy his corpus across debt and equity, with a small exposure to the latter. This is how the snapshot will look like with a 5 year gap (Corpus is the corpus at the beginning of each year) :
Figure 1
Practically, it is not possible to expect a 10% return each year. Either it will be more than that or less.
The impact of a more than 10% rate on return is positive for the retiree and therefore, welcome. Extra money never hurt anyone.
But it is negative returns that hurt like anything.
Let us assume that the return in the very first year is actually -10% while the rest of the years it continues at a figure of 10%. See the impact to the portfolio till life expectancy in figure 2.
The retiree will run out of money by age 80 but has another 5 years to go. That is not good because it leaves no money for the retiree to live his daily life for 5 years.
You could argue that the portfolio could generate more returns in the next few years to make up for the loss. The issue with that assumption is that you can probably do that by parking a lot of the retiree’s money in equity. But for a retired person, too much equity exposure is not recommended. One would need to think twice before taking such a huge risk with the aim of making up for losses.
Figure 2
My point here is simple – negative or low returns in any year during retirement can jeopardize a person’s cash flow planning. It can also put the retired individual in a situation where he is forced to take risks not in line with his financial well being.
The other issue with such a scenario is that if from a depleted corpus the person takes away more money for his expenses, the corpus shrinks even more. That is like a double edged sword.
You could extrapolate the above is see what happens if the returns are at 10% in the initial years but turn negative during the later years. In such a case, the retiree will run out of money just before his life expectancy and maybe not as early as 80 years of age.
Monitor, monitor, monitor returns of retirement portfolio
As a qualified financial planner, I believe that the task of monitoring your retirement portfolio returns and tracking how you are doing each year is important at any stage of a person’s financial life but its importance is absolutely mandatory during retirement planning.
I believe each year is the minimum a person should be tracking his portfolio and assessing how his corpus is doing with respect to the cash-flow planning. It is these occasions when he will catch the missing pieces and try and mitigate the impact early in his retirement life span.
It is better to be safe immediately after the years of retirement than be sorry when you run out of money towards your life expectancy.
This article is an eyeopener for the younger generation too. Considering the kind of economy that we have and the kind of resources (or lack of them) available in the country I think inflation will always be around 7-10%.
When we make a retirement plan I think we should overestimate the corpus needed by at least 10-20% and invest at least the surplus in equity when we retire. As and when we get sizable gains we switch the gains to debt (latter part of this notion was Shubra’s idea)
Most people plan for a retirement with a constant pension. This is suicide. One of the biggest challenges for a CFP would probably be to try and index the pension close to inflation while stretching the life of the corpus for such a person. A tall order!
I think early retirement, say at 45 will not work for most people unless their net worth is considerable.
A FP told me recently that conventional retirement plans are going to give way to a new mode of thinking where passive income holds centre stage. Call me old fashioned, but I think this will work for only a handful in India.
Radhey can you do a post on passive income?
Hi Pattu,
If you overestimate by say 20%, how are we sure it will fit into the savings model of the investor. While it is good to have, I think 20% on extra corpus is good to have but tough to achieve. It can also put back in oblivion some other goal on the person.
As you rightly say, I do not think early retirment is possible for too many people. The wants are too many and income/savings don’t match up.
I will try and do a post on passive income.
I understand. I think it is prudent to save a little more than what is reqd. In most case people flinch when asked to save even what is reqd. because they have spread themselves too thin in terms of expenses very early in life and find it difficult to change.
Yeah agreed !
@Pattu,
Very well said, as you are a Government employee and eligible for pension, will the pension amount that people receive after 20 years be the worth of peanuts or will it be able to sustain part of monthly expenses.
Before Pattu answers, I can tell you that it will be peanuts ! I think it wont even sustain 50% on monthly expense. That is why they say there is no social security in India.
Yes peanuts it will be!
Why do you think the govt forced employees who joined after Dec. 2004 to NPS from GPF? In a GPF the pensioner gets inflation indexed DA twice a year (although the basic pension will hardly be sufficient to pay for expenses). In NPS we say goodbye to the govt after we exit. So the govt is reducing its liability.
The NPS contribution I make is only 36% of my total monthly retirement savings. That is probably how much it will fall short ~50-70% as Radhey points out when I draw a pension. Several people I know believe that this NPS is enough for retirement!
Hmmm, NPS is a nice option but I think is a victim of no marketing much like the sorry state of MFs are after the entry load was slashed.
@Pattu Since you have been investing in NPS, you mind writing a guest post on NPS?
How does it work and how much returns one can expect from it? Is it good for private employees etc.
I am also (guilty of) investing in NPS.
@TWW How’s your experience with NPS? Would you recommend it to people for long term investment purpose?
Hi,
I would like to introduce the concept of ‘Life Styling’ in your article which as very nicely described the investment vs retirement objective.
Life Styling concept says that you have more investment into high risk assets and less into low risk assets during your earning stage of your life. As you approach nearer to your retirement age, you switch your investments from a high risk into a low risk asset gradually (generally in last 5 years). If we talk in terms of mutual funds, it would be a STP from Equity into Debt funds over a period of last 5 years.
This process would reduce the risk sitting in an unfortunate situation of being affected negatively by the market situation which is hitting us since 2008 till now.
Once you have approached your retirement, you may want to tweak your investments in line with details mentioned in my article http://insight.banyanfa.com/?p=130 .
Yep, a very important but effective strategy.
Is this your terminoligy – Life Styling ?
Hi,
Lifestyling is not my term. It is a standard terminology used in the pension market, specially in western / developed markets. However, I think it is not very commonly heard term in India.
Ah thanks BFA.
Life-styling .. a fancy term for “switch from equity to debt as you approach your goal”. Perhaps such jargon is necessary for a client to feel satisfied that he is getting something for the advisory fee!
You tell a client personal finance boils down to commonsense (life everything else in life – from taking a piss to getting a phd as I tell my students) I think they will refuse to pay!
Ha ha ha ! Nice one Pattu. Good term to adapt.
Very good analysis, i wonder how people who invest only in EPF, PPF, FD’s and Insurance policies would be able to match this requirement. Unless we don’t invest in equity we won’t be able to gather so much surplus.
The best part is that no one actually calculates whether the portfolio is big enough to deliver the expense each month till life expectancy. Everyone takes each day one at a time.
And then you have the world to milk senior citizens high and dry…
Don’t you think in today’s stressful world it is better to take each day one at a time?
There are people who face the problems as and when they come and been quite successful that way. There is a saying “sab sar pe padti to sab ho jata hai”
Nahin re raja ! Retirement ka planning abhi karo. I have client aged 65 with only 5 lakhs of money to last their retirement years. They never planned !!
I am planning and investing for retirement but I just wonder how do people manage who take one day at a time? or they just end up like your 65 year old client, speaking of which what advise you give to such clients? Start working again! 🙂
Equity is not everyone’s cup of tea and most importantly lack of knowledge kills this investment resort big time.
The article is good in terms of sending a message that how important is to plan for retirement portfolio and keep monitoring it regularly even after you retire.
But I think it lacks the practical measures to deal with the monetary gap. It is not possible for everyone to achieve the retirement corpus with 10% inflation, the figure becomes too huge to achieve. What to do in such scenarios?
Also, post retirement if you feel you are going to run short of money, what to do? Get back to work again or rearrange your investments? I think some practical tips to achieve a healthy corpus pre and post retirement would make this article very very useful.
May be something to consider writing in near future?
Yes, I can cover that in the future. I see two alternatives – reverse mortgage or living in a retirement home where the costs are quite less.
There is only 1 practical measure to bridge the gap – INVEST EARLY IN LIFE !!!!
Reverse Mortgage is a good option but sadly it has not picked up in our country, maybe in the next 10 years it would pick up. Retirement home is a booming business and very expensive in metro cities.
But the option does exist and is a very good alternative actually.
You are right, I like the the concept of reverse mortgage and I’d prefer that too.
By the time we reach the retirement age I am sure it’d be more popular and synchronised.
Do you how does the concept of retirement home works in India? I mean what the cost and facilities are like? I hope they give a respectable life and are not like some refugee shelters.
I might do an article on this.