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The retirement crisis

Post-retirement investment management and income generation is still the hardest problem in personal finance, but it needn't be

The retirement crisis

I answer questions on a lot of topics related to savings and investments, but the ones that worry me most are the questions on retirement planning, specifically on post-retirement management of income and expenses. In fact, when I read the kind of questions that old people are asking about post-retirement income, I feel a kind of a panic. The reason is that when you are young and earning, most savings mistakes are fixable with some patience and maybe a little temporary discomfort. For senior citizens, it's sometimes too late to avert disaster.

One major reason for these problems is the deep-rooted belief that the main issue in retirement savings is that one should be invested in 100 per cent 'safe' asset classes, essentially, fixed income deposits of one kind or another.

Nothing could be further from the truth. Even for people who have a reasonable size of savings, the main problem in retirement planning in India is to compensate for inflation. If India had a modest two or three per cent inflation rate, this may have been the case. However, the reality is that our savings are eaten away at a ferocious rate by the declining purchasing power of the rupee. Over the average 25-year period during which a retiree needs income, one can expect prices to rise by about five times.

If you need Rs 50,000 a month for your monthly expenses today, you will need almost Rs 1 lakh a month after ten years, and Rs 1.3 lakh a month after 15, Rs 1.8 lakh a month after 20. Not only will the withdrawals from your retirement kitty need to increase, the remaining capital must also increase in order to support those higher withdrawals. It's not an easy problem to solve.

At Value Research, we have a simple rule of thumb to estimate how much you can withdraw. This concept is easy to understand. In order to support an inflation-adjusted withdrawal rate, you should only withdraw whatever your savings earn over and above the inflation rate. Think about that carefully. If your savings earn 8 per cent, and the inflation rate is 6 percent, then you must withdraw only 2 percent per year. This will allow your savings to grow at least with inflation and ensure that you will not become poorer in old age.

One percent means that to support a current purchasing power of Rs 50,000 a month, you need Rs 3 crore! That's a lot of money. If you map this concept on to what we can get from 'safe' instruments like fixed deposits and such, you can see what the problem is. Look at the inflation rate - not just the consumer price index but the real inflation in your life. Then compare it to the FD and other rates that are being offered today.

The difference is pathetic. In fact, it's actually beyond pathetic, it's often negative. These instruments rarely pay anything much above the consumer inflation rate. Therefore, if you stick to the principle of using only income over and above inflation, you can't really withdraw anything from a bank deposit! In terms of it's real value, the money is not growing at all

This is the reason that I have always said that post-retirement income must include some equity. Of course, it cannot be all equity since the variability really is too high. Which brings us to hybrid funds, or balanced funds as they are still called. Over the past two decades or so, hybrid funds would have supported an annual withdrawal rate of 4 per cent or so. This does not mean any guarantee for the future simply because no investment has a guarantee.

What it does do is to make sure that you get the best chance at actually beating inflation. Remember, the withdrawal rate is not a fixed return that the saver is entitled to. In the initial years, it's best to keep it as low as possible in order to let the money grow and compound for the future.Sometimes, I get savers who keep asking me again and again if they cannot withdraw a little more than I recommend.

My response always is that you cannot bargain with the future. It's better to keep something in hand. That's a great principle in all savings decisions, but is absolutely necessary after retirement.