Managing post-retirement investment and income is a hard problem, more so because it's as much about psychology as finance
05-Jan-2023 •Dhirendra Kumar
If there is a universal problem in savings and investments, then it is that of retirement. Except for the lucky few who have enough wealth or some kind of protected income, there is no one who does not worry about what will happen after you stop earning but have to keep spending. The fear of the unknown is always there in the background. The years of retirement are long nowadays, when lifespans are longer. 20 or 25 years is not uncommon and yet because 'healthspans' are not as long, medical expenses too mount up. We all know old people who are struggling to keep up appearances, to meet all expenses. Without enough money, life becomes a burden.
In my experience of advising people, I always get the impression that many retirees go through a cycle of overspending and then having to underspend. When a salaried person retires, he or she gets this sum of money that could be perhaps Rs 30 or 40 lakh. It feels like a big sum of money. Almost certainly, it's more than anything that the retiree has been given at one go at any previous point in life. They feel that they can spend comfortably. Simple maths seems to suggests that. Rs 50 lakh at a withdrawal of Rs 25,000 a month should last for more than 15 years, right? On top of that, the retiree feels that there will be some increase in the amount too because, you know, the money is there in a fixed deposit or some government scheme which should provide a lot of cushion.
Unfortunately, these are just assumptions which have no basis in reality. Fundamentally, one reason for these problems is the deep-rooted belief that the main issue in retirement savings is that one should be invested in these deposit type 100 per cent 'safe' asset classes.
This is a delusion. Even for people who have a reasonable size of savings, the main problem in retirement planning is to compensate for inflation. If inflation was a modest 2 or 3 per cent a year, the above scenario may have worked out. Unfortunately, the reality is that our savings are eaten away at a ferocious rate by the declining purchasing power of the rupee. At an inflation of 6 per cent per annum, over a 25-year period during which a retiree needs income, one can expect prices to rise to about four times. At 2 per cent inflation, it would be just 1.6 times. Quite a difference, isn't it? Unfortunately, this mental compounding and 'de-compounding' is not an intuitive thing to understand.
If you need Rs 50,000 a month for your monthly expenses today, you will need almost Rs 1 lakh a month after 10-12 years, and Rs 1.5 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.
I have a simple, easy to understand rule to estimate how much you can withdraw without the threat of old age poverty. 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 this concept carefully. If your savings earn 8 per cent, and the inflation rate is 6 per cent, then you must withdraw only 2 per cent per year. This will allow your savings to grow at least with inflation and ensure that you will not become poorer in old age. This inevitably means that you will have to invest some amount in equity.
However, like so many things personal finance, success does not come with just understanding the numbers. Instead, it's the psychology of the investor that is more important. The facts above are easy to understand but overcoming the fear and the safety instinct is difficult. I don't blame those who find it difficult to do, but there is no other way out.
Suggested read: Retirement: A fast disaster or a slow one?