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A low-stress step-by-step guide to creating a retirement portfolio

Posted on 13 Apr 2022
Author: Sayan Sircar

Tags: Step by step ; Retirement

9 mins read
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This article shows you an easy step-by-step way to start retirement planning.

A low-stress step-by-step guide to create a retirement portfolio

📚 Topics covered:

The hardest problem in finance
Step 1: Know yourself
Step 2: Know the investment options
Step 3: Make and execute the plan
- Pre-retirement period: the accumulation phase
- Post-retirement period: withdrawal phase
Step 4: Review in the face of uncertainty
Next steps

The hardest problem in finance

“nastiest, hardest problem in finance.” - William Sharpe, Nobel Prize winner, regarding the withdrawal stage of retirement

Retirement planning can be daunting for those who have either not started planning for retirement or are having difficulty choosing from the multitude of investment options available in the market today. There would also be investors who have already started investing but require guidance regarding reviewing their portfolios. There are multiple general challenges in investing:

where to invest
how much to invest
how to manage existing investments

However, with retirement there are a few unique risks:

longevity: how long will you be alive and will your money last until then
life situations: how to handle medical emergencies or recurring high medical costs
inflation: what if prices go up suddenly
the sequence of returns: what markets fall suddenly or stay depressed for long periods of time

The way to handle these risks is to acknowledge that they exist, take steps today that allow you to create a portfolio that full fill your retirement goal and create a review process to manage these risks.

In this article, we will cover the steps to construct and maintain a retirement portfolio in the easiest possible way.

Step 1: Know yourself

A journey of a thousand miles begins with a single step - sourced from sage Laozi’s Tao Te Ching

The first thing to figure out regarding your retirement portfolio is the type of lifestyle you wish to have in retirement relative to your present lifestyle. You need to decide that in retirement, do you wish to have a lifestyle which is:

extravagant compared to the present
similar to the present and this is the default if you cannot decide
minimal compared to the present

You should be able to figure out in general how much you spend today on expenses in the following buckets:

essentials: groceries, transport, clothing, utilities, fuel, health insurance
discretionary: entertainment, travel
children related: school and activities
loans and EMI: home, car, credit card, goal or personal loan

The first two will survive in retirement since most people should not have the other two in retirement. Once you add up the total for the whole year, you will end up with today’s expenses. Let’s say that this is ₹10 lakhs/year. Now, based on the lifestyle target, you wish to have a slightly more extravagant lifestyle due to regular travel so that the total expenses in retirement is ₹12 lakhs/year.

Estimation of the expenses in retirement is covered here How can you figure out your expenses in retirement/FIRE?.

Other goals like a house purchase, children’s college/marriage or any other large goals have to be planned and managed separately:

You can use the comprehensive goal-based investing planner to plan for these items together.

Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.

Step 2: Know the investment options

We will need to construct a retirement portfolio that:

takes care of the four risks explained above: inflation, longevity, life situations and sequence of returns
is easy to understand, construct and manage at all ages: 30-90 and by either spouse/trusted family members
should be hands-off/easy to review and manage without requiring recurring form-filling and bank visit type running around
should be tax-efficient and can be invested/redeemed in small amounts (ticket size)

Before touching on the investment options, let us understand the basic premise of retirement savings from the perspective of the need to beat inflation. We will consider the following numbers:

25 years to retirement
40 years in retirement
12L/year lifestyle in retirement
7% inflation before and after retirement

Let’s assume a world where prices do not increase i.e. inflation is zero. In such a world, if your target lifestyle costs 12L/year today, it will cost the same when you retire as well and for the next 40 years in retirement. This means you need 12 times 40 = 4.8 crore as a retirement corpus to be accumulated by the time retirement starts. This means that if 25 years is left say from today and until retirement starts, then every year you need to accumulate 480/25 or almost 20 lakhs in your retirement corpus starting at zero corpus. The formula for the amount you need to invest/year is:

Yearly investments = (Desired_Lifestyle_Expenses * Years_in_retirement - Corpus_you_already_have) / Years_left_to_retire

In the above case, we get

Yearly investments = (12 * 40 - 0) / 25 = 480 / 25 = 19.2L/year

Inflation adds another level of complexity to this. If inflation is 7%, then prices double in 10 years since 1.07^10 = 2. This means that the 12L that you are targeting in retirement becomes

12 * 1.07^25 = 65L in year one of retirement
12 * 1.07^26 = 70L in year two of retirement and so on which means the target of 4.8 crore will actually become 24.28 crore in retirement which is 5x due to inflation.

To ensure that this 5x bigger corpus is reached, we need to invest in a manner where we stay on top of inflation for the next 25+40 i.e. 65 years. If we look for assets that have historically beaten inflation over such long periods of time, there are very few options that satisfy both the inflation-beating and small ticket size requirements: market-linked assets like equities meet both the criteria while real-estate does not meet the ticket size requirement. You can invest/redeem as low as ₹1000 in equity mutual funds but cannot build a real estate portfolio for ₹5000/month.

In the rest of the article, we will focus on mutual funds (including NPS), RBI bonds, and provident fund (PPF/EPF/VPF/Sukanya Samriddhi) for creating and managing a retirement portfolio. We will exclude FD, direct stocks, gold and real estate for taxation, risk/return and ticket-size considerations.

If substantial assets already exist in real estate or others from the second list, you need to get started first and consider liquidating if you are unable to make progress with market-linked assets.

Step 3: Make and execute the plan

Since we have done the heavy lifting in the previous sections, we will now use the information we have to construct the retirement portfolio.

Pre-retirement period: the accumulation phase

Using the following numbers, we will use the comprehensive goal-based investing calculator to find out the SIP amount:

22 years to retirement, aiming to retire early in 17 years
40 years in retirement after 22 years
5L/year lifestyle expenses in retirement in today’s money
7% inflation before and after retirement
11% and 4% post-tax equity and debt returns respectively
10% increment of the SIP amount with a yearly review

Easy Retirement planning calculations

The calculator will also show where to invest both the lump sum and SIP amounts in equity and debt asset classes using funds from this guide: Which funds should I invest in?. At any point, you can find out how much progress you have made using this post: How long will your money last if you retire today?.

Here is a simple way to estimate the retirement corpus: How much money do you need for retirement?

Post-retirement period: withdrawal phase

Bucket composition

If you are already in retirement, we will create a very simple portfolio that is easy to manage and is expected to meet both the inflation and longevity risks by creating three buckets of assets:

Bucket 1: Cash - The purpose of this bucket will be to hold living expenses for the next five years
Bucket 2: Income assets - The purpose of this bucket is to hold assets that generate income. Income from this bucket will be used for day-to-day expenses
Bucket 3: Growth assets - This bucket will have everything that is not there in buckets 1 and 2 above. This bucket exists to provide growth that beats inflation over time

Step 4: Review in the face of uncertainty

At all times ensure that you have the following in place

an emergency fund with 6-12 months of expenses
a term insurance policy (unless you are retired with no income)
a health insurance policy (separate from the company provided one if any) for 10-15 lakhs as a base policy with a 50-100 lakhs super-top up
a personal accident insurance coverage to safeguard against accidents where you do not die but cannot earn
no high-interest debt like credit card or personal loans

and once you start investing,

perform yearly review and rebalancing as per your glide-path
never interrupt compounding by making these avoidable mistakes

Next steps

Please refer through this follow-up article to check how to do retirement planning for yourself:

Low-stress retirement planning calculations: worked out example

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Worked out case studies for goal-based investing

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Case Study: How should couples in their 40s with a new baby plan their financial future?

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Asset Allocation (21) Basics (8) Behaviour (12) Budgeting (12) Calculator (25) Case Study (6) Children (17) Choosing Investments (40) FAQ (12) FIRE (13) Gold (21) Health Insurance (5) House Purchase (29) Insurance (16) International Investing (12) Life Stages (2) Loans (17) Market Data (7) Market Movements (16) Mutual Funds (46) NPS (7) NRI (19) News (18) Pension (8) Portfolio Construction (53) Portfolio Review (27) Reader Questions (8) Real Estate (7) Research (5) Retirement (38) Review (15) Risk (6) Safe Withdrawal Rate (5) Set Goals (28) Step by step (15) Tax (59)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself.

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