Plan early and follow your financial goals to nurture the fountain of youth right through your sunset years
Many a times, investors are tied down with meeting short term goals like wedding, buying a house and keep postponing retirement planning. And the solution is to do the financial planning in a holistic way. Remember that retirement planning is a subset of your overall financial planning.
START EARLY
There is another advantage of starting early also and this is known as the power of compounding (i.e., the money you save in the initial years generates compounded returns for a very long time). For example, to reach a retirement corpus of 1 crore, at 12% rate of interest, you will have to invest 43,471 per month if you have only 10 years in hand. But if you have 35 years in hand, you will reach the same target by investing just 1,555 per month. In other words, the 20s and 30s are probably the best time to plan for retirement — of course, along with other financial and career goals.
EQUITY ROUTE
The first thing that you need to decide is what corpus you would need at the time of retirement. It is important to first quantify how much you will need to maintain your lifestyle at the time of retirement. Quantify how much you need to spend to enjoy your current lifestyle. Assuming inflation in the 6-8% range in the long run, you can arrive at the amount you need at the time you retire. Very high inflation on the one hand and the absence of a social security system on the other hand makes maintaining your lifestyle post retirement a big challenge. Therefore, it is imperative that the retirement corpus has to be invested in products that can generate maximum returns in long term. It is proved historically that equity generates maximum returns among all asset classes, so investors can use the equity funds/balanced funds to build their retirement corpus.
EQUITY FUNDS
Though you can invest directly in the stock market to generate your retirement corpus, the mutual fund route is more convenient. The mutual fund route is more transparent and comes with the least costs. It also offers liquidity, making it a good candidate for long-term investment.
BUILD A PORTFOLIO
"Depending on where you stand today and your risk-taking ability, you should construct a portfolio of funds with a long-term consistent track record," explains Pandit. Most financial planners recommend diversified equity funds if you have more than 20 years to go for your retirement. Since Somani has full 30 years to retire, his retirement plan can be made of three equity mutual funds. We recommended him to invest 10,000 per month through SIPs in three equity mutual funds namely, HDFC Equity Fund, Reliance Growth and DSP Equity Fund.
The assumption here is simple. Assuming a 15% return from equities per annum for the next 30 years, 10,000 per month invested will give him a corpus of 6.92 crore. Assuming that Somani will shift his corpus entirely to debt at that age, and earn a 6% post-tax return, his interest income would be 3.46 lakh per month. Now, we come to the expense part. Somani's current monthly expense is 30,000 per month. Assuming a 8% inflation, at the age of 55, his monthly expenses would be 3.02 lakh comfortably helping him retire peacefully. Depending your risk-taking ability, you can either go for an actively managed mid cap funds (i.e., for high risk takers) or go with a plain-vanilla index fund (ie for low risk takers).
BALANCED FUNDS
Balanced funds also make good candidates for retirement planning since they offer good post-tax returns in the long term. This is because if the average equity component is kept above 65% (most of these balanced funds do it), there is no capital gains tax after a year of holding. He prefers HDFC Prudence Fund and DSP BlackRock Balanced Fund amongst the balanced fund category.
ASSET ALLOCATION FUNDS
Asset allocation funds (where the fund managers move between equity and debt depending on the market conditions) are another option that can be considered. But not all financial planners prefer to go with these readymade tools. Being fund of funds, the asset allocation funds are treated like debt funds and taxed accordingly. Instead, it makes sense to invest in the right combination of equity and debt funds and generate better post-tax returns than the fund of fund route.
MANAGE THE CORPUS
Building a retirement corpus is just one part of the game, managing the corpus post retirement is another ball game. The first part is to reduce the high-risk equity component slowly. As you move closer to your retirement age, i.e., when you are 5-7 years away, shift the corpus gradually into hybrid products.
The next step is the use of systematic withdrawal plans (SWPs) offered by mutual funds to reduce your tax burden in the golden days. Please note that systematic withdrawal plan will ensure that the money in your hand is subject to capital gains tax whereas a pension income generated from other products is added to your income and taxed at the marginal rate.
