The 3 main challenges in retirement planning and how to overcome them

Capitalstars Investment Advisor

The real problems in retirement planning are not about corpus. If we have an aggressive saving habit and have enough income to not touch it while working, we are all likely to retire with enough wealth.

Do I have enough money to retire? This is easily the most asked question in retirement planning. When I wrote about the need to take charge of your 40s, friends asked for a method to evaluate whether they have enough. Let’s consider some pointers. How much is enough is a tough question to answer. The easier approach is to look at the current spending levels and assume that the same lifestyle has to be maintained in retirement. If someone spends Rs 50,000 a month on an average, in current rupee terms, and if we assume that such a person will live 30 years into retirement, we can use a thumb rule to ask if they have a retirement corpus of Rs 50,000 x 12 x 30, or Rs 1.8 crore.

Purists will argue we have not considered inflation. We can counter-argue we have also not considered the growth in the corpus. Since we are not going to use up the Rs 1.8 crore in one shot, but use only a part of it, we would invest the rest and thus it will appreciate it. The Rs 100 we have saved today will grow in value if it is invested.

The real problems in retirement planning are not about corpus. If we have an aggressive saving habit and have enough income to not touch it while working, we are all likely to retire with enough wealth. In this day and age when most middle-class incomes leave behind a surplus for saving, building an adequate amount of wealth to be able to retire comfortably is not a challenge.

There are three primary challenges in retirement planning. The first is whether our corpus is invested well to grow aggressively in value. The second is whether our income needs in retirement are well thought through and provided for. The third is whether the amount we draw from the corpus and the amount we keep invested is well balanced.

Consider the retirement saving challenge. Many believe that the contribution to PF is a good way to save. The best thing about PF is the employer contribution. When our saving is matched by the employer, we have more money to work for us. However, the biggest pitfall of this investment choice is that it is a long-term investment meant to appreciate in value over time, but is mistakenly invested in income assets that generate a defined return.

This mismatch of objectives has not been adequately addressed due to misconceived notions about risk and diversification. Even the NPS has not been able to popularise the simple idea that an index fund invested in equity shares of the largest listed companies would have provided a better return on investment. This shortchanging of the longterm interests of the saver is unfortunate.

While we may not able to change the PF rules, we can apply the principles of diversification to the rest of our savings. A simple index fund or ETF —a Nifty-based or Sensexbased product—is the simplest, easiest and lowest cost route to building a default retirement corpus. There is no need to select a fund, monitor it, and chase returns. Simply investing in the index is adequate to build a decent retirement corpus that leverages the power of equity to enhance its value.

Second is the question of income needs in retirement. Many of us believe our retirement will mean a more frugal lifestyle. That may not be necessary, nor should it be the objective. We may have made specific plans to keep our expenses in check. Owning a house by the time one retires is a good plan to keep rents in check.

The mix of expenses will change in retirement: you might spend more on new interests; on travel and tourism; on health and medicare; on gifts and giveaways. It is not always easy to estimate these expenses, and some of them may be unexpected. Many of us are not used to severe budgeting and planning exercises and are rightly spooked about running short. The limit to our expenses is set by the third factor in that list.

The third element in retirement planning is the much-feared drawdown. What this means is the amount of the corpus we will actually end up spending in retirement. The simplistic assumption many make is that they will invest the corpus, and live on the interest it earns. That is harmful thinking in at least three ways: One, you leave the corpus unchanged in value, investing it to generate income for a long period of 30 years. Such a long-term asset should be invested better.

View your corpus as one large pool. You draw some of it—income or growth won’t matter—and you let the rest stay invested and grow in value. Your expense as a percentage of that corpus should be a small single-digit percentage. If your corpus is Rs 1 crore and your annual expense is Rs 6 lakh, you are drawing down 6%. That is quite a large number, and you may run out of it as you age. Keep that number small, at 3-4%.

That thumb rule at the start is based on this math: When you apply that simple rule of 30 times your spend as your corpus, ensure it is available to use as we just elaborated. If that wealth is locked in your house, you save on rent but earn no income. That won’t help. Hence that 30% rule: 30% of your money in the property you have anyway bought; 30% in equity for appreciation and inflation protection; 30% in income assets for your expenses and 10% as a buffer. Most of us should do well with these rules.