This post estimates the retirement corpus to reach a target spending figure and how to save for it

Creating a corpus for retirement is one of the most important financial goals of any investor. There are multiple factors involved in getting to the retirement corpus needed and how to save for it.

📚 Table of Contents

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• Corpus size estimation
• Where to invest during retirement
• Thumb rules and assumptions
• Walk-through of the example
  • Assumptions made:
  • Output from the model
  • Sensitivities
• After one year of running the SIP
• A note on having the prerequisites in place

Corpus size estimation

How much money is needed in retirement depends on

• what is the annual expenses in the first year of retirement if retirement happened today. This includes mandatory (like food, living expenses, utilities and health insurance) items and variable items (like travel and entertainment)
• 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. We assume constant inflation throughout the period (saving for retirement and drawdown during retirement)
• 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, more the 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
• 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

Estimation of the expenses in retirement is covered in more detail here.

Where to invest during retirement

To beat inflation, one of the best options is equities. Historically equities have beaten inflation both in India and abroad and the trend is expected to continue. This article talks about choosing equity investments in detail.

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

Apart from equity, there are many debt instruments to invest in for retirement corpus creation. This includes debt mutual funds, NPS, provident fund and others and is covered in more detail here.

Thumb rules and assumptions

A common retirement corpus estimation formula uses the present value of the expenses in retirement discounted using real rates of return in the retirement period. This is an excellent formula to get started:

Corpus = PV(real return,time in retirement,-expense in the first year of retirement,0,1)

The issue with this formula is the difficulty of assuming the real rate of return in the retirement portfolio. An oversimplified version is to just assume that real returns will be some figure say -2% or 0% or 2% in retirement.

You can use this formula as a starting point to quickly estimate your retirement corpus but do not use it to actually plan retirement. Instead, use our plan Excel template or web-based goal-based investing calculator. Both calculators use individual expenses to provide a more accurate estimate of your retirement corpus.

Walk-through of the example

We will use the plan Excel template to estimate this.

Assumptions made:

• Annual expenses in the first year of retirement are ₹ 1 lakh/month in today’s money
• Inflation is 7% and is uniform before and after retirement
• Investments are incremented at 5% yearly throughout the accumulation i.e pre-retirement phase
• Retirement starts 20 years from now and the money lasts for 30 years in retirement
• the risk profile is moderate (60:40 equity and debt allocation for goals > 15 years away: see this for details)
• Starting corpus is zero

Output from the model

The model shows that the corpus required is ₹ 12.90 crores to be accumulated in 20 years. The SIP amounts are ₹ 1,38,327/month with ₹ 82,996 to be invested in equity and ₹ 55,331 in debt per month which implies an asset allocation of 60% in equity and 40% in debt. This looks like a massive figure but a disciplined approach in investing where a regular review and rebalancing via a proper glide-path will maximize your chances of hitting the target.

Sensitivities

This shows the target corpus values for various amounts of monthly expenses in retirement and the SIP needed today. For example, for the 1lakh/month lifestyle after 20 years (the same example used so far) the target is a corpus of ₹12.9 crores and SIP of ₹ 138,000/month.

After one year of running the SIP

The following needs to be done in this order:

• find the new corpus which is the sum of the current value equity and debt fund values
• review the goal parameters (new horizon is 1 year less, review the current cost of the goals to adjust for actual market inflation etc.)
• re-balance between the equity and debt fund values

In this example, after 1 year, the saved amount is ₹17 lakhs say, retirement is 19 years away and the new SIP amounts are changed accordingly. The new target corpus is ₹12.05 crores and the corpus is rebalanced to ₹6.8 lakhs in debt and the rest in equity.

A note on having the prerequisites in place

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

Once you start investing,

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