Getting poorer in retirement
Nothing will damage old-age financials of Indians more than our obsession for investing only in fixed incomes
By Dhirendra Kumar | Jan 10, 2018
The other day, I received a WhatsApp message from a senior citizen whose returns from a fixed deposit have gone down by 25 per cent. This difference has come about between a five-year deposit that he made in August 2012, and when he renewed it upon maturity in August 2017.
Of course, to those who are just reading the headline numbers on interest rates, this doesn't make sense. Depending on when you are measuring, interest rates have gone down by two or three per cent. However, here's a part of the exact message: '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 any deposit from 10 to 8 per cent is a reduction of 20 per cent on the income. If you were earning Rs 20,000 a month, you will now earn Rs 16,000 a month. The '2%' reduction is an illusion.
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 all very well but 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 no solution. This yearning for higher rates is there because 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. For the last five years, 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 a FD may give 1.5 per cent above inflation, equity will generate 3 to 5 per cent.
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 roughly three years' expenses aside and gradually invest the remaining amount into a set of two or three conservative hybrid funds (balanced funds). After three years, you can start withdrawing every year, from these balanced funds, an amount that is roughly three to four per cent 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. The icing on the cake is that unlike your deposit interest, this income will be tax free.
As I've said often, if one is to avoid old-age poverty, then this phobia of equity investment in retirement must be gotten rid of. There's no other way out!