Retirement planning is one of the most important life goals for any family. Unfortunately, in our country, most people do not take retirement planning very seriously until it is too late. In the absence of a sufficiently large retirement corpus and lack of adequate financial support from children, many senior citizens face financial stress when confronted with problems like declining interest rates and inflation (in particular, skyrocketing healthcare related expenses).
It is human nature that short term aspirations get far more importance than long term goals. For example, quest for rapid economic prosperity led nations to indiscriminate industrialization, without considering the long term consequences it would have on our environment and the health of our future generations; with our cities choking with pollution and ecology under threat, we are now facing the consequences.
The same applies to personal financial management, especially among young people. Short term gratification or desires are often given much more importance than longer term goals. In behavioral economics, the difference in attitudes towards short term and long term objectives is known as short term bias. Young people may think that there is always enough time to meet their long term goals. In reality though, they are likely to face the same or even more problems, which the current generation of senior citizens are facings. Young people, especially the millennial, are the future of our country. Technological advancements have created numerous opportunities for young people, but is there something below the surface?
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A survey done by Morningstar shows that there are a lot of misconceptions regarding the millennial segment of our population. The millennial segment of the population refers to people who were born around 30 years back or later, in other words, young people who are aged around 30 or below. The common perception is that millennial are very confident. The survey found that even though millennial had lofty ambitions compared to previous generations, they were not very confident about their financial futures. Another common perception is that millennial are extremely tech savvy and more knowledgeable than previous generations. In the survey, millennial acknowledged that they had limited knowledge about the financial services industry.
Another perception is that millennial are natural self-achievers. It is true that many startup founders who have achieved a lot of success are millennial, but based on my interaction with few millennial I found that, while many wanted to pursue something which interest them, when I probed a little deeper most were unsure about their financial futures. The reality is that, millennial face many of the same financial challenges which previous generations. While millennial undoubtedly have more opportunities than before, the dynamic nature of economic landscape also means that they have to be better prepared for the future compared to previous generations.
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Why young people need to get serious about retirement planning?
Beneath the veneer of confidence, we saw there is a sense of lack of financial security among young people. Easy access to credit, whether it is through credit cards or goods purchased through monthly EMIs, has made spending easier in a way we could not have imagined 20 years back. But more spending means less savings and this has a serious consequence on your financial future. Let us now discuss the challenge of retirement planning.
Let us assume you are 30 years old. You will retire at 60. Your current income is Rs 10 Lakhs per year. Let us assume that, your basic salary is 50% of your gross salary. You contribute 12% of your basic salary to Employee Provident Fund (EPF). Your employer makes a matching contribution. In addition, let us assume you will save another 10% of your gross income for retirement planning. Let us further assume that you get a salary increment of 10% every year. The chart below shows how much you will save till your retirement.
On a cumulative basis, you will be able to save around Rs 8 Crores by the time you retire, assuming 8% return on investment. However, this is just a theoretical number, based on the assumptions made above.
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Based on practical experience, you will probably not be able to save even half of the amount. This is because there are several other life-stage goals like making down-payments for vehicle and home purchase, home-loan prepayments, funding children’s higher education and spending for children’s marriage. Each of these other goals will have to be met before your retirement.
Let us assume you are able to save around only Rs 5 Crores for retirement after meeting your other goals.
Let us now look at expenses. Let us assume currently you are spending around 70 to 80% of income, which means your current expenses are around Rs 7 – 8 Lakhs per year. Let us now factor in inflation of 5% per annum. This means that by the time you retire your expenses will be Rs 30 Lakhs per year. You also have to factor in lifestyle changes; let us not forget with rising income, your lifestyle will also change.
Let us assume the impact of lifestyle change in expense terms is 1 – 2% per annum. This means by the time you retire, your annual expense will be Rs 40 – 50 Lakhs. The goal of retirement planning is to maintain your pre-retirement lifestyle. So your annual income should at least be Rs 40 – 50 Lakhs, in order to maintain your lifestyle.
Let us assume post retirement, the inflation rate is 4%. In a maturing economy, interest reduces over a period of time. In the US, the long term bond yields are in the range of 2 – 3%. We cannot expect 7 – 8% interest rates to last forever in India. Let us assume after 30 years, the interest rate is around 5%. With a retirement corpus of Rs 5 Crores let us see how long will your corpuses last?
You will lose your financial independence by the time you are 70. This is certainly not the kind of financial independence, which any of us want. Therefore, it is high time that you get serious about retirement planning.
Conclusion of this part
In this part we discussed the challenge of retirement planning. Without serious thought and planning from an early stage of your career, retirement planning can become a daunting challenge later in life. For young people, who are expecting windfall gains later in their careers to secure their financial future, let me tell you that such gains are extremely rare and bestowed upon only a few lucky. As far as the rest of us are concerned, we need to plan and save for our retirement. Even saving is not enough, because as we saw in this post, even after you saved around 15% of your gross salary, the savings corpus was not sufficient. The idea of this post is not to scare you, but to make you aware of the challenge you face. You need to have a financial plan which can secure a happy long retired life. In the next part of this post, we will discuss how mutual funds can help you secure your retired life. In the meanwhile, you can read basics of mutual fund investing
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