If you are in your 20s and 30s, you may assume that retirement is far away. However, planning for it at the beginning of your career can help you reap the benefit of compounding, making your money work harder. There are two parts to retirement planning – estimating the requirement of post-retirement expenses and planning to accumulate the amount. If you are planning to work out your retirement kitty, here is how you should do it.
Start by calculating your current expenses under different heads. Then, discount for those heads that will not exist in retirement. For example, loan EMIs, insurance payments and children’s education cost will not exist after you retire. Make a judgement of what expenses will get added, for example, medical expenses, travelling and hobbies. All of the above judgements are as the costs would be if they existed today and on a per annum basis.
Next, calculate the costs as they will exist at the time of retirement by applying the relevant rate of inflation. For example, general inflation could be assumed at 5% per annum. Calculate these costs for every year of retirement, using the same inflation rates as above. Once you have the expected cost of living for every year of retired life, each of these can be discounted by the expected rate of return from investing and summed up to complete the estimation of the corpus required for retirement. Once the required corpus, available time, and other resources available are known, you can calculate the required monthly investment to reach this amount.
But how do you calculate inflation while planning for a long-term investment amount, say, for 30-35 years? The calculation of inflation needs to be taken as an average of the past. In India, the inflation as of now is 3.05% but in the past, it has gone as high as 11.75%. But assuming the economy will improve and the inflation should be low, an amount of 5% can be taken for future value calculation.
Still confused how to do it? Here’s a quick illustration: For a person aged 30 years, her estimate of post-retirement expenses, as they would exist in today’s terms, is ₹6 lakh per annum. Let’s assume her retirement age is 60 years and life expectancy is 80. Assuming inflation at 5% per annum and expected returns from investing at 10%, the expense of ₹6 lakh would become ₹25.9 lakhs once she turns 60. From 60 till her life expectancy, the expense of ₹25.9 lakh will be required every year increasing at 5% per annum. Discounting the expenses for the 20 years would form a required corpus of ₹3.4 crore. To reach this corpus, an investment of ₹16,500 per month will be required.
Hence, in case of long-term goals start by first calculating your expenses. Once you know your total expense, factor in the average inflation for the period you need the money. Once you know how much you need to meet expenses during your retirement period, you can then look at investment instruments after factoring in your risk appetite. If you are a conservative investor, your portfolio is likely to be tilted towards fixed income products. In case you are an aggressive investor, your portfolio is likely to be exposed more towards equity.
Nitin Vyakaranam is founder and chief executive officer, Arthayantra Corp Pvt Ltd