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How much money do you need for retirement?

This article discusses a quick thumb rule for retirement corpus estimation that you can do today.

How much money do you need for retirement?


12 Oct 2022 - Contact Sayan Sircar
6 mins read

This article discusses a quick thumb rule for retirement corpus estimation that you can do today.

How much money do you need for retirement?

Table of Contents

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 not started planning for retirement. Many are having difficulty choosing from the many investment options available today. There would also be investors who have already begun investing but require guidance regarding reviewing their portfolios. There are multiple general challenges in investing:

  • how much corpus is needed
  • where to invest
  • how much to invest every month
  • how to manage existing investments

Often taking the first step, i.e. finding out the corpus needed, becomes very difficult for investors. This post will help you estimate this number.

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A thumb rule for the target corpus

Corpus (C) = Inflation factor (F) * Longevity (L) * Lifestyle Cost (E)

where

  • Corpus (C) = Total amount to be reached at the point of retirement
  • Lifestyle Cost (E) = the money to be spent in Year 1 of retirement at today’s price level
  • Inflation factor (F) = Due to inflation, the corpus will be higher at the point of retirement than it is today
  • Longevity (L) = The amount of time spent in retirement in years

The thumb rule assumes that the real return (actual returns adjusted against inflation) on the post-retirement corpus is zero.

Related:
How long will your money last if you retire today?

Calculating lifestyle cost

(click to open in a new tab)
Case Study 03 Aug 22 Expense Calculation

We can use this retirement expense estimation tool to calculate today’s expenses and determine how much to spend in retirement.

Since our calculation is back-of-the-envelop, we can use an estimate based on current lifestyle expenses and use it. The goal is to arrive at a good corpus number quickly to get started with planning instead of trying to perfect the numbers.

Estimating inflation factor

India Inflation

Source: Ministry of Statistics and Programme Implementation (MOSPI)

Given that inflation is an essential, but often overlooked factor in goal planning, we will explicitly call it out. We will use the Rule of 72 to calculate the impact of inflation.

Rule of 72

The rule says: Rate of doubling * Time in years = 72

Rule of 72 lets us quickly calculate the impact of inflation over time. For example, using the rule, we can see that:

  • the purchasing power of money halves every ten years at 7% inflation. For example, one crore worth today will be worth 50 lakhs in 10 years and 25 lakhs in 20 years
  • a lump sum payout, say from an insurance plan, is worth around four times less in today’s money if received in 20 years
  • if you need one lakh/month in living costs in the first year of retirement, that will be two lakhs/month in ten years and four lakhs/month in twenty years

Cost after N years = Cost today * (1+Inflation) ^ Time

Here is a table that applies the above rule:

Effect of inflation on goals

For example, at 7% inflation, a retirement goal ten years away will increase by 2 times. If the retirement corpus at today’s price level is ₹2 crores, then post inflation adjustment it will be ₹4 crores.


Goal-based-investing plan

Assuming longevity

India Life Expectancy 1950-2022 Source

Longevity is difficult to assume since there are multiple factors:

  • advances in medical science: what if, 30 years from now, it is possible to replace organs damaged due to heart disease, stroke or cure cancer that dramatically enhances our lifespan
  • critical diseases: what if a disease like cancer suddenly cuts our lifespan short
  • what if expenses increase suddenly due to a chronic illness

Using the rule

Corpus (C) = Inflation factor (F) * Longevity (L) * Lifestyle Cost (E)

where

  • Corpus (C) = Total amount to be reached at the point of retirement
  • Lifestyle Cost (E): we assume this to be ₹50,000/month or ₹6 lakhs/year. E = 6.
  • Inflation factor (F): If retirement is 20 years away, at 7% inflation, F = 1.07^20 = 4.
  • Longevity (L): We assume L = 40

Corpus (C) = Inflation factor (4) * Longevity (40) * Lifestyle Cost (6)

or

C = 4 * 40 * 6 = 6.4 crore

or

C = 160x current expenses

We are deliberately taking out the current expenses (calling it x) so that:

  • the corpus figure can be compared among various investors
  • since x will change year on year, instead of chasing the moving target, it is easier to chase the multiple
  • financial literature and social media content generally talk about retirement / FIRE corpus in terms of the current expense. For example, the 4% SWR rule, which does not work in India, assumes a 25x corpus at retirement

Addressing a common mistake

Many investors miss out on inflation adjustment when applying SWR-based rules. A good example is thinking that say 40x of current expenses is sufficient for retirement. ‘ The above statement is technically true but only at the point of retirement. If the multiple is using today’s expense, then the inflation factor from the table above needs to be used to scale the multiple.

If 40x is the target and if retirement is 20 years away then at 7% inflation,

C = 4 * 40 = 160x

and not just 40x.

Next steps

The rule described above (C = F * L * E) is a thumb rule only to get started based on rough estimates and assumptions. Please refer to the following articles to explore the retirement planning process in detail:

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Asset Allocation (17) Basics (8) Behaviour (10) Budgeting (9) Calculator (13) Case Study (3) Children (9) Choosing Investments (28) FAQ (3) FIRE (10) Gold (6) Health Insurance (4) House Purchase (13) Insurance (12) International Investing (8) Life Stages (2) Loans (10) Market Movements (8) Mutual Funds (14) NPS (5) NRI (4) News (5) Pension (6) Portfolio Construction (36) Portfolio Review (22) Retirement (29) Review (7) Risk (6) Safe Withdrawal Rate (5) Set Goals (26) Step by step (8) Tax (16)

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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This post titled How much money do you need for retirement? first appeared on 12 Oct 2022 at https://arthgyaan.com


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