Check inflation risk, interest rates for longer investments

Early start to savings helps in saving more, and cultivates the habit of saving


I want to retire 10 years before the retirement age of 60. I’m 27 right now, unmarried and earn Rs80,000 a month. I live with my parents and have expenses of Rs40,000 a month, including an education loan equated monthly instalment (EMI) of Rs30,000, to be paid off by 2021. How should I plan for my goal? I want to start my own non-government organisation (NGO) at the age of 50, with a start-up cost of Rs70 lakh.

—Nirmal Mehta

Early start to savings helps in saving more, and cultivates the habit of saving. This further leads to a greater surplus of income in your high-earning years being put away for investments. More importantly, the benefits of the power of compounding are available only in the long term, which means, when the interest amount starts earning an interest. And in your case, early planning will ensure that you can achieve your financial goals at the desired age.

Currently, you have the advantage of a low expense-to-income ratio. You can use this advantage to maximise your savings. The current surplus of income over expenses, of Rs40, 000, can be saved for the next 5 years, which can be further increased by another Rs30, 000 as your education loan gets over after 5 years.

For calculation purposes, we have not considered any increase to savings and not factored in any other expenses. The idea is to come up with an amount you can save, based on your current profile. These calculations can always be modified as you change your life goals with time.

Your total principal investments over the next 23 years (when you turn 50) would be: Rs24 lakh (Rs40, 000*12*5) + Rs1.51 crore (70,000*12*18) = Rs1.75 crore. This investment should become Rs5.46 crore, assuming an interest rate of 10%. This corpus can be used to provide for the NGO as well as the retirement corpus.

There are a few points in these calculations that should be kept in mind to get fuller understanding. First is the inflation risk. The corpus attained is the value at the end of 23 years from now, i.e., when you turn 50-years-old. This amount looks large now but with inflation adjustment it may not be large enough, and you also need to determine the rate at which you want this investments to grow.

To know this rate, you need to understanding your risk profile. If you want risk-free returns, you can look at the rate of bank fixed deposits (FDs). However, this rate also needs to be adjusted for taxes, based on the investor’s marginal rate of tax.

To get returns above the bank FD rate, you will have to take some risk. If you want higher returns, the risk too would be higher. A risk profiling will determine your risk appetite and capacity.

As age is on your side and you have a long-term investment horizon, your risk capacity is good. It is the risk appetite, i.e. how comfortable you are about taking risks and how you react to volatile situations, which will help in determining your asset allocation.

So, to achieve attractive inflation-adjusted returns, allocation to equity is needed. You need to decide how much you want to allocate to assets that involve risk.

The investments need to be done on a monthly basis, as you have a regular income, and you should invest via mutual funds. They offer schemes with both debt and equity assets.

For debt schemes, look for a combination of short-term as well as long-term debt funds. In equity, you can spread your investments in large-cap, multi-cap and mid-cap funds. You can also invest in hybrid schemes: a combination of debt and equity assets.

Surya Bhatia is managing partner, Asset Managers.

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