Last Updated on November 8, 2024 at 10:03 am
We break down the retirement planning process into nine simple steps for a beginner to get started. We shall assume retirement is 25 years away.
Step one: Have a clear goal: Why the money is needed and when it is needed are 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 ten years”, without clarity on the why and when no investment planning can be done.
Retirement planning seems like a simple enough goal, but our needs and aspirations change over time. So retirement planning is not a one-time process. It is a yearly activity that can be completed in about 15 minutes once the essentials are in place.
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The second step is to recognise inflation. If we consider no additional expenses, long-term inflation in India 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% before retirement and 6% after.
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 the lower the return expectation, the more would be the investment required to reach the target corpus.
- Inflation is the benchmark. Our portfolio return after tax over the next 25 years should at least match inflation. For a start, we will assume an inflation of 7% and an overall portfolio return of 8%. These numbers will change down the line.
The fourth step is to plan an asset allocation for this return. For this, we must have some return expectations from different asset classes. Getting an 8% post-tax return from fixed income assets is impossible. 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: Delay in EPF interest payment: Is there a loss to the subscriber?
The point is that fixed income alone is insufficient, and the return from the fixed income should be assumed to be considerably lower: 6% post-tax is a reasonable assumption for now, but these estimates should be revised each year.
A safe assumption for long-term return from equity would be 9% after tax. Why? See:
- What return can I expect from a Nifty 50 SIP over the next ten years?
- Do not expect double-digit returns from Nifty Next 50 index funds!
- Nifty 50 SIP Returns Jump up by 7%, but the returns trend is opposite to price!
Some people react, “If I am going to have to expect only 9% over equity over the long term, I 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 is 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 that this is not your portfolio’s annual return. This is the expected overall portfolio return after 25 years (in this case) which is not bad.
Of course, when we project it on a spreadsheet, the 7.5% will be an annual return, but annual equity returns easily fluctuate from -50% to 150%, so it is important not to take that projection too seriously. See: My retirement equity MF portfolio return is 2.75% after 12 years!
A few good years for equity, combined with regular rebalancing and a systematic investment increase, will reduce our dependence on X% or Y% returns. It will take a few years. Got to hang in there. See The 2016 Personal Finance Audit: Returns do not matter!
The key is, that 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 tool.
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. This is a guide for building a basic calculator: Find out how much you need to retire!
Or you can use the robo advisory tool by including your existing investments, pension or income sources, an asset allocation schedule and a post-retirement bucket strategy with income flooring or annuity laddering features.
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 and increase our investments as much as 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 have 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 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, and NPS (with little or no equity).
The eighth step is the annual portfolio review. Initially, a simple asset allocation check and rebalancing are enough. I do this each December: Portfolio Audit 2021: How my goal-based investments fared this year.
If you want some inspiration, check out reader reviews:
- How Suhas tracks his MF investments and reviews financial goals.
- How Avadhoot Joshi evaluates his investment portfolio.
- How a single mom is on track to financial freedom
- How Gowtham started goal-based investing & took control of his money
- Why my financial independence & early retirement plans were postponed by four years?
The ninth step is to stay the course. Have the conviction to stick to the plan and stay disciplined. It would seem like not much has been happening for many years but hang in there. Equity returns are not uniform. Sometimes it will pour, and sometimes it will be dry. We must keep investing during the dry periods to change our lives when it pours.
Watch The simple secret behind investing in equity.
This free seminar is also a good starting point: Basics of portfolio construction: A guide for beginners.
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Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter(X), Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3,000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
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