In this article, we discover what a 35-year-old reader who wishes anonymity should do to retire by age 55. He is married to a homemaker aged 30.
We shall plan for retirement income from when he reaches 50 to when his wife (or, generally, the younger spouse) reaches 90. Therefore, he has 15 years to invest and needs to plan for inflation-protected retirement income for 45 years.
What is inflation-protected income? This retirement income increases each year as per the family’s needs. It considers inflation in expenses as well as lifestyle modifications. Young earners should not think about constant income or pensions in retirement today. They should consider consistently beating inflation with an inflation-protected income (or inflation-indexed income). Read more: Generating an inflation-protected income with a lump sum.
What is financial freedom? The ability to generate inflation-protected income for a given number of years, preferably until the death of the youngest dependent. In this case, the reader’s family requires financial freedom for 45 years.
We shall use the freefincal robo advisory tool to create the retirement income plan. We shall consider 6% inflation before and after retirement. It is better to determine how much your expenses are increasing yearly and use that rate. You can use our Personal Inflation Calculator.
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Inputs and assumptions
- Monthly expenses of Rs. 50,000
- Another Rs. 50,000 annual expenses.
- Existing assets: Rs. 65 lakhs in stocks, mutual funds, and Rs. 50 lakhs in EPF
- The expected return from equity is about 10% (post-tax), and the return from EPF is 7% (this is after 15Y, so it is better to err on the side of caution).
Output:
- Average monthly expenses at the time of retirement will be about Rs. 1.3 lakhs.
- The total corpus required (excluding existing investments) is about Rs. 5 Crores!
- Factoring in existing investments, the net target corpus to be achieved is only Rs. 1 Crore. That is the power of starting early and accumulating a sizeable corpus by age 35.
- The monthly investment (including mandatory EPF or NPS deductions) is Rs. 27,000! If he can increase the investments by 10% a year, the initial investment will come down to Rs. 15,000!
To ensure the portfolio is adequately de-risked and the actual retirement corpus at any time is close to the expected corpus, the robo tool recommends a variable asset allocation, as shown below.
As the portfolio’s equity exposure decreases, so too does the expected net return from the portfolio. This is factored in from day one in the above calculation.
This is only one part of the retirement calculation. What about after retirement? The second part determines how the corpus will be divided into buckets. A retirement bucket strategy refers to how a retiree invests her corpus in different investments and tries to generate inflation-protected income.
The robo tool divides the retirement corpus into five buckets. That is, the retirement corpus will be divided into five parts. This is only one of many ways to construct a bucket strategy. This assumes 45 years in retirement.
- An emergency bucket to handle unexpected expenses. Example: 5%
- Note: The overall equity allocation from the entire corpus is only 35% after retirement.
- Income bucket that provides guaranteed income for the first 15 years of retirement. During this time, investments are made in the following three buckets.
- Corpus from a low-risk bucket that provides retirement income from year 16 to year 26. To provide this income, the low-risk bucket will have an asset allocation of 50% equity and 50% debt during the investment period (years 1 to 15 of retirement). This corpus weighs about 25%.
- Corpus from a medium-risk bucket will provide retirement income from years 27 to 35. To provide this income, this bucket shall have an asset allocation of 70% equity and 30% debt during the investment period (year 1 to year 27). This corpus weighs about 15%.
- Corpus from a high-risk bucket will provide retirement income from years 36 to 45. To provide this income, this bucket shall have an asset allocation of 100% equity during the investment period (year 1 to year 36). This corpus weighs about 9-10%.
- During this investment period, the buckets will be actively managed to reduce risk: rebalancing and profit booking from one bucket to another. To understand how this works, try The Retirement Bucket Strategy Simulator.
- After 15 years, the low-risk bucket can be turned into 100% debt and provide income for about 11 years. After that, the other buckets can also be progressively used. One can always customize this usage after retirement.
- Please note that bucket allocations will change as per the user inputs and are auto-determined by the robo tool.
Will the reader achieve financial freedom in 15 years and retire? Yes! They have done most of the hard work by accumulating a sizeable corpus. They also have some time on their side. They can retire comfortably in 15 years and fight inflation with disciplined investing and risk management.
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