Tuesday, 24 Oct 2017

Don't Forget To Factor in Inflation When Spending Retirement Corpus


Don't Forget To Factor in Inflation When Spending Retirement Corpus

My friend sees herself as a financially independent, recently retired person who deserves rest, recreation and absolute discretion to use her money as she wishes. After working for 35 years, she plans to have fun travelling the world, eating the food she loves, meeting friends and enjoying life, as she calls it. However, she worries if she would run out of money by doing all that?

That should easily be the most frequently asked question about retirement: How much money is enough? An accomplished retirement planner would be able to show the math in detail and showcase the impact of various factors on the adequacy of your retirement corpus. It is in the interest of the numerically inclined to carry out such an exercise, preferably well before retirement so that an adequate corpus is built.

But my friend does not care much for numbers. She looks at the freshly deposited provident fund benefit of Rs 35 lakh in her savings bank account, and a trip to Paris for Rs 4 lakh does not seem like a big deal. She argues that she deserves at least that much. I did not want to hurt my friend, but my assessment was that she did not have enough for the extravaganza she had in mind. It would be unwise to withdraw 10% of the corpus in year one.

A large lump sum can create a high sense of wellbeing. Not all of us can calculate future values or incorporate inflation into our thinking. We still think that the days of gold prices being Rs 1,000 per 10 gm were the good old days. We like to believe that the appreciation in the value of the house means we are better off and made a sound financial decision to buy it early. We buy insurance products paying premium over a long time, in exchange for a few lakhs so many years into the future, thinking that the money will amount to a lot.

My friend’s logic is simple. She would use some of the money to indulge herself now. While it is true that the future can be uncertain, it is also true that the present is all she has. Denying herself small pleasures with so much money in the bank is not a great idea. Then she will simply live off the interest income of the corpus for the rest of her life, without touching the principal. Simply tell me where to invest this money, and how to keep it safe, she says. In her mind, investing well should take care of everything.

There is only one enemy to fight in retirement: “INFLATION”. It is prudent to assume that one will live long and consider whether the money will be adequate over a 25-year time frame after retiring at 60. It is tough to make accurate forecasts, but it is fair to assume that there will be a positive rate of inflation. Even if it were 5% per annum, in 25 years my friend will need Rs 3.4 lakh for every one lakh today. She cringes at the math and asks for a thumb rule. I tell her that she should have  as corpus at least 15 times her expected annual needs now.

There are only three things to look for when checking the adequacy of the retirement corpus. How fast will the money grow? How much of it will be needed for use? And how will this need increase due to inflation? It is important for the rate of growth to be higher than inflation, and the amount needed for use to be in a low single digit of the corpus (not over 5%). So if she has a corpus of Rs 35 lakh, and if it grows at say 8%, while the inflation is at 6%, and if she draws about Rs 1.5 lakh from it to begin with, she should do fine.

There is no big charm in the “principal” being intact, if it is constant and therefore less and less valuable over the years. To invest is to enable its value to increase each year. And ideally, the amount drawn should be a smaller percentage of the corpus and since it will increase due to inflation, it should preferably grow at a lower rate than the investment return. Without increments to the corpus which comes from checks to spending, she will lose the fight to inflation.

My friend should have worked out how much she likes to draw, and created a corpus large enough so that a 5% withdrawal would be enough for her spending plans. But now that she has retired, she must cut the coat to the cloth. Drawing too much too early means, too little stays invested to protect her future. It is at this point that retired investors start becoming aggressive and reckless about their investment choices, pushing for high-risk high-return deposits with dubious companies, hoping that investment returns will make good the inadequacy of their corpus.

Spending the corpus early is a very common mistake in retirement. The other common ones are: choosing the wrong investment; financially supporting adult children; investing in ventures of friends and family; being house rich and cash poor; and retiring too soon. There is nothing wrong in wanting to travel the world or seeking some fun and recreation in life. It is just that these spends should be proportionate to the earnings, corpus and savings.

My friend is very disappointed with my conservative approach that asks her to limit her annual spend to Rs 1.5 lakh, something that will buy her a modest holiday that does not match her aspiration. But that is the problem with our money life. To enjoy life, travel the world and have the fun you deserve, you need to work hard first to get a job that pays you enough. Then you need to save enough and invest well to build a large corpus that you can access when you are ready to take long breaks. After a life of mediocre employment, below average savings, and lazy investment, it is tough for retirement to suddenly become grand and large. Everything needs to add up.

Much as my friend dislikes it, in the end it is all math, and it is not about a magical investment choice that will make it all happen. I chose not to be too harsh. But I did tell her that taking the slow train to the hills and trekking up in the pre-dawn moonlight to catch the glimpse of a remarkable sun rise is also a joy that retired life can provide. And it won’t cost the world either.

 (By Uma Shashikant, Chairperson, Centre for Investment Education and Learning. Views expressed are personal.)


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