What return should a 30-year-old investor aim for their retirement portfolio?

Published on / By M. Pattabiraman Twitter: @pattufreefincal

Published: January 23, 2021 at 10:54 am

Last Updated on February 12, 2022 at 6:14 pm

Let us discuss a question received a few days ago: “What return should a 30-year-old investor aim for their retirement portfolio?” Retirement is assumed to be a good 25 years away.

The first step of having a clear goal: Why the money is needed and when it is needed is already part of the question. So 25% of the question is already answered! I have seen investors in personal finance questions ask questions like, “What return can I get from equity over three years?”. If you tell them three years is too risky, they would immediately say, “ok over five years, repeat the answer, and they would go, ‘ok over 10 years” without clarity on the why and when no investment planning can be done.

The second step is to recognise inflation. Long term inflation in India if we consider no additional expenses is at least about 6%. If we consider lifestyle changes (good or bad), then 7-8% inflation is a safe bet. It is possible that it can decrease in future (and retail inflation has) but, considering we import fuel – one of the key overall inflation drivers, it is better to err on the side of caution and assume at least 7%.

The third step immediately becomes clear: what should be our target portfolio return after-tax: Technically it can be 5% or 7% or 9%, but it should be obvious that lower the return expectation, more would be the investment required to reach the target corpus.

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  • Inflation is the benchmark. Our portfolio return after tax over the next 25 years should at least match inflation. To avoid depression results, we will assume an inflation of 7% and an overall portfolio return of 8%.

The fourth step is to plan an asset allocation for this return. For this, we must have some return expectation from different asset classes. It is impossible to get 8% post-tax return from fixed income asset alone. Over the next 25 years, we can expect PPF to inch below 7% at the very least. EPF may still theoretically give 8%, but if they keep at it, they will credit “annual” interest once in about five years and exploit their Ponzi nature: Delay in EPF interest payment: Is there a loss to the subscriber?

The point being, fixed income alone is not sufficient, and the return from the fixed income should be assumed to be considerably lower: 6% post-tax is a reasonable assumption as of now – meaning these estimates should be revised each year.

A safe assumption for long-term return from equity would be 9% after tax. Why? See:

Some people react, “If I am going to have to expect only 9% over equity over the long term, might as invest in high-return bonds or FDs”. The risk, particularly hidden risk, is incredibly high here. If the stock market crashes, there is an excellent chance it will eventually recover. If a corporate FD or bond defaults, you might kiss your money goodbye (unless it has Ponzi powers like EPF which defaults on its debt every year like clockwork).

The fifth step is to decide the initial asset allocation mix. Suppose we decide on a 50% equity and 50% fixed income portfolio  – this works quite well: see: Will Benjamin Graham’s 50% Stocks 50% Bonds strategy work for India? – then the overall portfolio return (our aim) is:

[50% x 9%] + [50% x 6%] = 7.5%

This may be disappointing to many, but please recognise this is not the annual return on your portfolio. This is the expected overall portfolio return after 25 years (in this case) which is not bad.

Of course, when we project it in on a spreadsheet the 7.5% will be an annual return, but annual equity returns easily fluctuate from -50% to 150%, so it important not to take that projection too seriously.

A few good years for equity, combined with regular rebalancing and systematic increase in investing will reduce our dependence on X% or Y% returns. It will take a few years. Got to hang in there.

The key is, if we expect less, it is easier to avoid disappointment with simple annual reviews and rebalancing.

The word “initial” is in bold red because we will have to plan an equity de-risking strategy – this can be automated with the robo advisory template.

The sixth step is to find out the retirement corpus required. That is we need to either use a retirement calculator or build one ourselves. You can refer to this detailed guide: Find out how much you need to retire in 15 mins: build your own calculator!

Before we do this, it is important to appreciate that the investment amount required will be higher than we can afford. This is a law of nature. There is no need to worry. We need to put our head down an increase our investments as much possible, at least increase at the rate of inflation, but a bit higher say 10% would be near-ideal: Why increasing investments each year is crucial for financial freedom.

Note to the newbie: We are six-steps in, and still not discussed any products. If we plan first, the product categories can be derived from the plan. If we look for products first, either we change the plan to fit the product or spend years undoing past mistakes.

“How to run a marathon?” asked the newbie to the Guru.
The guru said: “you need to train for many months. Starting with short distances and then gradually increasing the distance.”
The newbie said angrily, “that is fine. Just tell me how to run a marathon?” The guru fell at the newbie’s feet, said ‘ok’ with folded  hands and blocked the newbie (ran away).

The seventh step is investing. Where should I invest that 50% equity? There are many choices, but the simplest would be a Nifty 50 index fund. The 50% fixed income for the salaried can be EPF, PPF, VPF, NPS (with little or no equity).

The eighth step is the annual portfolio review. Initially, a simple asset allocation check and rebalancing are enough. If you want some inspiration, check out  reader reviews:

The ninth step is to ask, “what is missing in this plan?”. This free seminar is a good starting point: Basics of portfolio construction: A guide for beginners.