Importance of Starting Your Retirement Planning Early

Planning is something that we do to ensure that any step we take ends up in success. As the famous quotation of Benjamin Franklin, “If you fail to plan, you are planning to fail” which holds so true even after so many years!

What is Retirement?

Retirement is a phase of our life when we take a break from active employment and reap the sweet fruits of our savings. This is perhaps the reason why they call retirement the golden years of our lives.

Retirement is often considered golden because all you do is relax and enjoy life without having to worry about the daily stress of working life. All said, your retirement can only be golden only if you plan well in advance for that. Expecting to enjoy a comfortable retirement life when you have no savings to provide for your day-to-day expenses is like asking and expecting your plants to flower when you don’t water them.

Retirement planning is a very important aspect of everyone’s life and having an optimum corpus or a steady flow of income is the only way to meet the expenses post-retirement. In the absence of a retirement corpus in place, surviving your retired days is a feat. You would have to depend on your children and let’s face it, given the modern lifestyle; you are very likely to end up in an old age home. Is this what retirement means to you?

When to start planning for Retirement?

So now when we have established the importance of retirement planning, knowing when to start planning is the second step. There is no scientific formula to determine the age from which you should start retirement planning but the crux is – the earlier you start the better it is.

Most people start planning for retirement only when they are almost 40 years old. The research team of Aegon developed the AEGON Retirement Readiness Index (ARRI) to better assess how well employees view their level of retirement preparedness. The India Index score of 7 is the highest of all 15 countries surveyed. This means that an ‘average’ or ‘typical’ Indian with online access has only a ‘medium’ level of retirement preparedness. 49% of the Indian employees surveyed, claim to be habitually saving, compared with 38% of the global sample. So even though the Marginal Propensity to Save in India is one of the highest in the world, Indians are not attuned to plan for their retirements from an early age yet!

The majority of workers (80%) have a retirement plan, however only 18% claim to have a plan that is written down. One-sixth (18%) do not have any plan at all.

‘The early bird catches the worm,’ and this saying holds true even in the aspect of retirement planning. The earlier you plan for your retirement corpus, the better you will be placed to enjoy your older age. But don’t go by my word only. I would give you two strong reasons why planning early is ideal. So read on –

• Compounding – the superhero

We studied Compound Interest when we were in school and even though most of us hated mathematics, this compounding factor is a superhero when it comes to our investments and the returns they yield. Compounding is a reinvestment technique wherein the interest earned is reinvested with the principal to earn further interest. As such, the resulting corpus becomes substantial. If you paid even a little attention in school, you know that compounding works best over a long-term horizon. Investments held for a longer tenure turn into a huge corpus by virtue of the superhero called compounding. Let’s understand by an illustration.

Suppose Tarun and Varun, close friends aged 30, work in a similar company at similar positions. Tarun starts investing towards a retirement fund immediately while Varun delays investments till he reaches 40 years of age. Assuming a 12% rate of return (say, they invested in a good Mutual Fund SIP plan) and a monthly contribution of Rs. 10, 000 by both of them, the corpus Tarun accumulates by the time he reaches 65 years is Rs. 3.53 Crores, while Varun manages to accumulate only Rs. 99.91 Lacs!

Though Varun delayed his investments for only 10 years, the difference between their corpuses is almost thrice!

*Rate of Return is assumed to be 12% per annum

The above example also shows that even If Varun did a monthly contribution of Rs 30,000 per month as well, i.e. thrice the amount of Tarun, even then he would not be able to match upto the corpus of that of Tarun.

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• Inflation – the super villain

We also studied economics in high school so we are aware of the real value of money. For those of you who didn’t bother understanding the subject, the real value of money is the value of money after adjusting for the underlying inflation. Inflation is a trend which is inevitable and which eats into the real value of money so that a similar amount of money loses its value a decade or two later when the economy is at an inflated state. When juxtaposed with your retirement planning suffice it to say that the expenses you incur today would be peanuts when you face the expenses you would incur when you retire two or three decades later. As such, planning and investing early and utilizing the super-power of compounding is the only way to build up a corpus sufficient enough to provide for your expenses after you retire.

To deliver a clearer picture let us understand this through an example–

Again let us take Tarun and Varun’s example. Tarun is 30 years old and his monthly expenses today are about Rs.30, 000. 30 years down the line, at a conservative inflation rate of 4% per annum, the same Rs. 30, 000 which is sufficient to cover Tarun’s monthly expenses today would fall short by a huge margin. At that time, Tarun would require about Rs. 97,302 to cover the same expenses, about thrice as much as he requires today. Today Tarun has earning potential and is drawing an income but what after his retirement? How would Tarun meet such huge costs when he will have no source of income post retirement?

Varun’s lifestyle is different and his monthly expense is around Rs 40,000 now. Thus, even in slight change in lifestyle you will need to save much more and in this case Varun’s monthly expenses will be around Rs. 129,736 compared to Tarun’s Rs. 97,302 after 30 years!

To calculate future value of your current expense, check this https://www.advisorkhoj.com/tools-and-calculators/future-value-calculator

This dilemma can be solved by investing early to receive a substantial corpus when you retire so that your compounded investments (superheroes) are equipped to face your inflated expenses (the supervillain).

Inflation in India:

According to Wikipedia, “The annualised inflation rate in India is 3.78% as of August 2015, as per the Indian Ministry of Statistics and Programme Implementation. This represents a modest reduction from the previous annual figure of 9.6% for June 2011.”

The India Inflation rate as of end March 2016 is 4.83%. Since the inflation in India is decreasing, we have taken the rate as 4% - Source: http://www.tradingeconomics.com/india/inflation-cpi . However, the above inflation pertains to Consumer prices known as CPI (Consumer price Index) which represents the most important categories such as, Food and Beverages, Housing, Transport and Communication, Fuel and light, clothing etc. However, the child education and health inflation in India is still sky high and hence a ballpark figure of 4% may not be the correct example. However, post retirement planning for child Education would not be required and we have also presumed that Tarun and Varun must have taken care of their health and medical expenses.

What should be your mantra for planning your retirement?

I explained why planning early is quintessential. Now let me tell you what you should do –

1. Start investing today

   - if you already wasted your earlier years, don’t wait. Start investing today. Your corpus would be lower than the one you would have accumulated had you started early but better late than never. For those of you who are still in their 20s, no time is better than the present. You can avoid the mistakes your father did. Start small, but start nevertheless. You can increase your contribution gradually as your income increases but don’t procrastinate.

Example – We have seen above that Varun started saving at the age of 30 and accumulated a corpus of 3.53 Crores in 30 years by investing Rs 10,000 per month through SIP for 30 years. Let us see, what happens if he starts saving early at the age of 25? His total corpus from the same investment would fetch him Rs 6.50 Crores! A whopping increase by Rs 3 Crores by just starting 5 years earlier!

2. Opt for Equity Mutual Fund SIPs

   - Equity Mutual Funds are the best solution for building a good corpus as it is the only product which can provide for an Inflation Adjusted Retirement Corpus. A systematic investment in equity mutual funds should address the concern for the long term retirement planning. These plans require monthly contributions which can be started with investing as small as Rs. 500 per month. These schemes are easy, provide good returns and instill the habit of savings regularly.

Equity Mutual Funds are tax efficient too! The long term capital gains from equity mutual funds are totally tax free. Also, Historically Mutual funds have given far superior return than PPF and Fixed Deposits. Please read this – Retirement Planning through Mutual Fund Systematic Investment Plan

3. Don’t consider your contributions an expense

   - having the right attitude to investment is as important as choosing the right investment plan. Consider your SIPs to be an investment which would give birth to a superhero (the compounded returns). Do not consider them to be an expense as it would demotivate your saving habit and factor adversely on your retirement planning.

4. Sit back and enjoy

   - if you build a habit of investing in SIPs, resist the urge to withdraw. Think of it as your retirement corpus and invest into it. Sit back and watch your investments grow with the power of compounding. And finally, enjoy your retirement, you ought to!

Conclusion

We have discussed how planning for Retirement is the most important aspect of your financial planning. Knowing two things makes all the difference – Future value of your current expenses and how to create an adequate corpus by starting investing early with a small amount. The other important aspect is to allocate your investments toward equity oriented savings to get tax efficient and superior returns than conventional saving scheme. Since Retirement Planning is the most important aspect of your financial life, taking a help and planning the same through a financial planner is the best way to go about it.