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How should I plan for my retirement?

One can never start planning too early for retirement.  Unfortunately most of us only start thinking about saving up for our golden years in our 50s or even later.  Whether saving for a child’s education (see article on planning for a child’s education) or your own retirement, the basic tenets for success remain – start early and invest regularly.  The sooner you begin, the more time your money will have to grow and the larger your nest egg will be (if all goes as planned!). 

Retirement can be expensive and none of us want to be in a position where we have to re-think  our spending habits in our old age.  Health care is likely to be  much more expensive. And you should also be able to enjoy your retirement. Travelling and seeing the world may figure in your plans now that you have much more free time on your hands. Again, this is a costly affair.  Also today, people live much longer than they ever did so planning well is critical. 

Provident Funds

You should assume that you will need at least ¾ of your final salary every year post retirement to maintain your lifestyle (perhaps more).  You may already be making contributions to your retirement corpus via an Employees Provident Fund and/or even a Public Provident Fund.  The returns you will get on your Provident Fund contributions are fixed and based on prevailing interest rates. Knowing that you will get your money back including a fixed return is certainly very reassuring. You can compare saving up for your retirement through the Provident Fund avenue with investing in debt securities, or putting your money into a fixed deposit. Whereas these are relatively safe instruments, the return you can expect to receive is also limited.

Consider investing in equities

In case your investment horizon (the time until you retire) is relatively long (at least 5 years), you should definitely consider investing in equities as well.   One of the primary reasons for this is that stocks usually act as an excellent hedge against inflation. Your rate of return from equities is likely to beat inflation while this may not be the case with debt investments.  The reason is simple: investments into companies via the stock market are claims on real assets, such as land, plant and equipment, which appreciate in value as overall prices increase.  History also supports this outcome - over extended periods of time, returns from stock markets have been shown to be greater than the rate of inflation.  For you this means that your “purchasing power” during retirement (i.e. the number of goods or services you will be able to buy for the same amount of money, adjusted for inflation) will be greater.

Mix it up!

Diversification is key – don’t put all your eggs in one basket.  If you have already started investing during your working years and therefore have a long term view, equities are likely to provide you the best returns and therefore mutual funds, managed by seasoned professionals, are a great option.  At this early stage you also have the capacity to take greater risk, enabling you to earn a potentially higher return.  In this scenario where you have begun early, you will also be well placed to change your investment mix depending on your current financial circumstances and how your various investments are faring.

Decrease your investment risk when you approach retirement

Everyone’s financial situation and circumstances are unique.  However, to be on the safe side, as retirement approaches, it would be prudent to reduce investment risks.  More often than not, this means reducing your exposure to equities since markets are unpredictable and an economic climate that is not conducive to growth  (for example, global turmoil or domestic policies that hamper growth) could have a negative impact on the performance of your equity investments.  These funds can then be moved into different forms of debt which will provide a more stable, guaranteed income at a time when you may need it most.

How you should plan your retirement.

Think about what your retirement expenses are likely to be and plan backwards.  Do your best to pay off any debt you may have accrued before retirement as it will eat into your savings.  The sooner you start investing, the more likely you are to beat inflation and benefit from the power of compounding which is the best way to accumulate wealth. 

For example, if you start saving at 30, you will have 30 years to build your retirement fund. At 30, Rs 10,000 invested every month will grow to a sizeable Rs. 2.1 crores (assuming a 10 per cent compounded annual growth rate) by the time you are 60. By comparison, if you start at 40, you will have just Rs. 73 lakhs at retirement. A delay of 10 years more than halves the corpus.

An early start enables you to put a large chunk of your investments into equities which will most likely provide you the best returns and therefore increase the purchasing power of your nest egg.  Many of us, especially when it comes to retirement, make the mistake of investing too heavily in debt too early and therefore run the risk of allowing inflation to erode the purchasing power of our interest payments.

Saving and investing are rewarding habits.  Remember, it’s never too late or too early to start investing!

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Mutual fund investments are subject to market risks, read all scheme related documents carefully.