A guy I know wanted to retire when he was 25. He just didn’t have the money. If I get Rs1 crore, he said, then I’ll retire. Now, 30 years later, he’s still working and still not done with gathering the corpus he needs to retire. Anyway, he’s wiser and agrees that financial security and going to work need not be either/or. People can continue to work even if they are financially secure. But how much do we really need to save out of our incomes to know that we will hit retirement with enough to maintain our lifestyle for another 30 years? Every time I speak to a friend about buying a life cover, he tells me—the risk we have is not of dying too soon, but of living too long.
Vikram Prasad who tweets at @enigma_twit pointed me towards a story about economist Willaim Sharpe who calls retirement planning for people “the nastiest and hardest problem in finance”. You can read the story here. Nobel prize winning Sharpe (https://web.stanford.edu/~wfsharpe/) is well known for his work on the capital asset pricing model. The model calculates expected returns based on varied levels of risk and states that taking on more risk is necessary to earn a higher return. Forecasting what you will need in retirement is tough, says Sharpe, because there are just too many things that can change—how long you live, how long your partner lives, what the inflation, equity market, risk-free return rates will look like, how much would you actually want to consume when very old. He has launched a Retirement Income Scenario Matrices project, where he has uploaded his data, programmes, results and resources for other researches in this area to work on. You can see the site here: http://web.stanford.edu/~wfsharpe/RISMAT/. I’m glad to see finance finally trying to solve problems of people and not just the Wall Street.
Getting the right amount for retirement is a tough nut to crack. Targeting too much compromises on lifestyle today, and having too little is not something we want to think about. So how much is enough? While most of the western models look at a retirement corpus that will go to zero at age 90 or 99 (people will keep eating into the capital till they either die or run out of money), this will not work in India. From all the old people I know, the capital they have is sacrosanct. The last thing they will do is have a plan that draws down on the capital. The capital will be left as inheritance to the kids, along with the house and other assets. Given our own cultural background, how do we plan for our retirements? How do we know that we’re on track?
We’ve asked this question earlier and found that saving your age till about 40-45 works. This means that if you are 30 and you save about 30% of your post-tax income for the next 30 years, you will have enough. If you are 40, have not saved anything yet for retirement and you save 40% of your post-tax income, you are good. But at 50 if you have not a rupee in savings, then you need to save 80% of your post-tax income—you’ve left it too late. My assumptions are that your income grows at 10%, your spending grows at 6% a year, you consume 70% of your pre-retirement spend at age 61 and then this consumption expense grows at 6%. You definitely use an equity route to retirement corpus building and you use laddering (using a mix of fixed return and equity post retirement), assume inflation is at 6%, risk-free return is at 7% and you live till 99. I also assume that your EMIs (equated monthly instalments) and other goals are all on top of this saving. Remember, the spending is only growing at 6%, while saving is growing at 30% or more—so there is enough elbow room to target other goals in this model.
This model also gives plenty of elbow room for black swan events by overestimating the final corpus. Do remember that this is a rough rule of thumb. If you already have savings and assets, then you can save a bit less. You could save less in the early years towards retirement and ramp it up in your 50 plus years when your earnings are higher and spends are lower. Do factor in the EPF (Employees’ Provident Fund) contributions and the PPF (Public Provident Fund) investments you make in that 30% or 40% saving number.
The other question that worries us is this: how do I know that I have done enough for my retirement already? If the goal is to have enough at age 60, is there another rule of thumb that can help us map our progress as we age? Fidelity Investments has a retirement guideline out that maps the journey of the retirement corpus over the years. You can see it here. At age 40 you should have three times your annual income as your retirement corpus already. If you earn Rs15 lakh a year at age 40, you should have Rs45 lakh in your retirement corpus. At 50, you should have six times your annual income. If you do Rs40 lakh annual income at age 50, you should already have Rs2.4 crore in your corpus. At age 60, or at retirement, you should have eight times your annual salary. Earning a crore at 60, must have Rs8 crore as corpus. The Fidelity numbers assume a US scenario with social security and other benefits, but the multipliers roughly work out to a rule of thumb for India as well.
Remember that these are rough rules of the road; for your individual situation you have no recourse but to find a good financial planner.