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| Capitalstars Investment Advisor |
Planning for retirement should ideally start the day you start working. Retirement is that stage of life when you don't have a steady flow of income coming in. Normally, a person retires after he/she has discharged all responsibilities and now looks forward to living peacefully for the rest of the days.
While discussing with your financial advisors about how much money you would need at the time of retirement, he will ask you some questions such as how much are your monthly expenses, what is the break-up of these monthly expenses?
While calculating the retirement corpus required by you, he will have to make some assumptions to arrive at the figure. But the question arises what role do these assumptions play? What will happen if these assumptions go wrong? How does one ensure that one stays on track on the way to building the targeted retirement corpus?
Importance of the assumptions
When your financial advisor calculates the targeted retirement corpus he assumes some of the numbers and some are actual numbers. For instance, calculation of how much your expenses will be by the time you retire is based on your actual current expenses and the assumed expected average inflation rate.
Inflation
The present monthly expenses of Rs 50,000 would cost approximately Rs 2.3 lakh after 20 years assuming average inflation of 8%.
Inflation, while measured as a number, is actually the difference between the amount we are paying right now to buy goods and services and the amount we used to pay for the same goods and services, say a year ago.
Any change in the inflation rate will directly affect your monthly household expenses at the time of your retirement and indirectly affect the corpus accumulated and post-retirement expenses.
Life Expectancy
The inflation rate is not the only important assumption that directly or indirectly affects your retirement corpus. Expected life expectancy also plays a crucial role. Taking life expectancy on the lower side may lead to a situation where you run out of money before you die.
Due to improved medical and health care facilities, a person is easily expected to live above 80 years. However, while planning for retirement one must also keep in mind the increase in medical expenses that will haunt old age.
The real rate of return
The rate of return earned on one's investments plays an important role in building the retirement corpus and also in the post-retirement period. In the pre-retirement period, a low rate of return earned will make the corpus grow at a slower pace which in turn will require additional savings to be made to accumulate the desired amount.
The nominal rate in simple terms can be said as the return which is mentioned on the bank fixed deposit.
When inflation is subtracted from the nominal interest rate, you get the real rate of return. It is the actual rate of return that you have earned on your investments.
Impact of taking a wrong assumption
Any mistake made while making assumptions for calculating the required corpus can have a detrimental effect on your retirement plans. In the worst-case scenario, you can run out of your retirement money at a later stage of life.
Illustration:
A person, aged 25, starts to save Rs. 5,000 per month. Assuming the average rate of return earned is 12% & compounding annually, he is expected to accumulate a corpus of Rs. 2.75 crore by the time he retires at 60 years of age.
How to stay on track?
Well everyone tries to avoid these kinds of situations where they outlive the retirement corpus accumulated by them or the retirement corpus accumulated by them is not enough to give the kind of lifestyle they want to sustain.
To avoid these dangerous situations, one must periodically review the financial goals with one's financial advisor. They should ask all kinds of questions about retirement planning from their financial advisors.
Similarly, while making an assumption for how much longer you will live, it is better to assume you will live long. It is a way to avoid the situation of running out of money in the retirement period.
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