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Getting poorer in retirement

Nothing will damage Indians' old-age financials more than our obsession for investing only in fixed income

Getting poorer in retirement

Earlier this year, I received a message from a senior citizen who said that his returns from a fixed deposit have gone down by 25%. This may sound surprising but it’s true. This was the difference between a five-year deposit that he had made in August 2012, and when he renewed it upon maturity in August 2017.

To those who just read headlines on interest rates this doesn’t make sense. Depending on when you are measuring and how you are comparing, interest rates have gone down by two or three per cent. But here’s what he said: ‘I was being paid an amount of Rs. 35,352 every month (of course subject to income tax) enabling me to lead a worry-free life financially. Now on maturity, I have reinvested the amount in the same bank and I will be paid Rs. 26,489.’

The interest rate on his FD may have gone done by just about 2.5 per cent, however, his income is down by 25%. In fact, this is essentially an obfuscation in the way the reduction of interest rates is announced and is carried in the media. A reduction in the interest rate on a particular kind of deposit from, say, 10 to 8% is a reduction of 20%. If you were earning Rs 20,000 a month, you will now earn Rs 16,000 a month.

Seniors have retired from the economy
In fact, the entire move towards a lower interest rate economy, while great news for the economy, is of little direct relevance to older, retired people. Lower inflation and interest rates, better fiscal management, and higher economic growth are will carry no benefit for them because they are no longer in the earning and accumulative phase of their lives. An older person is not going to get a better job, or a higher salary because the economy is growing. That phase of his or her life is over.

However, wishing for higher interest rates is not a solution. This yearning for higher rates is there because for years we have been conditioned to ignore high inflation, which is the evil twin of high interest rates. I’m sorry to say this, but the person in the above example is financially doomed anyway. In the previous 5-year FD, when he was getting Rs 35,352 as interest income and spending it, he was actually eating away his capital. Out of that income, no more than Rs 7000 to 10,000 was real income. The rest was just the inflated value of the currency.

Here’s the key fact that he and crores others like him ignore: his real income has probably not gone down. If he was spending only his real, inflation-adjusted income, he would probably find that it has actually increased. And how would he have spent only his real income? The answer is, by spending only about 1.5 % of the deposit per year, and letting the rest compound and accumulate. This is based on the assumption that FD rates are about 1.5% higher than the inflation rate.

Obviously, he would need far more money to do that. Instead of Rs 40 lakh as deposit, he would need more than Rs 2 crore as deposit, which he does not have. There is no complete solution to this particular case. However, even a partial solution can only come from the returns that equity can generate. Real (inflation-adjusted) equity returns are actually double or triple that of fixed income. Where an FD may generate 1.5 % above inflation, equity will do 3% to 5%.

No way out but equity
There is no way out except to take some exposure to equity in a measured, de-risked and tax-efficient way. The ideal method would be to follow these steps: First, keep a year’s expenses aside and gradually invest the remaining amount into a set of two or three hybrid funds. After that, you can start withdrawing, from these funds, an amount that is roughly three to four per cent per annum of the total remaining sum. Roughly speaking, this will give you an amount that is equal to, or more, than what you are earning from a fixed income deposit today. The best part is that the value of the remaining investment will also grow at roughly at the inflation rate. If you can implement this, then there is a virtual certainty that you will not be faced with old age poverty. Moreover, this approach will be vastly more tax efficient.

If one is to avoid old-age poverty, then this fear of equity in retirement must be gotten rid of. There’s no other way.