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Retirement Planning: Investing for an unpredictable future

How do you plan for retirement when so many relevant questions are unanswered? You don’t know how long you will live for, but can you calculate what your expenses will be, how inflation will affect expenditure, and much else. Debashis Basu, trustee of Moneylife Foundation, presented a clear picture to the participants in a session on retirement, explaining of the various factors to be considered and the dangers of insufficient planning

 

Moneylife Foundation hosted the first of its two-part seminar on retirement planning on 23 March 2013. Addressing a packed audience at the Moneylife Knowledge Centre, Debashis Basu, trustee of Moneylife Foundation, discussed how to arrive at a figure that will be sufficient to last a retired life. Mr Basu began by discussing how and why it is neglected. He said, “We rarely ever bother to make the calculation, even though it is not difficult at all. One reason why it is not done is because there are competing objectives. When retirement planning is supposed to be ongoing, there are EMIs (equated monthly instalments) to pay off and the high cost of college education. Another reason is that there is much that is simply not known. Many assumptions are to be made when making a retirement plan.” Assumptions, he argued, may prove to be right or wrong, but this is no reason not to make them at all.

Mr Basu then moved on to a fictional scenario, which spanned over 40 years, to help participants understand how to formulate a plan. He said, “In this example, I have assumed everything. I have assumed that a 45-year-old man named Mr Kumar is earning Rs60,000 a month, saves Rs15,000, spends Rs20,000, has Rs20 lakh in savings and an EMI to pay off. At the same time, he is worried about his children’s higher education and wishes to travel abroad when he’s retired, two objectives competing with a much-needed retirement plan for his finances.”

If your income grows as inflation rages on, it may be possible to ignore the adverse effects of inflation. But when your income is static, it becomes a major problem. Mr Basu said, “If Mr Kumar spends Rs20,000 a month now, in 15 years, when he’s 60 and retired, he’ll be spending Rs72,000 a month. But let’s agree that his expenses drop to 80% in retirement. This means that, at 60 years, he’ll be spending Rs60,000. Have you any idea what his monthly expenses will be when he’s 85 years old? Rs480,000 a month. It’s certainly not unlikely that he will live till age of 85. In urban India, it is common. At the same time, inflation is always higher than the national figure for urban India.”

Indians do save their money, but often don’t look beyond fixed-income schemes, such as bank FDs or investment-oriented insurance products. Mr Basu said, “I have assumed that Mr Kumar has invested in recurring deposit and money-back plans. FDs give very poor post-tax returns and we’ve examined traditional insurance plans at Moneylife and found that they don’t give anything more than 6% to 7%. This is not a good rate of return. What Mr Kumar is then left with is his largest asset, which is his house. But this is an illiquid asset, which means it isn’t income-generating.”

With poor returns from investment and high inflation, how long does Mr Kumar’s retirement corpus last? Mr Basu calculated that, if Mr Kumar’s Rs20 lakh grew at 7% and he put aside Rs15,000 each month until he was 60 years, which also grew at 7%, the corpus would work out to Rs1.03 crore. If inflation then continued each year at 9%, which is likely to happen in India, Mr Kumar would run out of funds by the time he turned 77. This led to the second part of the session, when Mr Basu discussed what went wrong.

The reason why Mr Kumar’s retirement corpus was insufficient was that he did not account for the six unknowns—underinvestment risk, the risk of longevity, failure to account for sudden spikes in monthly expenses, the dominance of a non-income-generating asset real estate in the portfolios, low growth of assets and post-retirement support.

Mr Basu said, “Underinvestment risk is the danger of not having saved or invested enough for retirement, if not both. The second risk, longevity, is a big concern. The longer you live, the more likely it becomes that you will run out of money.”

The third factor, failure to account for sudden spikes in monthly expenses, is one that is completely unknowable. You cannot, for example, predict when you’ll need surgery in your later years. Mr Basu said, “We have assumed that your retirement expenses will be 80% of current expenses. But what about the month when you need surgery or are under costly medication? At this time, it could be 135% of current expenses.

The problem of overreliance on property is another problem. “Real estate works just like stock. It can go up, it can go down. In a good economic scenario, real estate appreciates, at other times it can be static. At the same time, we must remember that it many areas even in Mumbai, rental income is just 2% per annum of the property value. Your largest asset should generate a return of more than just 2%.” Mr Basu advised equity exposure as a means to achieving a sizeable corpus. Mr Basu said, “It’s difficult if you’re not the type to take risk, but you have to convince yourself. It’s the only asset class that is able to give higher returns. Of course you may have invested in mutual funds or stocks in 2008 and decided never to do so again. But you must realise its potential. Healthcare costs are rising at 20% compounded every year. A fixed deposit cannot meet this rising expense. Equity can at least try.”

Lastly, Mr Basu discussed one unknown that even he did not take into account. He said, “I haven’t included support, both monetary and non-monetary, from a son, daughter or any other family member. Indian children do support their parents, so perhaps you won’t need to bother about that big healthcare cost. I haven’t taken this into account because it’s different for different people.”

The session was followed by an engaging Q&A session, which addressed topics such as property rates, rentals and reverse mortgage. The second part of the session, the date for which will soon be announced, will focus on how best to generate this retirement corpus.
 

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COMMENTS

Nem Chandra Singhal

4 years ago

Whatever is said by Mr. Basu was right. But the problem of avoidance of equity of Indian population is much bigger problem. Many people enter in equity market and exit it with losses and never return. They had loss of faith in equity. Something is to be done to strengthen the equity culture, which is regarded as a cashino in our country. Even the 24 X 7 news channels projects the equity market as a short term money making market. How can then long term investors believe the occasional saying to invest in equity. Thanks.
Nem Chandra Singhal

Nilesh KAMERKAR

4 years ago

The retirement planning problem is larger than it looks. Superb article Mr.Basu!




Nifty, Sensex, may be headed for a rally: Weekly Market Report

If Nifty closes above 5,690 it may target 5,825

 
The Indian market closed in the negative for second week in a row, this time on political developments and concerns about further rate cuts raised by Reserve Bank of India (RBI) in its mid-quarter policy review earlier this week. The European Central Bank’s (ECB) threat to cut off emergency funds to Cypriot banks, after 25th March, if the beleaguered nation is unable to fulfil the conditions for an EU bailout, also weighed on the domestic market, keeping it down for all the trading sessions in the week. Trading volume will be lower next week on account of trading holidays on Wednesday and Friday.
 
The Sensex plunged 692 points (3.56%) to close the week at 18,736 and the Nifty finished at 5,651, a cut of 221 points (3.77%). The market is headed for a rally. If Nifty closes above 5,690 it may target 5,825.
 
The market settled in the negative on Monday as cautiousness prevailed a day ahead of the RBI’s policy review. The market closed in the red on Tuesday as political concerns after the DMK’s withdrawal of support to the ruling UPA-led government at the Centre overshadowed the RBI’s 25 basis point repo rate cut.
 
The benchmarks settled lower on Wednesday as the political logjam in Delhi ignited worries about inflows from foreigners and a slowdown in growth. The indices pared their gains in late trade and settled lower on Thursday on weak global cues on the Cyprus bailout issue. Political worries continued to trouble the market on Friday, leading it lower for the sixth day in a row.
 
While the BSE Fast Moving Consumer Goods index ended flat, all other sectoral indices settled lower. BSE Realty (down 13%) and BSE PSU (down 8%) were the top losers.
 
ITC (up 1%) was the lone gainer on the Sensex this week when the market plunged over 3.5%. BHEL, Tata Steel (down 9% each), State Bank of India (down 8%), ONGC and Maruti Suzuki (down 7%) each were the main losers.
 
Lupin (up 3%) and ITC (up 1%) led the Nifty higher while Reliance Infrastructure (down 18%), DLF (down 15%), Jaiprakash Associates (down 14%), Tata Steel and BHEL (down 9% each) were the main laggards on the benchmark.
 
The Reserve Bank of India (RBI) in its mid-quarter policy review on Tuesday, cut the repo rate by 25 basis points (bps) to 7.50% but kept the cash reserve ratio (CRR) unchanged at 4%. The cut in the repo rate for the second time in 2013 is seen as an attempt to spur growth.
 
Also on Tuesday, the Dravida Munnetra Kazhagam (DMK), an ally of the United Progressive Alliance (UPA) government at the Centre, withdrew its support to the government following differences over the Sri Lankan Tamils issue. The move rattled the market for the entire week.
 
A pan-India undercover investigation by online magazine Cobrapost has accused HDFC Bank, ICICI Bank and Axis Bank of running a vast, nation-wide money laundering racket. Cobrapost, which conducted a sting operation across various branches of the banks, claimed that bank employees are readily accepting black money from customers to convert them into white money as a standard practice.
 
In international news, Cypriot lawmakers endorsed capital controls and legislation to wind down banks as they scrambled to secure a European bailout and avert a financial collapse of the debt-stricken nation. The country’s parliament passed nine bills late Friday, after a day locked in talks between Cypriot and international officials in Nicosia.

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