Retirement Planning (Part 2) – How to Plan for Retirement?
Check Part 1: Why Retirement Planning is important?
Ramesh: Hey Suresh, Good Morning !!!
Suresh: Hi Ramesh, Good Morning to you too!! So, you are here, let us continue our discussion.
Ramesh: Yes please, this whole time I have been feeling like Jon Snow from Game of Thrones, like I know nothing about retirement planning.
Suresh: Ha ha, do not worry my dear, soon you will be like Tyrion as we drink (coffee) and we know things (about Retirement).
Ramesh: I would very much love that, so you were going to tell me how much do I need to save and how to do it.
Suresh: Yes, so as we discussed, if you want to have monthly expenses equivalent to today’s Rs 1 lakh on Retirement at 55 yrs of age, then at that time, considering inflation at 7%, the expenses will be 5.4 lakh per month. So, for next 25 years (assuming life expectancy of 80 yrs) you need approx 65 lakh every year for the expenses.
Ramesh: Wait a minute, will I not need increased amount every year, due to inflation.
Suresh: Good catch, now you are getting the hang of it. Yes, you are absolutely right; the amount required each year will increase. But to simplify things, let us say that the corpus you would have accumulated by your retirement will earn same interest as the inflation, say both Inflation and Interest Rate will be 7%. Hence, the amount each year required will remain the same.
Now the amount you need at your retirement to live a good life till age of 80 years is 25 times your yearly requirement, which comes out to be 25*65 lakhs, i.e. 16.28 Cr approx.
Ramesh: 16.28 Cr, isn’t that too much?? How will I be able to accumulate this much??
Suresh: Do not worry; we will get to that also. There are several ways to plan. First let us see how much do you need to save monthly to achieve 16.28 Cr corpus at age 55 yrs. You know about mutual funds, am I right?
Ramesh: Yes, I know, I have been planning to invest in them too; I have heard that they give 18%-20% returns.
Suresh: Good that you know about mutual funds and are planning to invest in them. Indeed some mutual funds, the equity ones, have given stellar returns in past few years; also some have given very good returns, similar to what you mentioned, over long term, which is 15-20 years.
However, past returns are not a guarantee that in future returns will be same, though equities tend to give very good returns in long term, but for our calculations, we will be conservative and use 12% returns Year on Year on the investments. Better safe than sorry.
Ramesh: Oh, ok. So, how much do I need to save if I assume 12% return?
Suresh: Well, according to the calculations, you would need to save around 12.21 lakh per year, i.e. 1.02 lakh per month.
Ramesh: Holy mother of dragons!!! How can I save this much, isn’t this a lot? I thought after my PPF investments and Provident fund deductions I would need a small amount more for my SIP for the Retirement.
Suersh: I can understand your feelings, when I did my calculations first time, I was as much shocked but this is the reality. However, there are few strategies which you can use, so that you can easily manage to create a corpus for your Happy Retirement.
Ramesh: I am very much eager to know that, but first I need a glass of cold water please.
Suresh: Ha ha, ok I will get it for you.
Ramesh: (after having 2 glasses of water): Yes, now please tell me, and keep that water bottle here only, who knows when I might need that again.
Suresh: Ok, so first thing that you can do is delay your retirement by 5 years, that way you will need to save monthly Rs. 63,000 to save for your retirement corpus enough to spend equivalent of today’s Rs. 1 lakh till the age of 80 yrs.
Ramesh: Hmm, though the amount is lesser now, it still is out of my reach to save this much monthly.
Suresh: Ok, then, if you delay your Retirement by 5 years and also decrease the monthly expense to equivalent of today’s 80,000, then you need to save around 50 thousand per month.
Ramesh: Oh, still I do not think I will be able to manage this.
Suresh: No problem, let us go back to your original requirement, i.e. to Retire at 55 years of age with expenses equivalent of today’s 1 lakh Rs.
Ramesh: But what is the use.
Suresh: You will see. Can you manage to save Rs. 20000 per month?
Ramesh: Hmm, that much I think I can.
Suresh: Good, what if you start today by investing Rs 20k per month and increase that by 10% every year, till your retirement.
Ramesh: Hmm, what do you exactly mean?
Suresh: I am saying that, invest 20k each month this year in an equity mutual fund and next year invest 22k each month, the year next to that invest 24.2k each month, i.e. a 10% increase every year. With increase in salary, you should be able to do this.
Ramesh: Yes, I think I can do that. Will this help.
Suresh: If you follow this strategy, then you will be able to save 14.6 Crs by the age of 55 years, keeping in mind the Rate or Returns as 12%. And if you start with monthly investment of Rs. 22,500 then you will be able to reach surpass your retirement corpus requirement and will have around 16.42 Cr. The final corpus might vary if rate of returns varies, but I think at 12%, we have kept it quite safe. However, be ready for surprises.
Ramesh: Well, the surprise that I got today was not less than a shock for me, thank you for enlightening me. But how come the amount required which was almost 1 lakh came to 22.5K only.
Suresh: That is the combination of power of compounding. At one hand your returns will get compounded and on the other hand your savings are also increasing due to the compounding effect of increasing them each year. However, you need to keep earning more each year to be able to save more. Also, keep expenses in check, when you get an increment, first increase your savings, then think of increasing your expenses.
Ramesh: Sure, I will try to do that and make full use of the magic of compounding. I am very happy that we discussed all this, thanks a lot to you for explaining it to me.
Suresh: You are always welcome.
Ramesh: But what about my Provident Fund and PPF?
Suresh: See, these are debt instruments, and debt instruments give proper cushion to your investments from market volatility. You should maintain a healthy mix of debt and equity in your portfolio, so for now you may invest around 20% in Debt instruments and 80% in equity. Keep increasing debt portion as goal comes near. You can opt for Debt mutual funds too apart from PF & PPF.
Ramesh: Hmm. Ok, will try to do that and if I need any help, will come back to you.
Suresh: Sure, anytime. Now let us have lunch and discuss some Game of Thrones theories. Who do you think will die in next episode???
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