Retirement, also known as “the golden years” is an interesting time. On the one hand, there is the relief of not having to worry about meeting work deadlines, which gives you the time to pursue other interests and hobbies. On the other hand, you no longer have a regular income, so you might be worried about your finances.
Luckily you can minimize if not completely eliminate post-retirement money worries. But only if you start planning for your retirement early and choose the correct investments for your retirement portfolio.
Traditionally, most Indians have invested in fixed return instruments such as Public Provident Fund, and Fixed Deposits to reach various financial goals. Unfortunately, even though these investments provide guaranteed returns and have almost zero risk, these features can no longer ensure that you will reach your retirement savings target. You will also need to invest in Equity-oriented investments to improve your chances for a financially secure retirement.
In this blog, we will discuss why Equity-oriented investments should be included in addition to fixed-return investments in your retirement savings portfolio. But first, let’s consider a key question – how much retirement savings will you actually need?
How Much Do You Need To Fund Your Retirement?
You might think that your expenses will decrease after you retire as you would have reached your long-term financial goals. It is true that some expenses such as loan payments, children’s education, etc. will not be there. However, other expenses such as healthcare costs will increase. In effect, your monthly expenses will probably not decrease much even after you retire.
In fact, due to inflation, your monthly expenses will increase significantly. To better understand how inflation will impact your post-retirement monthly expenses, let’s take an example.
Suppose 35-year-old Arun with a monthly salary of Rs. 90,000 and monthly expenses of Rs. 50,000 plans to retire at the age of 60 years i.e. 25 years from now.
Over the past decade, the inflation rate in India has been around 6% p.a. If we assume that the same trend will continue for the next 25 years, Arun’s post-retirement monthly expenses will increase to Rs. 2.15 lakh. So Arun will need Rs. 25.8 lakh every year post-retirement to just cover his monthly expenses and maintain his current lifestyle.
Now, to arrive at a target amount for your retirement savings, another aspect that needs to be considered is life expectancy, i.e, how many years you will live post-retirement. Over the years, due to medical breakthroughs, life expectancy has increased. But, the downside of living longer is that you need to have more retirement savings.
Now assuming post-retirement annual expenses of Rs. 25.8 lakh and a life expectancy of 25 years post-retirement, Arun will need savings of Rs. 6.45 crore.
Saving For Retirement: EPF Is The Default Debt Instrument
Most of us, knowingly or unknowingly, start saving from retirement the moment we get our first salary. This happens through the monthly contribution to the Employees Provident Fund (EPF). EPF is a government-backed fixed income investment and as per rule, a monthly contribution equivalent to 12% of your basic pay plus dearness allowance (DA) has to be made.
So, as a starting point, all of us have a part of our retirement savings going into a debt instrument. And it is a good thing. That’s because a good investment plan has a mix of different asset classes. However, the problem happens when you rely only on EPF or use debt for creating the remaining corpus. Let’s look at why by going back to Arun’s example.
As Arun’s monthly salary is Rs. 90,000, his basic plus dearness allowance would be around Rs. 50,000. So the maximum monthly EPF contribution that Arun can make is 12% of Rs. 50,000 i.e. Rs. 6000.
Now let’s assume that Arun’s salary increases on an average by 5% every year for the next 25 years and the interest rate he earns is the current rate of 8.5%. This is what Arun’s EPF balance will be when he retires at 60.
|Current Monthly Contribution (12% of Rs. 50,000).||Rs. 6,000|
|Average Annual Salary Increase||5%|
|EPF Interest Rate||8.5% p.a.|
|Investment Tenure||25 years|
|Total EPF Corpus at Retirement||Rs. 1.13 crore|
As you can see, Arun’s EPF contributions till retirement would allow him to accumulate Rs. 1.13 crore. That clearly is not enough. Sure, the salary might increase faster, but it is always a smart idea to be conservative with these estimates.
Equities: The Smarter Way To Build The Remaining Corpus
Like Arun, for most of us, EPF balance will not be enough. So, we will need to invest more if we wish to have a happy retirement. Now, there are two asset classes to invest that money. You can either go for debt instruments like FDs or you invest in equities through instruments like Mutual Funds.
To know why equities are a better option, let’s continue with Arun’s example and play out two scenarios.
Scenario 1: Arun Invests In A Mix Of Debt Instruments
Arun opts for guaranteed returns and chooses a mix of FDs and PPF to build the remaining corpus. At present, FD rates in India are 6% while the PPF rate is around 7%. Let’s assume for the entire period, we will get an average interest rate of 6.5%.
Here is how much we will need to invest every month.
|Amount Needed at Retirement||Rs. 5.32 crore|
|Average Annual Interest Rate||6.5%|
|Investment Tenure||25 years|
|Monthly Investment Required||Rs. 70,680|
So Arun will need to invest Rs. 70,680 per month for the next 25 years to reach his retirement savings. Considering that Arun’s monthly salary is currently Rs. 90,000, monthly investment in excess of Rs. 70,000 will be impossible.
Scenario 2: Arun opts for Equity Mutual Funds
It is true that, unlike fixed return instruments, Equity Mutual Funds do not provide guaranteed returns. However, over long periods of time, equities do beat fixed-income products like FDs.
In fact, over the last 15 years, the NIFTY 500 Index has provided returns between 12% and 20% returns 86% of the time if the investment was held for 20 years.
Assuming conservative average annual returns of 12% p.a. from Equity Mutual Funds, the below table shows the monthly Systematic Investment Plan (SIP) amount that Arun will need to reach his savings target:
|Retirement Savings Target||Rs. 5.32 crore|
|Average Annual Returns||12%|
|Investment Tenure||25 years|
|Monthly SIP Required||Rs. 28,040|
So, as you can see, if Arun chooses to invest in Equity Mutual Funds instead of fixed return instruments, the monthly investment amount needed comes down to Rs. 28,040. This number can come down further if he decides to increase the amount every year as his salary increases.
Now, you might have a significantly higher income, so you might feel that due to the assured returns of fixed deposits, it is safer to make larger monthly investments. In that case, just consider whether you would rather have some extra cash post-retirement by investing in Equity Mutual Funds or just have enough to maintain your current lifestyle after you retire.
Your retirement savings strategy portfolio must have Equity investments along with fixed-return investments to improve your chances of reaching your retirement savings goal. This way you can get the best of both worlds – potentially inflation-beating returns of Equity investments along with the guaranteed returns of fixed-return investments.
This content was originally published here.