Introduction
That’s quintessentially what most of us have been trying to get an answer for. Why is it so difficult to determine? Few moving pieces make it difficult to estimate expenses, inflation, returns and longevity. Let’s looks at each of these aspects one by one. Watch on
Expenses
First, one needs to bifurcate the expenses that they would incur during their post-retirement life into mandatory and discretionary expenses. Estimating the same would help them in getting a better idea about the corpus. Mandatory expenses are those which the individual or family cannot avoid whereas discretionary expenses are those which can be avoided if the need arises. This aspect could be managed to an extent by controlling own behaviour.
All I want is everything attitude does not augur well for those with limited resources and a long life ahead in retirement so prioritising expenses helps in increasing the life of retirement corpus. Also, saving a portion of income and that too regularly during the wealth accumulation phase of life helps in generating corpus which could help in meeting expenses during the wealth distribution phase.
Inflation
Second, inflation means that the value of money over a period goes down. For example, if today one could buy 1 unit of an item for say 100 ₹ and in 12 years the same unit of item costs 200 ₹ then the inflation during the same period was around 6%.
So, as you can see inflation is a silent killer and an individual or family must always account for it while planning for their financial goals be it retirement or any other goals. While inflation control is a thing that is better left to the government or central banks but an individual or family can control their consumption pattern to an extent to reduce the effect of it or by investing in assets that beat inflation over a period.
Returns
Third, as we know that value of money goes down with time due to inflation hence one needs to save now for their goals into assets so that with time these assets generate a return over and above inflation to achieve financial goals. These assets could be productive or non-productive. Productive assets are those which can generate cash flow. These include equity, real estate (if rental income could be generated) and fixed income instruments.
On the contrary, non-productive assets are those which do not have the potential to generate cash flow. For example, commodity as an asset class cannot generate cash flow and return on this asset class over a period depends on supply and demand scenario in future. So, one must invest in productive assets which have a comparatively better probability of beating inflation during the holding period.
Longevity
Finally, to put together the final piece of the puzzle one needs to plug in the number of years for which the corpus should last so that the individual or family can withdraw from it to meet its expenses during post-retirement life.
With the advancement of medical facilities, the longevity has increased which could mean for someone retiring at say 60 years that the corpus should last for another 30 years till the person is alive. Living a long and fulfilling life is the best thing one could look forward to and living post-retirement life with a worry about the adequacy of the corpus is not the way to go about it.
Risks
All said and done estimating expenses, inflation, returns, and longevity is just that – estimation so one should always account for few or all things going wrong. Hence, always plan for expenses, inflation, and longevity to be higher and returns to be lower than initially estimated that’s having a margin of safety. As the protagonist said in the Hollywood movie ‘21’,” In life, always account for variable change.”
So, let’s try to decode how much corpus would be required for someone retiring today with an annual withdrawal of say 12 Lacs ₹ with an average 1 % return above inflation for the next 25 years. One would require a corpus for 3 Cr ₹ but what if the annual expenses are 15 Lacs ₹ with an average 1 % return above inflation for the next 30 years then 4 Cr ₹.
As Carl Richards once said,” Risk is what’s left when you think you’ve thought of everything.” So, take estimates of corpus required for post-retirement needs with a lot of salt.
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