As the length of retired life of a person is almost equal to his/her earning life, if not more, it is very important to realise early the need and importance of building retirement corpus and start investing.
Government employees, who joined their services till December 31, 2003, are privileged people as they will get inflation-adjusted pension during their retired life. However, other not so privileged individuals need to invest throughout their earning life to accumulate enough retirement corpus to maintain their standard of living after retirement.
As the length of retired life of a person is almost equal to his/her earning life, if not more, it is very important to realise early the need and importance of building retirement corpus and start investing for it as early as possible, preferably from the day of getting the first salary. This is because time is the most crucial factor to derive the power of compounding.
Once the importance of building the corpus is realised, the questions arise – where to invest and how much to invest?
Let’s take an example to explain. Mahesh, a salaried individual of 30 years of age wants to build his retirement corpus through his 30-year employment period, so that he may spend a peaceful 30-year retired life (taking into consideration life expectancy of 90 years) without any financial constraint. His current monthly expenditure is Rs 25,000. Assuming an inflation rate 5 per cent throughout his life span, he would need Rs 1,08,050 to buy same amount of goods and services in the first month after his retirement and the monthly expenditure would go up to Rs 4,66,980 at the end of his retired life.
Now, assuming a risk-free return of 7 per cent for senior citizens (taking into consideration current 6.5 per cent risk-free return for younger people), he would get an inflation adjusted real rate of return of 1.9 per cent during his retired life, with the assumption that he takes no risk on the capital invested after retirement.
For simplicity, income tax is ignored while calculating the retirement corpus.
So, at the real rate of return of 1.9 per cent, to spend 1,08,050 for 30 years, he would need a retirement corpus of around Rs 5,23,16,032, which he may invest at a risk-free rate of 7 per cent to get enough inflation-adjusted return every month for expenditure throughout his retired life to exhaust the corpus. However, if he wants return of the capital invested after his demise at the age of 90 years, he would need nearly Rs 10 crore retirement corpus.
Now let’s see, to accumulate Rs 5,23,16,032 during his service life of 30 years, how much he should save and invest at the beginning of each month in different investment options viz PPF, NPS and MF.
Public Provident Fund (PPF)
Assuming the current PPF interest rate of 8 per cent would continue throughout the accumulation period, he needs to invest around Rs 36,905 at the beginning of each month to accumulate the retirement courpus of Rs 5,23,16,032 in 30 years.
Now, the required monthly investment is not only more than this current monthly expenditure, but the yearly investment of Rs 4,42,860 is also not allowed in PPF in a financial year, as the current limit is Rs 1,50,000 per financial year only. So, he can’t accumulate the intended retirement corpus by investing in PPF.
National Pension System (NPS)
NPS funds are invested partly in equity and partly in debt instruments, generating around 10 per cent return (on the higher side), and assuming that the current rate would continue throughout the accumulation period, he needs to invest around Rs 25,161 in the beginning of each month during his 30-year service period.
In NPS also, he needs to invest an amount slightly more than his current expenditure, which may be difficult for him initially. But he may invest slightly lower amount initially and catch up by increasing the investment amount as his salary increases. His other financial goals, however, may be missed due to want of spare money to invest.
Mutual Fund (MF)
Although investments in equity MFs bear market risk in the short run, but equity is only investment that beats inflation comprehensively in long run and helps in building a large corpus. Assuming that equity MFs would generate a long-term compound annual growth rate (CAGR) of 12 per cent throughout the accumulation period, he needs to invest around Rs 16,981 at the beginning of every month.
So, it looks feasible for him to accumulate the retirement corpus and even funds for other financial goals, by investing in equity MFs.
If Mahesh relies on PPF only to avoid taking any risk, he would end up accumulating Rs 1,83,51,880 as retirement corpus in a accumulation period of 30 years and may end up compromising his standard of living after retirement or even end up in poverty.
So, while the aim should be to avoid taking unnecessary investment risks, but taking no risk would be the biggest risk especially to fulfill long-term financial goals like building retirement corpus.