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How do you get SIP amount for retirement: Part 3

05 Jun 2021 - Contact Sayan Sircar
9 mins read

Walk-through: Get SIP amount for retirement goal

Calculation of SIP amount

We have already covered

We will extend the concept developed while calculating for a goal like a college education with multiple payments (once every year for each year of college) and use it for retirement planning. If you are entering retirement within the next year, please see this detailed post instead. This post approaches the same problem from a different direction by estimating the corpus for retirement.

Table of Contents

Assumptions for retirement

  • what is 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 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, 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
  • 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

Estimating real returns during retirement

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 with assuming the real rate of return in the retirement portfolio. An oversimplified version, which readers of this blog must avoid, is to just assume that real returns will be some figure say -2% or 0% or 2% in retirement. This is a fallacious assumption because the real returns of the portfolio will depend on the asset allocation and the glide path of the individual expenses in each year of retirement and cannot be guessed.

Real return during the retirement period depend on:

  • real return assumptions of each asset class in retirement corpus. Typically this will be equity, debt and cash. Many others will have real estate and gold in their portfolio
  • the asset allocation for each individual expense goal based on the horizon. We are creating one single goal for the expenses in each year of retirement using the same concept described in this post: how to get SIP amount for a goal with multiple payments
  • the glide path for each of the individual goals
  • inflation in the accumulation phase (when you are saving for retirment) and in the psot-retirement phase

Instead of assuming the overall real return, we will use the assumptions above and create the retirement portfolio. Our plan Excel template or web-based goal-based investing calculator both use this individual expenses method to provide a more accurate estimate of your retirement corpus.

Start of retirement

Today with early retirement being common across many professions, the typical 58-60 age for retirement may be brought forward for many reasons. The example Excel workbook assumes retirement to start 20 years from now.

Inflation rate and length of retirement

Typically for married couples, this is the life expectancy of the younger spouse and could be as 100 years nowadays. We need to adjust the duration of the retirement accordingly. The longer the duration (assumed 40 years in the Excel example), the more savings are needed every month. We assume constant inflation throughout the period.

Here each year of retirement is modelled as a separate goal. Naturally, once the retirement period ends, there is no money expected to be left for any heirs. If that is needed, please create a separate goal for that using this method.

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.

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 this is covered in more detail here.

Expenses estimation

One of the important assumptions will be the expenses in the first year of retirement (20 years from now in the example) assuming the retirement starts immediately. This needs to include expenses like housing, health insurance and travel and will assume no income. If pension or other income is present, then the expenses will be assumed beyond this income. This is covered in more detail here.

Calculation of SIP amount for multiple goals

These calculations are explained in this comprehensive goal-based planning tool.

Increasing SIP every year

A very important part of planning for a long term goal is increasing the monthly SIP amount as income increases. In the example, the increase is assumed to be 10%/year.

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

Our new Goal-based investing tool will help you to create and manage all of your goals in one place. Click the image below to get access:

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Video showing how to calculate retirement SIP value

This video shows you how to use the web-based calculator to easily find out your retirement SIP value:

This is the link to our web-based calculator.

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 sinking fund for insurance payments (health, car) and recurring known expenses (building maintenance, holiday travel etc.)
  • 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
  • no high-interest debt like credit card or personal loans

and once you start investing,

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Next steps:

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

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