How much money is important to have a comfortable retirement? How do you figure that out?
Dhirendra: I really don't have an answer as it is a very subjective thing. It entirely depends on your circumstances. One has to consider several factors, including the number of dependents you have when you retire, your state of health, whether you have your own house or not and so on.
Still, if someone has to do a calculation, then based on your current income and expenditure, figure out how much you would need to live comfortably when you retire. Let's assume that you would need 10 lakh a year. Now work backwards. Will you be getting any pension or rental income? If yes, subtract that to arrive at the income requirement, which will be dependant on your investments.
Assuming that you need the entire 10 lakh rupees from your investments and you have nothing else-pension or rental income, this 10 lakh should be five per cent of your capital. This is because an ideal retirement plan should be something with a withdrawal rate of not more than four to five per cent in the initial years to ensure that you are able to generate inflation-adjusted income during the later years of your retirement. If 10 lakh a year is sufficient for your expenses during the first year of retirement, it may not be enough five years down the line. You may need Rs 11 lakh because of rising inflation.
So, to summarise, look at your current expenses, account for the changes which will impact your requirement when you retire and accordingly, work on the financial plan. Assuming a five per cent withdrawal rate, you would need 20 times of that annual requirement as your retirement corpus. In the above example, it would work out to Rs two crore.
I am giving this plan after assuming that you would want to leave your capital for your heirs. This is an ultra-conservative plan. Otherwise, a much smaller corpus can work but that would also add to the risk of outliving your investments if you live longer.
Where should we invest for our retirement during the accumulation phase?
Dhirendra: People always look for the formula, the best vehicle or the best plan, which is conclusive. NPS is moderately trying to achieve that. It allows you to have an equity allocation of up to 75 per cent. But it is very important to understand conceptually what it should be.
You have a long accumulation phase of 20-30 years where you should be regular and disciplined with your investments so that compounding can work for you. You have to be disciplined of not using that money elsewhere. During this phase, one should invest in equity as much as possible. If you go with mutual funds, you can have a 100 per cent equity allocation for the initial 15-20 years. And maybe then you can start with a re-balancing plan and have a 10-25 per cent fixed income allocation or with any other asset allocation that you want. You should be very aggressive during the accumulation phase.
How do you use the accumulated corpus after retirement in the income-generation phase? Should there be a change in the asset allocation as we near retirement?
Dhirendra: You need to take care of several things. Two to three years before retirement, start moving a part of your accumulated corpus to the fixed income. And to be more cautious, ensure that money worth three years of your expenses are in fixed income funds. Rest of your money can still be long-term. It is equally important for you to have an equity exposure there, as that is also your long-term money, which will be required over a period of 20 years or more. You need to ensure that it grows moderately to beat inflation.
However, you can follow a much more conservative allocation there. You may use a 50:50 equity debt allocation. Use equity funds and debt funds separately for this and ensure you re-balance regularly every year. Alternatively, to keep things simple, you can choose a balanced fund to maintain the asset allocation automatically. If you want to be more conservative, you can go for an equity income fund. But as I said earlier, don't let your withdrawals exceed four-five per cent of the corpus.
So, I think, one should be aggressive and invest as much as possible in equity during the accumulation phase and once he retires, he may follow a conservative plan with any of the above-mentioned allocations. But he should ensure that he is investing some part of his corpus, 30-50 per cent in equity and does not make an annual withdrawal of more than five per cent of the corpus.
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