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