I am sick and tired of fluctuating equity returns. Why can’t I use recurring deposits and fixed deposits to build my retirement corpus?
How would you answer such a question? I would say, Yes, you absolutely can do so!
To make my point clearer, let us run through a specific retirement corpus calculation. A more general account of how retirement calculators work can be found here.
Let us consider a 30 year old named Grouchy Smurf. His current yearly expenses are approximately Rs. 3, 60,000 (Rs. 30,000 per month). He belongs to the 30% tax bracket. His retirement is about 30 years away, and he wishes to plan for a retirement corpus that will last up to age 90.
Assuming his expenses will increase each year at an average rate of 8% throughout his life, he would require a little more than 3.25 Lakhs each month in his first year of retirement! Subsequently this sum should increase each year by 8%.
If he is able to source recurring deposits and fixed deposits that offer at least 8% p. a. throughout his lifetime*, then the effective post-tax return is 5.53%.
(*) Those witnessing rate cuts for the first time, will also realize how far-fetched this assumption is!
Over a 60 year period (30 years before and 30 years after retirement), it may be practically impossible to get recurring/fixed deposits that offer 8% each year. However, since there will be years in which Grouchy maybe able to lock onto interest rates much higher than 8%, we will roll with this assumption and see where it leads us.
With the above assumptions, Grouchy would require a whopping 16.75 Crores to ensure he is financial independent for 30 years after retirement!
With 5.53% post-tax return, Grouchy will need to invest about Rs. 48,000 per month and increase this sum by about 10% each year until he retires.
If Grouchy can manage this, he can plan his retirement with recurring and fixed deposits without breaking his head over fluctuating equity returns.
In fact,he can do much better than this if he started a SIP in a liquid fund or even an arbitrage fund. These would offer much better (post-tax) returns with practically insignificant risk over a 30 year period. So clearly there is no need to worry about finding high interest (in this case 8%) RDs and FDs.
Therefore, the most important question to ask Grouchy is: can he manage to (initially) keep aside 48,000 per month for retirement?
If he cannot, what are his options? I will leave it to you to make suitable inferences.
The power of compounding depends on three factors: time, investment amount and returns, in that order.
- If I can start investing early for my goals,
- If I can invest quite a bit of money each month (in Grouchy’s case a 160% of his current expenses!!) then,
- I can afford to choose an instrument with low volatility, at the cost of securing a lower, but assured return.
Of course a prudent investor will choose much better instruments to secure higher returns. My point is, starting early and investing as much as possible is more important than running after ‘high' returns.
- The contended investor recognises that A frugal lifestyle is the only guaranteed means of beating inflation.
What do you think?
Post script: Grouchy Smurf is one of my favourite cartoon characters. Although I won’t do it, I can now almost afford to plan my retirement with fixed income instruments.
Need help in planning your retirement? Choose from a wide variety of retirement calculators suitable for all ages!
Want to know the return required for a given investment amount, use this four-part series on goal-based investing.
- Can You Think Of A Risk-Free AND Tax-Free Mutual Fund?
- Comprehensive Fixed Deposit Calculator - I: Total and Advance Tax Liability
- Debt Mutual Fund vs. Fixed Deposit Comparator - Version II
- Debt Mutual Funds vs. Fixed Deposits: Volatility Simulator