There is more to retirement planning than just buying a few retirement plans. Retirement planning requires number crunching more than one gives credit to it. A proper mathematical approach will not only help identify the retirement needs but also how to reach the target, how much to withdraw regularly without running out of capital, and so on.
Unfortunately, we have seen that, in most cases, an individual has not saved enough for his retirement.
It has been observed that an individual haphazardly approaches retirement planning by purchasing insurance schemes with retirement benefits or through some retirement plans. We focus too much on the off-the-shelf instruments, or one that is widely advertised, or a plan that has a big pension fund backing it, or one that claims to offer a very high yield without considering the risk behind such claims.
Steps in your retirement planning:
Monthly requirement: One of the most important points to consider in retirement planning is to have a rough idea of your financial requirement post retirement, without sacrificing too much of your standard of living. With that number, a guesstimate, in hand, one can approach retirement planning scientifically.
Capital requirement: The next task is how much corpus you need in order to receive a cash flow of that amount regularly. Here, math comes in handy. There is a rule of thumb when we talk of retirement planning, it is called the 4 percent rule.
The rule states that you can withdraw 4% of that total investment corpus during your first year of retirement. For subsequent years, you adjust the amount that is to be withdrawn by taking into account inflation. Following this rule gives a room of 30 years post retirement.
Remember, this is just a thumb rule and one can change the withdrawal rate as per their estimation. The rule highlights the thought process needed for retirement planning more than a mathematical formula.
Capital allocation: To reach the capital needed at the time of retirement, one needs to start saving from now. The capital that needs to be saved and the instrument that is to be selected so that the target is met require thorough planning.
There is slightly complex math involved here to calculate the optimal capital required and what returns will be ideal to meet your retirement goals. But one can use some standard rule of thumbs also to achieve the target.
The 15-15-15 rule or how to be a crorepati rule requires an investor to save Rs 15,000 every month for a duration of 15 years in an instrument that generates a 15 percent return. One can start an Rs 15,000 Systematic Investment Plan (SIP) of Rs 15,000 to meet this goal.
Other rules are to get an idea of the time taken to double, triple or quadruple your capital. The rule of 72 is used to calculate the time taken to double your capital. Dividing 72 by the expected returns or interest rate will tell you the time it will take to double your investment. Similarly, the rule of 114 requires you to divide 114 by the expected ROI gets you the time taken to triple your capital. To find the time to quadruple your capital, divide 144 by the returns.
The key here is in knowing the expected returns of the instruments and then using the output of the mathematical formula to select the instrument.
Points to ponder: A retirement planning portfolio is generally built with a focus on capital protection as well as returns. It is a mix of debt instruments and either direct equity or equity market linked instruments. The challenge is in selecting an ideal mix of the two instruments. Depending on the corpus available for saving, funds needed after retirement, and possible income streams, the mix is selected.
A factor that becomes important in retirement planning is taxes. Some of the instruments available attract taxes, while some are exempted. The planning has to be done taking into account these taxes, however, these may change as per the government’s rules.
Also as most debt schemes come with a fixed tenure, one would need to balance their cash flow requirement by selecting schemes based on their maturity duration also.
Another important factor that needs to be considered during retirement planning is withdrawals. Since some important events like children’s marriage may come post-retirement, one needs to plan for such lumpy withdrawals.
Needless to say, all retirement planning has to be on the back of strong medical insurance that will take care of any emergencies.
Retirement planning instruments: There various pension schemes, some sponsored by the government that are available in the market. One can use financial instruments like Pradhan Mantri Vaya Vanda Yojna, Senior Citizens Savings Scheme, RBI Floating Rate Bonds, Public Provident Fund, Kisan Vikas Patra, National Savings Certificate, National Savings Monthly Income Scheme, Bank Fixed Deposits and high rated corporate bonds and debt mutual funds. Balanced and equity schemes can be considered for capital appreciation.
Retirement planning, as the word suggests, requires a lot of planning and serious effort as with no or lower income during the golden years, the cash flow from the savings is all that will help sustain during this period.
(By Vikas Singhania, Director, TradeSmart)