Sunday, 23 July 2017

Art of managing retirement corpus...


Financial planning and the art of managing our post retirement corpus is a fascinating topic to me and I am going to dwell upon it in my today's blog.
Retirement is the act of  retiring or of leaving one's job, career or occupation permanently, usually because of age or early retirement because of critical illness and/or disability.  It's not an event but a long phase in your life that can last up to three to four decades  Your financial situation will certainly undergo a sea change when you retire. Your income is likely to fall and spending patterns often change as you grow older, for example you have paid all the loans etc which you might have taken for buying a house, child's education, child's marriage etc.
During those decades, your corpus will be subjected to inflation which, in turn, will adversely affect  the value of your savings. If your savings do not give you enough return, you are going to run out of them within your lifetime and left high and dry on the financial front .
But there are ways and means to prevent this from happening. It would have been of immense help if this would have been a subject of teaching in schools and colleges but it's not so as of now. You can take help of experts and experienced people in this field which is not difficult to find. Yours truly is one such person having lived and experienced my financial journey and now trying to help people.

The first part is to save enough during your working years and invest the savings wisely. 
Don't wait until after you have retired to deal with changes to your financial circumstances. Many of these changes can be estimated and prepared for in advance. By drawing up a budget for your expected income and spending as early as possible you will give yourself a much greater sense of control over your situation.
You can always revise your budget later to reflect any areas where your estimates were wrong.If your budget reveals a gap between your spending and your income, then you need to look for ways to increase your income, cut your spending, or both.
Your budget of income and spending might identify areas where you are spending more than you might have expected, and where you think you could easily spend less.

If you haven't retired yet, you might still have time in the last few years before retirement to boost your pension income by increasing your contributions by as much as you can afford. The option can be especially attractive if your employer will partly or fully match your extra contributions.
Another option might be to defer the date on which you start taking your pension income which can increase your income because your savings have longer to build up  and your pension will be payable for for a shorter period.
The second part is about deriving income from these savings after you have retired.
The basic requirement is self - evident: you should spend only that part of your investment returns that exceed the inflation rate. The single most important thing to understand is that you must reserve the real, inflation-adjusted value of your principal, and not just the nominal face value. So how do you do this ? One such instrument is equity backed mutual funds.
Let's take a simplified example. Suppose you retire today with  Rs. 2 crores as your retirement savings. You place it in a bank fixed deposit. A year later, it is worth Rs. 2.14 crores. So you have earned Rs. 14 lakhs, which you can spend. But there is a twist here. Assuming a realistic inflation rate of 5%, if you want to preserve the real value of your principal, you must leave Rs. 2.10 crore in the bank. That leaves Rs. 4 lakh that you can withdraw to spend over an year, which is Rs. 33333 a month which is surely not enough for a middle class person.
The interesting thing is that this calculation does not change even when interest rates rise because inflation and interest track each other quite closely. But very few people in middle class will have a retirement corpus of Rs. 2 crore. So it can be very will imagined what will be the plight of those who have a corpus of say, Rs. 1 crore or 50 lakhs or even less.
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Further, there have been periods of time when the fixed income interest rate has been below the inflation rate. Moreover, income tax has to be paid whether you realize the returns or not. There can be a situation when the interest rate barely exceeds the inflation rate and the income tax on the interest effectively reduces the value of the money.
The situation is quite different in equity linked mutual funds. Unlike deposits, they are high earning but volatile. In any given year, the returns could be high or low, but over 5 to 7 years or more, they comfortably exceed inflation by 6 to 7% or even more. The returns may fluctuate in individual years, and that's something which you have to put up with, but the threat of old age poverty does not exist. 
In such funds, one can comfortably withdraw 4% a year and still have a comfortable safety margin. On top of that, there is no income tax.
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 As long as the period of investment is greater than  one year, returns from equity funds are completely tax free. This means that to have a given monthly expenditure through equity funds, you need just half the investment that you would make in deposits. An additional advantage in this case is, no matter how high your savings and expenditure, it's all tax free.
People are gradually learning to appreciate  this idea and have started doing it.
They tend to be those who have used equity funds to their advantage as their savings vehicle anyway and are used to the idea of ignoring short term volatility in the interest of long term gains. However, the vast majority of Indian retirees are still wedded to  the mythical safety that deposits provide and end up facing tragic problems as they grow older.
Do you realize that there is no need for you to be one of them ?
What one should do in today's scenario ?
1. Take help of experts for your financial  planning
2. Save 30% of your earning right from day one
3. Start planning for your retirement the day you start earning
4. Remember it's not only you but also your spouse which you need to consider for planning
5. Do not plan to depend upon your children or anybody for that matter for your post retirement needs because they have their own needs and in most cases they will not be in a position to accommodate you even if they have the intention to do so
6. Follow 100 minus age allocation rule which is a rule of thumb developed over the years in the attempt to provide guidance for equity and debt allocation decisions.
a) Subtract your current age from 100 and  the resulting number is the percentage that you must allocate to equities and remaining to the debt asset class. This means that if your current age is 30 years, you should put in 70% in equities while 30% should go to debt.
b) As the age increases the allocation to equities keep declining, reducing volatility and risk of the portfolio.
c) This rule might be a good starting point, but it is not aligned with the financial goals which are the actual purpose of creating a financial portfolio and building a corpus.
7. Always have a diversified portfolio
8. And above all life insurance has to be the first instrument when you get your first pay cheque

Wishing you all lots of financial planning, real planning...
God bless !

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