Many young income-earners often overlook the importance of retirement planning. However, starting early can have a significant impact on their financial future. The following tips can help young individuals who want to take the first steps in their retirement planning journey.
Inflation and compounding: Beginning your retirement planning and investment journey at a young age allows you to stay ahead of inflation during your retirement years. Inflation erodes the purchasing power of money, so it is essential to ensure that your savings grow at a rate that keeps up with rising living costs.
Compounding is another powerful concept that can work wonders for your retirement savings. Contributions made early and consistently can generate substantial growth over time due to compounding. For example, a monthly SIP (systematic investment plan) of ₹20,000 for 25 years, yielding 12% annualized return, can give you a corpus of ₹3.76 crore as a retirement corpus. Post-retirement, it is important to earn returns which are inflation-adjusted.Thereafter, you can start withdrawing about ₹2.5 lakh as monthly income from your corpus for the next 20 years. This withdrawal can be increased by 5% every year to keep pace with inflation.
Starting small: Many young income-earners mistakenly believe that significant sums of money are required to start investing. However, the key is to develop a habit of regular and consistent savings and investments, regardless of the initial amount. Starting small is perfectly fine, as long as you are committed to contributing consistently. Over time, even small but regular contributions can accumulate into significant savings over the long-term.
Emergency fund: While retirement planning is crucial, it is equally important to have a safety net in the form of an emergency fund. Set aside about 10% of your income to build an emergency fund. This fund will help you navigate unexpected expenses or financial hardships without having to dip into your retirement savings prematurely. Having an emergency fund provides peace of mind and protects your long-term financial goals.
The right investments: If you are in your 20s to mid-30s, consider allocating 100% of your savings towards equity investments. Historically, equities have been the ideal asset class for long-term growth, consistently outperforming inflation. The average annual rolling return of the Sensex is 14%; factor in an inflation rate of 5%, and you will find that the real return on equity investments can be around 9%, effectively combating the impact of inflation. However, if you are starting later, a balanced portfolio consisting of 40:60 combination of debt and equity investments may be more suitable. This will, however, impact the retirement corpus since debt or fixed income will earn a lower real rate of return.
Assessing risk tolerance: Understanding your risk tolerance is crucial in designing an investment strategy that aligns with your financial goals. If you have a higher risk appetite, consider investing in multi-cap, mid-cap, and small-cap funds that offer the potential for greater returns. However, it is essential to diversify your investments to manage and mitigate risks effectively. Diversification helps balance potential gains and losses, reducing the overall volatility of your portfolio.
Balancing multiple goals: As a young individual, you may have various financial goals alongside retirement, such as purchasing a car, homeownership, marriage or your children’s education. It is important to integrate retirement planning with these goals and leverage the power of compounding to ensure you have sufficient funds for each objective.
Seeking professional help: Consider consulting certified financial planners as retirement planning can be complex. They can help you create a plan tailored to your specific needs and goals. They can assist with goal planning, provide investment advice and review your portfolio periodically. Their expertise will help to keep your retirement goals on track.
Retirement planning may not be a top priority for young income-earners, but starting early and making informed investment decisions can lay the foundation for a secure financial future.
Nisreen Mamaji is founder of MoneyWorks Financial Services.
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Updated: 22 Jun 2023, 10:23 PM IST