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How much returns should you expect from your retirement portfolio?

This article shows you the total expected returns for your retirement portfolio from the day you start investing for retirement to the day you stop drawing down from it.

How much returns should you expect from your retirement portfolio?


11 Dec 2022 - Contact Sayan Sircar
10 mins read

This article shows you the total expected returns for your retirement portfolio from the day you start investing for retirement to the day you stop drawing down from it.

How much returns should you expect from your retirement portfolio?

Table of Contents

How to invest for retirement

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

This article will cover an essential concept of lifetime real returns from the retirement corpus. The return is estimated over the entire investing period for retirement, i.e. the accumulation stage to the drawdown stage during retirement.

If you need the background, we have covered the concept of retirement planning in detail here: How do you get the SIP amount for retirement and here: A low-stress step-by-step guide to creating a retirement portfolio.

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Assumptions for retirement planning

  • each year in retirement is modeled as a single goal. Therefore investing for 40 years of retirement becomes investing for an aggregate of 40 such goals. This is easy with the right tools
  • what are the annual expenses in the first year of retirement if retirement happened today. This includes mandatory (food, living expenses, utilities, insurance etc) items and variable items (like travel and entertainment). We assume constant inflation throughout the period (saving for retirement and drawdown during retirement). Estimation of the expenses in retirement is covered in more detail here.
  • what is the rate at which the cost of goods and services increase with time i.e. inflation rate: this is generally tricky to estimate and can vary depending on what the family spends more on - food vs. travel vs. health insurance
  • at what rate investments can be increased due to income increase (like salary hikes) vs. managing lifestyle inflation
  • when does retirement start: further the retirement, the more chance you have for investments to compound faster than inflation
  • how long do you expect the money to last in retirement (for example 30 years of drawdown during retirement requires 20-30% smaller corpus than 40 years). Typically for married couples retirement duration is the life expectancy of the younger spouse and could be 100 years nowadays
  • the Risk profile of the investor: this depends on how much risk the investor can take based on life stage i.e. time left till retirement, corpus accumulated so far, ability to invest more and more as well as the willingness to take the risk to beat inflation

Related:
Inflation: the impact on your goals and how to choose assets that beat it

We will assume the following numbers:

  • 25 years to retirement
  • 40 years in retirement
  • 10L/year lifestyle expenses in retirement in today’s money, i.e. approx ₹80,000/month
  • 7% inflation before and after retirement
  • 11% and 4% post-tax equity and debt returns respectively (equity return is 3% above inflation, debt return is 3% below inflation) i.e. the same numbers as this post on lifetime returns for retirement
  • 10% increment of the SIP amount with a yearly review

We will assume the medium risk profile for the investor and apply the following glide path (60:40 and reducing) for each of the retirement expense goals:

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Sample strategic asset allocation

What does a retirement portfolio look like over time

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Retirement Portfolio over Time

We are looking at 25 years pre-retirement and 40 years in retirement, with the x-axis having 65 years. The left y-axis shows the corpus in ₹ crores and breaks down the total portfolio and the equity and debt components. The right axis shows the asset allocation and the equity component over time. If you have not seen such a chart before, you should note how the equity component does not become zero, which is a common misconception, at the start of retirement. You can read more on this here: How much equity should you have in your retirement portfolio?.


Goal-based-investing plan

Estimating the real returns of a retirement portfolio

We have assumed that equity as an asset class gives a return, called the risk premium, higher than inflation. In the table above, we have taken the risk premium as 0-4%. Similarly, we have assumed that debt as an asset class has a risk premium that is lower than inflation. In the table above, we have considered the risk premium minus 0-4%.

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Real returns vs asset class risk premiums

The table shows that lower risk premiums predictably lead to lower real returns over the entire period. The average real return over all 25 cases is slightly negative. If we consider only the middle 9 cases, the average is again negative.

Each cell in the table combines equity and debt risk premiums over inflation.

We will combine the risk premiums with inflation like this:

Expected return = (1 + Inflation) * (1 + Risk Premium) - 1

We get for a 60:40 asset allocation, the expected returns, with 7% inflation and risk premiums as 3% and -3%, respectively, as:

Equity return = 1.07 * 1.03 - 1 = 10.21%

Debt return = 1.07 * 0.97 - 1 = 3.79%

60:40 portfolio return = 0.6 * 10.21 + 0.4 * 3.79 = 7.642%

While this value of 7.642% is higher than inflation, we progressively reduce the asset allocation to more conservative values as the goal becomes closer. This derisking reduces the average return from 7.642% to a lower figure.

Time left Equity % Debt % Weighted return % Average return % Real return
25 60% 40% 7.642% 6.166% -0.779%
24 60% 40% 7.642% 6.105% -0.836%
23 60% 40% 7.642% 6.039% -0.898%
22 60% 40% 7.642% 5.967% -0.966%
21 60% 40% 7.642% 5.888% -1.040%
20 60% 40% 7.642% 5.801% -1.121%
19 60% 40% 7.642% 5.705% -1.211%
18 60% 40% 7.642% 5.598% -1.310%
17 60% 40% 7.642% 5.479% -1.422%
16 60% 40% 7.642% 5.345% -1.547%
15 60% 40% 7.642% 5.194% -1.688%
14 54% 46% 7.257% 5.021% -1.849%
13 48% 52% 6.872% 4.851% -2.008%
12 42% 58% 6.486% 4.684% -2.164%
11 36% 64% 6.101% 4.522% -2.316%
10 30% 70% 5.716% 4.365% -2.462%
9 24% 76% 5.331% 4.217% -2.601%
8 18% 82% 4.946% 4.078% -2.731%
7 12% 88% 4.560% 3.955% -2.846%
6 6% 94% 4.175% 3.854% -2.940%
5 0% 100% 3.790% 3.790% -3.000%
4 0% 100% 3.790% 3.790% -3.000%
3 0% 100% 3.790% 3.790% -3.000%
2 0% 100% 3.790% 3.790% -3.000%
1 0% 100% 3.790% 3.790% -3.000%

Conclusion

Your retirement portfolio will produce a zero or slightly lower return than the inflation over a period of decades. This conclusion allows us to model long-term portfolio sizes easily by simply multiplying investments and years together using zero real returns:

  • to reach a corpus that lasts 40 years in retirement, you need a corpus of 40x the expenses in the first year of retirement. We have used this result here: How much money do you need for retirement?
  • to know how much money needs to be invested for retirement. For example, if your retirement is 20 years away and you have not invested anything yet, in each working year, you need to invest double your annual expenses planned in retirement. We have covered this topic in this article: Does the 50/30/20 budgeting rule work in India?.
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Asset Allocation (17) Basics (8) Behaviour (10) Budgeting (10) Calculator (13) Case Study (3) Children (10) Choosing Investments (29) FAQ (4) FIRE (10) Gold (6) Health Insurance (4) House Purchase (13) Insurance (14) International Investing (8) Life Stages (2) Loans (10) Market Movements (9) Mutual Funds (17) NPS (5) NRI (5) News (6) Pension (6) Portfolio Construction (38) Portfolio Review (23) Retirement (30) Review (11) Risk (6) Safe Withdrawal Rate (5) Set Goals (26) Step by step (9) Tax (19)

Next steps:

1. Email me with any questions.

2. Use our goal-based investing template to prepare a financial plan for yourself
OR
use this quick and fast online calculator to find out the SIP amount and asset allocation for your goals.

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