Let me tell you about a 60-year old gentleman, whom I recently met. He had just stepped into retirement, had a retirement fund of 1 crore and, to start with, needed an income of 65,000 p.m. I take this example because I think this is reasonably representative of the retired people I have met. Most retirees that I have met (who have retired around the age of 60), have had retirement funds that were between 100 and 200 times their desired monthly income at the start of retirement- this individual had a retirement fund that was about 154 times that. Additionally, like most retirees that I have met, he was keen to invest his money in an option that carried an assurance of a fixed return, preferably from the Government, or a Government-owned entity.
After a bit of looking around, he had short-listed monthly-interest paying deposits across three banks, which were offering a rate of 9% p.a.. If he invested his entire fund, he would get 75,000 p.m. from these deposits. Leaving aside taxes, it was his opinion that the bank deposit would be more than adequate for his needs. So certain was he of his choice that his only question to me was regarding the tenure of the deposit, “Should I go for a 5 year deposit, or should I go for a 10 year deposit?”
As I saw it, he was, most likely, in for an unpleasant surprise.
The biggest challenge for any retired investor is to deal with inflation (or price rise). While inflation impacts us throughout our lives, its impact is arguably most severe during the years of retirement. In the above example, if we were to assume an annual inflation rate of 6% (which is a reasonable assumption), that would mean that to maintain the same quality of life a year later, he would need a monthly income of 68,900. Two years later, the monthly income would have to go up to 73,034. Five years later, it would have to go up to 86,985. Ten years later, it would have to go up to 116,405.
While the deposits are not designed to match such increases, in the first couple of years, these would generate a surplus (over the required monthly income), which could be reinvested and used in later years. However, this wouldn’t last too long. If the surplus were to be reinvested at the same rate of 9% p.a., then somewhere in the seventh year of retirement, it would run out. The only way to survive from the income from the deposits would be to cut his monthly expenses by a third.
But let’s go back to the start. In this example, to adequately counter the impact of inflation, the deposits should have generated a monthly income of just over 110,000 p.m. (this calculation assumes the person lives till the age of 90). To get that kind of income each month, this person would have had to invest about 1.47 crore (@ 9% p.a.). In other words, on this count alone, he should have had a retirement fund that was about 226 times the monthly income needed at the start of retirement.
Even so, this would still leave the issues of taxes to contend with. Secondly, there would still be the very realistic possibility of inflation being higher than 6% p.a. (a number of people may regard my assumption on the rate of inflation as being unrealistically low). If we were to consider taxes and a higher rate of inflation, then one would need a much bigger retirement fund.
In my estimate, anyone retiring at the age of 60, and relying on bank deposits for monthly income, should have a retirement fund that is at least 300 times the monthly income needed at the start of retirement. My experience also suggests, as I mentioned earlier, that most Indians entering retirement do not have a fund of that size. Therein lies the case for mutual funds.
Having a slice of equity funds in one’s portfolio is a great way to counter the impact of inflation. Having debt funds instead of fixed deposits (or other debt instruments) carries two advantages: a. it allows for efficient withdrawals i.e. you can withdraw the exact amount that you need, exactly when you need it and b. it offers greater tax efficiency i.e. you can defer the incidence of taxes and even bring down the amount of taxes needed to be paid. Thus, using debt and equity funds together, it is very possible to enjoy the quality of life one aspires for, with a smaller retirement fund compared to what would be needed if one invested only in options with assured returns.
