Retirement the golden phase of your life where all your responsibilities are over both personal and financial. You have all the time in the world to pursue your passion and chase your dreams. But the onset of retirement also marks a big financial change in an individuals life – a change in saving and spending pattern in the absence of a regular income stream. The main concerns of every retiree are:
Generating a regular income stream
Safety of corpus, i.e., capital protection
Meeting contingency needs, incl. medical emergency
Long term growth of the corpus
The last point is something which retirees do not get real about. Ask any retiree about growing his retirement corpus and he would state the obvious options fixed deposit, annuities and the various post office saving schemes. Interest rates of post office schemes are now linked to market rates and revised every quarter. Take the case of PPF whose rates remained static at 12 per cent from the 1986-2000 period. Now these are at a historic low of 8 per cent (revised in the September 2016 quarter) and may fall even further next year.
While most retirees naturally gravitate towards safer debt options, the fresh interest income is not enough to beat inflation. Also, each withdrawal reduces the income generating capacity of the retirement fund. Retirement is a long journey spanning 20-25 years, may be even more because of the increased life expectancy. The retirement fund is a finite amount and inflation is likely to eat into it and exhaust his savings faster than a retiree could imagine.
The only way he could manage the inflation risk is to allocate a portion of his retirement fund in growth assets like equities. The general perception about equity investing is that they are only for the young & working. A retiree should typically shun equities after 60 because of the volatile nature of the stock markets and park 100 per cent of his corpus in debt.
Here are 2 scenarios which would help a retiree understand that not investing in equities would actually be the biggest risk he would be taking.
Scenario 1:
Suppose an individual retires with a fund of Rs.1 crore. He invests all the money in fixed deposits. Assuming an interest rate of 8 per cent per annum, he would earn Rs.7 lakh every year post tax. Consider his annual expenses to be Rs.3.6 lakh, i.e., Rs.30,000 on a monthly basis. His interest earnings would be more than what he requires to meet his expenses. He utilises the income to the tune of what he requires to meet his annual expenses and the rest remains invested under fixed deposits.
As the years pass by, expenses would rise along with inflation. There will come a time when the interest income is not sufficient to meet the expenses. A retiree would have to dip into his capital to meet the rising costs. Gradually, the withdrawal amount from the invested corpus is bound to rise too. An inflation of 7 per cent per annum nearly doubles the expenses in about 10 years. A retiree is likely to fall short of the funds sooner than he could imagine.
Scenario 2:
Now, considering the above example, let us assume that a retiree divides his fund of Rs.1 crore into 2 parts for investment he allocates 70 per cent of his funds in fixed deposits (Rs.70 lakhs) and the balance 30 per cent (Rs.30 lakhs) in equities. He earns about Rs.5.6 lakhs as interest income, (about Rs.5 lakh post tax), more than his annual requirement. As expenses rise gradually over the years, income is bound to become insufficient to meet the rising expenditure.
By the time the funds in fixed deposit near depletion, the balance Rs.30 lakhs invested in equity mutual funds would have doubled to Rs.60 lakh assuming a 12 per cent compounded average annual return (at 12% – corpus nearly doubles in 6 years). He can partially redeem the equity corpus and park the proceeds in fixed deposits. This would provide sufficient income for requirement while the balance amount in equity continues to grow.
This is just a hypothetical simplistic example of explaining the perils of investing the entire retirement corpus in fixed deposits as against the calculated risk of allocating a portion in equities.
To conclude, managing retirement corpus and sustaining it till lifetime is a big challenge. One needs a proper investment strategy wherein a portion of the retirement savings can be invested in fixed income for sustenance. The balance can be invested in equities to allow it to grow in value and beat inflation. A professional financial advisor can be consulted to seek guidance on managing the retirement corpus.