Those who get a substantial pension or have multiple sources of income during retirement are truly a favoured lot. But few are that privileged.
Most of us have to be extremely prudent in how we invest our retirement kitty. Add to it longer life spans and falling interest rates, and the issue gets even more trickier.
This query from a Morningstar reader captures that dilemma well.
I plan to retire in around 5 years. I will have a corpus of Rs 1 crore at that time. I have no other source of income. How must I invest this corpus? How much can I withdraw from the corpus on a monthly basis? I need an inflation-adjusted retirement income for 25 years.
There are so many uncertainties when planning for retirement. And when we think about it, it can erode our sense of confidence. Of course, time can wreak havoc even on the best-laid plans. But we must work with what is in our control.
Given the lack of information in this query, we decided to focus on inflation (which erodes the value of the corpus), and withdrawals (which decrease the corpus amount).
We approached Vipul Shah, chief executive officer of Lakshya Financial Planner, to suggest a strategy. Below are his views.
You have a corpus of Rs 1 crore that has to be stretched out over a span of 25 years. I shall assume that you are retiring at the age of 60, with a monthly expense of Rs 25,000. Considering the Rule of 72, and an inflation of 6% per annum, after 12 years, expenses would double to Rs 50,000.
(The Rule of 72 determines how long an investment will take to double given a fixed annual rate of interest. By dividing 72 by the annual rate of return, investors obtain a rough estimate of how many years it will take for the initial investment to duplicate itself.)
Here are some suggestions on how to sustain a portfolio of Rs 1 crore over a period of 85 yrs.
- Emergency Fund
It will be a drain on your finances if you have to tap into them for an emergency. Worse, if you get into debt. So I suggest you keep money aside towards this end. To understand more on this subject, please read 4 questions on an Emergency Fund. For your Emergency Fund, I suggest you keep Rs 5 lakh in a bank fixed deposit, where you will get an interest of 7% per annum.
- SCSS
Invest Rs 30 lakh in the Senior Citizen Savings Scheme. Since the limit per individual is Rs 15 lakh, I suggest that both you and your spouse invest Rs 15 lakh each. If you have not yet attained the age of 60, do so under parents’ names. This return is assured, and the investment is guaranteed by the central government. It will give you a return of 7.4% per annum.
- Fixed Income
Invest Rs 15 lakhs in a mix of small finance banks and non-convertible debentures, or NCD’s, of AAA rated companies offering 8% per annum.
The pre-tax return you will get from all of the above will be around Rs 31,416 per month, which shall take care of existing expenses. Now let us move on to growing your assets.
- The debt to equity transition
Park Rs 50 lakhs in a liquid fund and initiate Rs 75,000 per month via a Systematic Transfer Plan, or STP, to a low-cost equity index fund. It would take around 6 years to shift the entire corpus into equities. The money will earn a return in the liquid fund and in the index fund. For the sake of simplicity, let us assume a return of 10% over this time. The corpus will reach Rs 75 lakhs.
With this strategy, you have Rs 50 lakh in fixed-income investments, and Rs 50 lakh gradually going into equity. The STP is needed to manage volatility. Even a 40% market crash will not erode the capital as in the initial years 90% of the money is in fixed income products.
- The equity to debt transition
At the end of this period, redeem Rs 25 lakhs from equity corpus mentioned above (Rs 75 lakhs) and invest as per step 1 to 3 to generate more income to beat inflation. The remaining Rs 50 lakhs will stay in equity for wealth creation.
You still have 5 years to retirement. I suggest that you save aggressively during this period.
