When the Chandrayan-2 lander crash-landed on the moon’s surface in 2019, ISRO scientists had their task cut out—to make Chandrayan-3 a success. They achieved this in 2023 when it landed successfully. However, we don’t always get a second chance, and we need to get it right the first time, especially when it comes to retirement planning. Because one might not be able to resume work in their retirement years, and by then, it might be too late to recover from the perils of a low retirement corpus.
The essential factors to consider while planning for retirement corpus are retirement expenses adjusted for inflation, expected returns, and life expectancy. So, to avoid running out of money in retirement, one is advised to follow conservatism, a term borrowed from accounting principles which factors in worse-case scenarios. Using this principle when one is planning for retirement, they should factor in experiencing higher inflation, lower returns, and higher life expectancy. That way one could avoid running out of money during the retirement years.
Inflation is a hidden tax that erodes the value of our savings, and it’s almost impossible to estimate. So, how much inflation should one consider while planning for retirement? Every individual or family’s consumption basket could differ from others’, and hence, the level of inflation they face might vary from the general inflation in the economy.
As an academic exercise, if one wishes, they can break down their expenses into consumption items and estimate the future inflation for each by observing past trends. However, by all measures, this method would be precisely wrong because, as individuals age, their consumption basket is likely to change. Being roughly right involves considering the inflation targeted by the central bank (RBI, in our case) to maintain stability. In the case of India, this target is between 2% and 6%. To plan for a worst-case scenario, it’s advisable to take a further step and plan with 7% inflation.
Now, turning to the estimation of returns from different asset classes, relying on past returns to predict future returns would be futile, as past performance may not persist. Consider an asset allocation, such as an equal distribution between equity and debt, with an expected return of 12% from equity and 8% from debt; the weighted average expected return would be 10%.
But one could again be precisely wrong since maintaining the equity allocation at this level throughout their lifetime might be challenging. Also, returns could be lower than the expected return. As our economy grows, it might slow down, as observed in the case of developed economies, and consequently, returns from equity and debt could be lower. Here as well, one would be roughly right by planning with an expected return of 9% instead of 10%
Finally, according to a government of India report, life expectancy at birth in the country is increasing and was already at 69 years in 2013-17, up from 49 in 1970-75. Again, it is not advisable to solely rely on past data and plan for, let’s say, 15 years in retirement when one turns 60. It would be prudent to plan with a life expectancy of 85 years or beyond instead of 75 years.
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Where do we go from here?
To sum it all up, let’s consider what it would mean for a couple in their 30s, bringing in a post-tax income of, let’s say, ₹2.5 lakh per month and spending ₹1.5 lakh per month. They are planning for their retirement with monthly savings of ₹1 lakh per month over the next 30 years. When planning for a monthly expense of ₹1.5 lakh with 6% inflation, 10% expected return, and a life expectancy of 75 years, a couple would require a corpus of around ₹14.5 crore. Now, let’s bring a conservative lens into play and plan retirement with 7% inflation, 9% expected return, and a life expectancy of 85 years. In this scenario, the required retirement corpus would be around ₹26.9 crore.
However, saving ₹1 lakh per month would not be sufficient for the couple to reach the required retirement corpus. Therefore, they need to either significantly cut down their expenses or increase their monthly savings as their income grows over the next 30 years. This proactive approach ensures they don’t run out of money in retirement. So, take a reality check and consider the facts while planning for retirement if you prefer to be roughly right rather than precisely wrong. What steps are you going to take?
Abhishek Kumar is a registered investment adviser and founder of Sahaj Money.
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Updated: 15 Nov 2023, 10:59 PM IST