Retirement Planning - Your reality Today! |
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There is one universal fear we all live in - no it is not the boogey man-but a fear that we will outlive our money! This is why we worry and plan for our retirement. Retirement planning is a bit like crystal ball gazing-it deals with unknowns in the realm of future! For the same reason, it is also possibly the most difficult planning to do. Ofcourse there are retirement fancy calculators, spread sheets offered by brokers and mutual funds to help you do so, but the main draw back in all these gadgets is the underlying assumptions-they have to be yours alone and cannot be generalized.
Your parents probably had a 20-year retirement and their great-grandparents, a 5-year retirement. But today personal finance experts urge a person considering retiring early, at age 55, to accumulate resources sufficient to last 30 years. They say that most people guess how much they should save for retirement by using "look around" method: they look around at how people older than themselves are doing--parents, neighbors, or colleagues--and take cues from their example. But the problem with this approach is that it works just fine in a stable environment but today's retirement world is very unstable. Inflation, real rate of return on savings and investments, medical expenses, etc. are all uncertain aspects today. For example the government's decision to reduce the PPF rate from12% to 11% has some far reaching effects on the retirement returns and planning of various people. Plus added to this dwindling rate of returns is the possibility of living longer.
In order to build the foundation of good assumptions a good starting point is ASSESS YOUR LIFE EXPECTANCY. How long are you likely to live? Unanswerable, of course, but important. A good indication could be the general life-expectancy figures revealed by the government (which may be outdated) or life expectancy tables published by Insurance companies. Generally accepted norm nowadays is that men who have reached 65 can expect to live another 15.9 years; women, 19. Family history and personal health should also be considered. The assumption that "I'll live to about the same age as my parents did." Is totally wrong. Great advancements have been made by science plus general living conditions have improved to give a longer life expectancy. People tend to underestimate their life expectancy. Also note that everyone runs very nearly a 50 percent "risk" of living longer than their life expectancy. A good rule of thumb might be to plan against the possibility that you will outlive three quarters of the people in your age group.
The next step after you have assessed how long you are going to live is to ASSESS YOUR NEEDS AFTER RETIREMENT. A general rule of the thumb is to assume that you will normally need 70 percent or 80 percent of current annual cash flow for your retired needs. Obviously things like the house and kids education and marriage will be out of the way, but the average cost of running a house plus the medical expenses will definitely be on the rise. A good projection of inflation is to base it on the past 10 years average inflation, and extrapolate it to see what your basic home running expenses will be. For example if you need Rs 30,000 to take care of all your household needs today then what will you need say 30 years from now. The sum may seem humungous and even bogus, but you can vary your inflation rate assumption by assuming two or three rates and working out what sum you would need. The cost of health care is more difficult to assume. But a safe assumption could be to take a rate higher than the assumed inflation rate, say by at least 3 percentage points above the general rate of inflation. But this is one area you definitely don't want to under estimate.
The next step brings you somewhat back to the present with an ASSESSMENT OF YOUR FUTURE EARNING YEARS AND EARNING CAPACITY AND SAVING TARGET. Estimating your future earning power is important when planning for retirement for two reasons. First, if you can count on substantial raises in the future, this will reduce the proportion of your income you need to save now to achieve a given standard of living in retirement. There is a second, more subtle truth to remember about raises: If your income keeps rising, you'll probably expect a higher standard of living in retirement, which will increase the total savings you'll need to accumulate. Many of today's affluent retirees, for example, would not be pleased if forced to return to the same standard of living they had at age 25.
Now what sort of raises should you expect over your remaining lifetime? Obviously it depends on your educational qualification and the general line of work you are in. Some fields like software, consultancy etc. pay higher than other like finance, marketing etc. But in estimating your own earnings prospects, beware of overgeneralizing from early successes. Assuming a career average of 1-3% percent real wage growth per years probably prudent for most people. Projecting how long you'll want to work, or how long you'll be able to, also depends on individual circumstances, but, again, caution is in order. You shouldn't assume you can work forever at the wages you think you deserve. Rapid technological change is likely to continue, rendering job skills that are lucrative today obsolete. For example the performance linked rewards and bonuses to fund managers etc. were huge in the last bull phase but many of them were out of a job in the next bear phase. So build in the industry scenario into your job.
Then it is time to make an educated ASSESSMENT ON YOUR REAL RATE OF RETURN ON INVESTMENTS. Here one of the most serious errors in recent years has been fostered by the stock market boom. People assume they are going to get 20 or 25 percent in the market because they have over the last few years, they remember the bull phase returns and not the bear phase erosions. "I'll make the same return on my savings in the future as I made in the past." is a very silly assumption to base your plan on. The rate of returns in bonds, fixed deposits, government securities are coming down, it is evident. As we align ourselves with the world, the rates will be lowered still further. So to assume that we will continue getting those artificially high rates of return which we could get in a closed economy seems to be suicidal. So assume one rate of return for the equity linked investments. This will obviously be higher than the return you are expecting for the debt or fixed income investments.
But don't become over cautious in your allocation and go whole hog for fixed income investments (bonds or other debt instruments). Because you have to continue looking for growth, so your nest egg can expand to modern longer lifespans. And that essentially means keeping a substantial part of your assets in stocks. A rough guideline for asset allocation: 120 minus your age equals the percentage of assets that should be in stocks; the rest can go into bonds. All these permutations combinations and assumptions will eventually lead to the nasty figure or rather range of nasty figures of how much you'll need for when you retire. Then assuming a rate of return you have to come to the big cut, of how much will you have to save today to spend tomorrow. With all the bills I have to pay, there is just no way I can afford to save more for retirement.
How much you can save today is a very subjective matter. You will be surprised how options such as cutting back on eating out, vacations, or movies, etc can increase room for more savings. And another very important factor is that review your investments and investment strategy every year. Retirement planning does not mean that the plan has to be reviewed at retirement alone. As is with all types of financial planning, even so with retirement planning-the sooner the better. Infact the first pay packet may be a good starting point. Remember the power of compounding-so keep a small amount away every month right from the beginning. Remember time is your ally. It irons out the volatility of the market, while compound growth multiplies your savings. Then, if your rate of withdrawal in retirement is equal to or below your rate of return, you will never run out of money.
Aru Srivastava