This blog is based on a book titled. “The 100 year life” by Lynda Gratton and Andrew Scott (Lynda and Andrew are professors at London Business School). One of my close friends suggested that I must read this book given my huge interest in managing investments for Retirement. Though the book discusses several aspects of Retirement, I will focus on the key thoughts shared by the authors on “How to finance your retired life?”
I must add that this blog is not a book review. The idea is to provide a perspective on key questions that all of us ask about Retirement:
- How long are you expected to live? In other words, how many years should you plan for post retirement?
- What are the monthly expenses that you would need to lead a comfortable retired life?
- What returns should you budget from your investments?
- What are the common mistakes household make in retirement years?
- How long are you expected to live?
The authors argue that increasing life expectancy is the biggest challenge that we will have to deal with in the coming years. Refer chart below. 50% of the children born in 2007 in the west are likely to live beyond age 100.
From a financing perspective, most of us are interested in answering the questions – how long we should plan to work and how much should we plan to save?
- What is the likely monthly expenditure to maintain a comfortable lifestyle?
The authors suggest that 50% of your last drawn salary could be adequate for a comfortable lifestyle for rich on high net-worth households. Some of you may find this inadequate and hence may want to budget for more. You can use this as a number as a starting point for your retirement plan.
- What should be the long-term return expectations from your investment corpus post Retirement?
There are significant variations in returns on a year to year basis but in the long run, the developed markets have averaged a real return (Real Return: Nominal Return less inflation) of 3% per annum. This translates to about 7% p.a. to 9% p.a. in the Indian context (assuming inflation rate of 4% to 6% and equal weighted portfolio of debt and equity assets).
India has witnessed high inflation rates in the past two decades. This has resulted in higher rates of returns from the equity and debt markets. Over the past two to three decades, the equity markets (as represented by BSE Sensex) and debt markets have delivered returns of 15% p.a. and 9% p.a. respectively. As a result, a higher return has got ingrained into our expectations. It is unlikely that these returns would sustain in the coming years. Hence there is a need to tone down your expectation of future returns from your investment.
If you were to assume 7% p.a. as your investment returns on your overall portfolio and budget for some taxation, you can assume an investment return of 6% p.a. on post tax basis. This would mean that a corpus of Rs 1 crore would be required to generate an annual income of Rs 600,000 (approx. Rs 50,000 per month).
- What are the common mistakes households make in investing during the retirement years?
The first mistake most households make is being underinvested in equities. 20% of HNI households have zero allocation to equities. Second, even if they invested in equities, the portfolios are not adequately diversified with significant holdings in stocks of their employers. Thirdly if the portfolios are diversified, there is a home bias with little exposure to global markets. Fourthly, they tend to sell securities that are making money for them and hold to their losses. Lastly households have a status quo bias – in other words households tend to hold on to their investments and do not revisit their portfolios.
In conclusion, my recommendation from an Indian perspective would be:
1 The Retirement Plan should cover expenses till Age 90.
2 Be adequately diversified. The ideal portfolio would have components that provide for guaranteed and stable returns, growth potential and liquidity.
3 There is a need to have a meaningful allocation to equity during the retirement phase of life. It will be very difficult for households to build regular income through investments in risk free assets only. An equal allocation to equity and debt can be a good starting point for investment planning.
4 There is a need to tone down the investment return expectation to 7% p.a. to 9% p.a. on the overall portfolio (equal allocation to debt and equity). Please note that we are trying to budget an average return for a long period of time (20-30 years) Further, there would be variation in returns on a year to year basis.
