Retirement Planning 101: Know your retirement corpus

Know your destination before starting your journey.

Retirement is your financial health which empowers you to move out of your pay-cheque to pay-cheque life cycle. Small and steady moves make great progress but not running behind the money in lure of highest returns.

Early 2018, I visited my home town. I realized that exuberance of equity markets can be seen in the remote towns of India as well. The financial education in the city is bare minimum specially for capital market linked products still people are going for products like ULIPs or MFs to some extent. Everyone is looking for exposure to equity markets in search of better returns. Very few of them understand the concept of Asset allocation or Risk-Return profile etc. We will try to channel this exuberance for equity in the right direction to benefit from it.

Since the knowledge of capital markets is limited, People think that diversification eliminates the risk of losing money. Let me say it loud and clear, DIVERSYFICATION DO NOT ELIMINATE THE RISK OF LOSING YOUR PRINCIPAL IN EQUITY MARKETS. Most of the questions I receive are like “Is it good diversification to generate maximum return if I opt for 2 large-cap funds/ 2 mid-cap and 1 small-cap fund?”. It is similar to the question “Is it ok to travel 2 hrs by plane/ 2 hrs by car and an hr of rail to achieve best travel time?”. Hope you understood that main problem in both questions is that destination or origination is not communicated. We know that equity is the relatively fastest route to grow your money like plane is to travel. Though you use planes to travel only long distances and not as intra-city transport. Retirement is one such destination which everyone of us has to reach and can be 10-20 years away from today, which means equity investments can be a better tool for us to save for our retirement years. In this article we will achieve 3 things; Calculate how much will be our expenses when we retire, how much corpus will we need to manage retirement expenses and how much should I save to build that corpus.

Retirement Expense:

The common error people make while planning for their retirement is understating their expenses. This happens due to 2 reasons; expecting the current expenses to fall significantly during retirement and misjudging the impact of Inflation. It is obvious to expect that retirement expenses will be lower than current as some of the expenses will go away e.g kid’s education/ clothing, Insurance Premiums etc.  Though they fail to imagine the incremental travel cost with more nuclear families and increasing health expenses. Also by the time we retire there are many changes in our lifestyle e.g instead of travelling by normal bus we prefer Volvo/ Instead of travelling by sleeper class we prefer AC tiers or Flights etc etc. This means the minimum expenses required should not be 70-80% of your current expenses.

Second is more mathematical in nature, adjusting for inflation looks too much of adjustment. I usually suggest a moderate inflation figure as per Indian market of 5-6% per year which means that cost of product will double in 12-15 years. Most of the people give the initial reaction that this is not correct. This is because we discard the gradual changes. For example: Wheat flour is expensive by just 3 Rs over last 3 years (18 Rs to 21 Rs per Kg) or for last 10 years the Glucose biscuit is increased by 1 Rs (5 Rs from 4 Rs). These are daily consumption items and when I calculate the inflation in these people are stunned as in both cases it comes out to be 5-6%.

Now we established that we should budget for 80% of current expenses, we should adjust for inflation for the remaining years before retirement to calculate the yearly expenses. We can use the following mini table for this purpose, the Columns with different inflation rate can be selected based on expectation and Rows indicates the number of year before retirement.

Factor for inflation adjustment		Inflation
		5.00%	6.00%	7.00%	8.00%
Years Before Retirement	5	1.276	1.338	1.403	1.469
	10	1.629	1.791	1.967	2.159
	15	2.079	2.397	2.759	3.172
	20	2.653	3.207	3.870	4.661
	25	3.386	4.292	5.427	6.848
	30	4.322	5.743	7.612	10.063
	35	5.516	7.686	10.677	14.785

Example to use the above table: Rohan is 25 years old and is planning to retire at age 50. He thinks that the inflation is going to be 6%. The factor he should pick is 2^nd column/ 5^th Row “4.292”. This means if his current annual expense is Rs 100,000 then at retirement his expense will be Rs 343,360 (4.292 x 100000 x 80%). Please note that this expense is for 1 year at start of your retirement and will continue to grow at a rate of inflation.

Calculate the Retirement Corpus

During your retirement years two changes are in motion. Your expenses, which will continue to increase at the rate of inflation, and your retirement corpus, which will earn some Interest/growth. If we have 100 Rs as retirement corpus and our annual expense is 20 Rs; Assuming no inflation or no growth of investments, we can have sufficient money for next 5 years. So as a rough estimate if your life expectancy is 90 years and you retire at 60, then 30* Annual expenses.

Though in reality, the retirement corpus as well as expenses will increase. If the return on investment is 10% and inflation is 5%; for year 1, you will take 20 for expense and 80 will stay invested which will grow to be 88 by year end. Similarly, for year 2 you will take 21 (20 + 5% inflation) for expense out of 88, which will leave 67 Rs to grow to 73.7 Rs. in the end you will be able to sustain for more than 5 years in retirement. Now what we need to do is back calculate the corpus which will suffice for retirement years. Below helps us achieve that:

Factor for retirement corpus: growth 8%		Inflation
		5.00%	6.00%	7.00%	8.00%
Years In Retirement	5	4.730	4.818	4.908	5.000
	10	8.838	9.207	9.593	10.000
	15	12.407	13.203	14.066	15.000
	20	15.507	16.843	18.335	20.000
	25	18.199	20.159	22.410	25.000
	30	20.538	23.178	26.300	30.000
	35	22.569	25.928	30.013	35.000
	40	24.334	28.433	33.557	40.000

Continue to above example, If Rohan expects to live till age of 90 years and still has same inflation expectation of 6%. His retirement corpus should be calculated by using last row/2^nd column factor “28.433”. Rohan’s retirement corpus should be Rs 97.62 lakhs (Rs 343,360 x 28.433).

Building the Retirement Corpus

Most of you will get the retirement corpus requirement closer to Rs 1cr to multiple Crores. The good news is that if time is on your side, it should not be a big deal. Below table can help you in calculating the monthly investment required to build your retirement corpus.

For every Rs 10 lakhs as retirement corpus		Investment Growth Rate
		6%	8.00%	10.00%	12.00%	14.00%
Years before retirement	5	14,332.80	13,609.73	12,913.71	12,244.45	11,601.58
	10	6,102.05	5,466.09	4,881.74	4,347.09	3,859.98
	15	3,438.57	2,889.85	2,412.72	2,001.68	1,650.75
	20	2,164.31	1,697.73	1,316.88	1,010.86	768.54
	25	1,443.01	1,051.50	753.67	532.24	370.94
	30	995.51	670.98	442.38	286.13	182.05
	35	701.90	435.94	263.39	155.50	90.07
	40	502.14	286.45	158.13	85.00	44.73

Now as per our example Rohan has 25 years before retirement, if he expects the return on his investments to be 10% year on year, he need to save Rs 753.67 (5^th row/ 3^rd column) per month for building a corpus of Rs 10 lakhs. This means for his retirement corpus or Rs 97.62 lakhs, he need to save Rs 7,357 (97.62 x 753.67 / 10) per month only.

Thanks for going through the lengthy article. Hope it helped to give you basic understanding of questions like what is your required retirement corpus/ Will you be able to comfortably accumulate it? Can you retire earlier than initially planned? Let me know in case of any questions.

Happy Investing!