I have been sharing a lot of my thoughts on the subject of Retirement Finances. Of all the factors that we need to address, I believe that there are five factors that could really hurt, irrespective of the amount of wealth you may have generated. In this blog, I am sharing my views on the top five factors one needs to consider while planning your Retirement Finances.
Key Challenge 1: Estimating your expenses in Retirement
In my interaction with several people, I found that the No. 1 challenge for all is to estimate your monthly expenses during Retirement. The reason why this is a challenge is that you are unable to get a clear view of how you plan to spend your retirement days. Will you do more of leisure travel? Do you want to contribute to charity on a regular basis? If you cannot determine your lifestyle, how can you determine your expenses? Even if you managed to determine your lifestyle somewhat accurately, what about inflation? What is a good number to use as your inflation target? Then there I the biggest unknown of all, Medical Expenses?
There are many ways one can estimate these expenses, but here is something that might help to address this question. As a thumb rule, you can start by assuming you would be spending at least 75% of what you are spending currently. You can refine this number as you get some more clarity about what you plan to do during your retirement years. You can start by budgeting from scratch, it may seem a bit tedious initially but eventually you would be able to get a good feel of these numbers.
It is difficult to estimate inflation. But given our own economic history and what we have seen around the globe, you need to budget for a inflation rate of at least 5% per annum. Investment Returns are generally linked to inflation so what really matters is what return you can generate over and above the inflation rate. To that extent, it is not the end of the world if your inflation estimates are not in sync with reality.
Medical expenses are the toughest to budget for. I would recommend that you buy adequate amount of medical insurance and supplement for a similar amount by keeping aside certain investments that would be use only in case of medical emergencies. For example, if you were to set aside Rs 25 lacs in a debt fund, the fund would grow over time and you should plan to use this money if there is a serious medical emergency.
Key Challenge 2: Longevity
No one can predict how long you will live. But one thing that is certain is that with more awareness about medical issues and advances in medical technology, there is a silent longevity revolution that we are witnessing. 50% of the children born today in some of the western countries are likely to live upto the age of 107 years. Even in urban India, my belief is that many of us are going to live much longer than what we think. Ideally I would suggest that the least age that you should plan for is 90 years. You would not only need sound finances but you would also need a support network that would be vital. Investing is social ties could be equally important, if not more, than investing in financial and real assets. If you have any doubts about this, just check how long did your grandparents and great grandparents lived compared to your parents.
Key Challenge 3: Investment Returns
Any plan is as good as its assumptions. So the crucial question is that what investment returns should you budget in your Retirement years. As I reflect on this question, I realise that the generation that will be retiring in the next 5 years will have serious challenges overcoming their own investment biases. Most of the asset classes, if not all, have given phenomenal returns to investors. Real Estate, Gold, Equity or Fixed Income – it did not really matter where you invested, you would have experienced a very positive investment experience. A question that I ask almost everyone is what are your expectations from your investments over the next 5 to 10 years. The answer is invariably, “I expect a return of 15% p.a. in equities and 10% p.a. in debt.” If you build your Retirement plans around these expectations, I think you are in for an unpleasant surprise. In my opinion, Equities (basis large cap indices) are unlikely to deliver returns that would exceed 12% and debt is likely to be closer to 7%. I am not an expert at predicting these numbers, but would strongly recommend that you budget for a far lower return expectation than what we have experienced in the past.
Key Challenge 4: A skewed Investment Portfolio
If you are unable to construct a well diversified portfolio, you are likely to face some big challenges. Some investors become over conservative and would like to invest all their money in bank deposits. The returns from debt coupled with high taxation are a sure recipe for a below par investment experience. If you skew too much towards equities, volatility can pose tremendous challenges and you may end up eroding your wealth altogether. It is certainly advisable to build a portfolio with an adequate mix of debt and equity. I have observed that many Retirement Income Funds tend to have an allocation of about 70% in debt and 30% in equity. The answer clearly is in what you are comfortable with but allocation zero to equity is not a good idea!
The skew in portfolio can also happen if you have some investments that are too concentrated. You should be worried about the number “one”. If a single investment is 40% or 50% of your portfolio, you are running a huge risk! Ideally no single investment should be more than 5% of your portfolio. If you have investments have a sovereign guarantee, then perhaps you are ok to have a higher concentration risk but otherwise it is not a good idea!
Stay diversified in terms of asset classes and individual investments!
Key Challenge 5: Flexibility
Retirement is a long period. A lot of circumstances can change. Markets can be more volatile than what you think, inflation rates could go awry, tax laws could change, your own personal circumstances can be very different than what you imagined. Since it is impossible to predict, all you can do is build an investment plan that can be flexible. The question that you must ask is, “What does it take to liquidate my investments and reinvest it elsewhere? Is it possible to do so? Will it be expensive to do so? Will my spouse be able to make the necessary adjustments”. You must ensure that there is some degree of flexibility in your portfolio.
In summary, you need to devote a lot more time thinking about your Retirement Plans. You need a plan that not only meets your requirements but also has the flexibility that can help you address any challenges that you may experience during your retirement days.
I wish all of you a long, healthy, happy and financially sound Retirement Life.
1 thought on “What can derail your Retirement plans?”
Very good assessment of risks which may have to be faced in Retirement planning. It’s an eye opener and every one should think about it and take adequate steps to safeguard his interests. Very well explained. Thanks for sharing
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