1. Ignoring inflation after retirement! Many online calculators are guilty of this. A part of the problem stems from the over importance associated with ‘pension’ and assuming it will be a constant number during retirement.
2. Assuming expenses will go down post-retirement! A 30- or 40-year old making this assumption when retirement is still a long way away is a humongous mistake! Some expenses will go down, and some will increase and there will be new ones for sure. The least safeguard to take is calculate based on current expenses. One can get a rough idea only when retirement is 5 years or so away.
3. Taking comfort in an average inflation of 6% Yes 6% is a decent number to start with. However actual inflation is notoriously difficult to estimate. So you should use as high a number as possible. At least 8% and if possible 10%.
4. Deciding equity exposure based on risk appetite. Equity exposure should be decided by how far retirement is and how much one can save. If I can save 75% of my salary for retirement I don’t need equity at all. If can save only 20% then I would need at least 60% equity exposure. The point is, for retirement the biggest risk is the risk of inflation. So one needs adequate equity exposure to combat this risk. The second biggest risk is shying away from equity based on unfounded fear. Volatility in return leading to short-term risk of capital is unfortunately the only way to achieve inflation adjusted capital appreciation. Read More: A Step-By-Step Guide to Long Term Goal-Based Investing
5. Ignoring tax on corpus and annuity/pension. If you are in the 30% tax slab right now chances are you will be paying at least 10% as tax when you retire. Investing in EEE instruments is great for a retirement corpus. Do keep in mind rules may change. No way you can account for future changes now but anticipation lessens the impact of the blow. If you are invested in non-EEE instruments you better factor in tax on corpus right now.
6. Assuming retirement age is fixed in stone. Never assume you are going to retire when you want to or have to. The future is uncertain. Your health is the most important investment. Ensure your fitness year-on-year and hope for the best. Of course you need to enter an age when you use a calculator. Understand that is an estimate like inflation. Remember to use the calculator every year! The road to retirement is as uncertain as how your retired life will pan out. By the way if you think staying fit is the key to good health think again. It certainly helps to stay fit. Rest is simply chaotic luck!
7.Assuming inflation will decrease after your retirement. Why? Because India will be a developed country by then! So said my grandfather I am told in the 60s! India has very few natural resources and heavily subsidizes its imports. It does not have a strong industrial economy and has a monsoon dependent agricultural economy. Under these circumstances I see no reason inflation will get to a comfortable low single digit number. The only practical safeguard is to assume it will hover around the lowest two digit number!
8. Overestimating returns, especially post-retirement. Expecting anything more than 12% returns from equity over a long term is crazy. The same as expecting 9-10% from debt instruments often ignoring tax. Don’t assume more than 7-8% pre-tax returns post-retirement. Yes it is important to invest in equity even after retirement. However, how much you can actually invest will become clear only after you retire. So don’t factor that in your expectations. Read More: How Achievable Are Your Financial Goals?
9. It is enough to save 15% of gross-pay each month. This is a myth made popular in the US where inflation hovers around 3-4%. Of course 15% is good for a start for a 22-23 year old. Depending on when you start and other parameters you would need to save anywhere between 70-100% of your monthly expenses. This is why it is important to keep away from debt and keep your housing loan EMI as low as possible. Read More: Should You Invest For Retirement as Much as You Spend?
10. Overestimating your salary growth. It is okay to assume that you will increase your monthly investment each year. However be practical in this assumption. Also factor in other expenses.
11. Over-importance to retirement calculators. Such calculators are like a night-lamp in a dark room. You get a rough idea of what is in the room. That is all. Don’t get too comfortable. Remember to stay alert.
12. Under-importance to retirement calculators. A bunch of people on the web (thankfully small) propagate the view that inflation is a hype created by insurance and investment companies to make people buy pension plans and that the huge corpuses generated by such calculators is just humbug! Thank God mathematics is absolute. It gives results based on the numbers you enter. No hype here. If inflation has not pinched someone they are probably comatose or dead.
Remember “If you want to make God laugh just tell him your plans”.
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