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Investing During Retirement

To ensure that you do not outlive your savings requires a different approach

Almost all the investment advice that is given out to retired people is wrong. In fact, not only is it wrong, it is downright dangerous. Instead of securing their financial future, it tends to push them towards poverty. The longer a retiree lives, the more severe are the ill-effects of such advice.

I know that's a very strong set of statements that I have started out with but if you bear with me for a few more minutes, I'll show you where the problem lies and why it is so serious.

The central premise of almost all the post-retirement investment advice I've ever heard is that retirees' money should always be entirely in guaranteed fixed-income instruments like post office deposits, RBI deposits, bank FDs etc. It is said that retirees should not have any stocks-based investment because they can't tolerate any risk.

The problem with such advice is that it completely ignores a big risk that retirees face, that of inflation. None of the fixed-return instruments provide returns that are adequate to cover real inflation, let alone actually give some returns. Some of them supposedly give returns of about one per cent above the official rate of inflation. However, the real rate of inflation that most of us personally face is always above the government's official rates. Over time, the effect of compounding ensures that the situation turns to complete disaster.

Here are some numbers that will show you what I mean. Take the case of someone who started retired life in 1985 with savings of Rs 10 lakh, a substantial sum in those days. Let us suppose that these savings are invested in conservative instruments that fetch 9 per cent a year. This retired person's monthly expenses were Rs 3000 in 1985 and these grow at a rate of 10 per cent a year. By 2006, when our retiree would be 84 years old, his money would have run out. The small differential of a mere one per cent between what his investment is earning and the pace at which his expenses are increasing would empty out his nest egg.

This is a hypothetical example. In reality, our friend would realise within five or seven years that his money would eventually run out. He would then start squeezing his expenses because he would be nervous about what kind of price rises the future would bring. Essentially, his golden years, when he should be free from financial worries, would be spent in mental stress.

All because his returns are one per cent short of the real inflation rate. Now let's see what happens if his returns are one per cent more than the inflation rate. In this case, the same age of 84 finds him happy, relaxed and richer. If his expenses grew at the same 10 per cent but his investments returned 11 per cent, then by 2006 his principal would have grown from Rs 10 lakh to Rs 36 lakh.

This example is a generalised one and real lives would be different. However, I personally know of several examples of both kinds, and the difference in happiness levels of the two kinds is amazing. The moral of the story is that in these days of ever-improving medical care, retired life is long. Over those long years, the compounding effect of inflation, as well as investment returns is massive.

Once you stop working, you will have to fight a continuous battle against inflation and the only thing that can help you win this battle is a little bit of equity. I'm not asking retirees to become day trading punters, but putting perhaps 20 to 30 per cent of one's money in equities through balanced funds is the safe decision. Over the long time periods retirees invest for, the ups and downs of equities balance out but low returns of fixed income investing eventually eat away one's savings in a guaranteed manner.