A retirement plan is a road map that helps you understand, plan and prepare for a financially independent life post-retirement. Well, that is what it is supposed to be!
Unfortunately, each person’s retirement roadmap is unique. While past and peer experience can aid to a certain extent, it is entirely up to us to chart our course with a few guiding principles and a generous dose of commonsense.
The bad news does not stop there! The guiding principles of retirement planning themselves have severe limitations!
- Planning with an average inflation of say, 8%, while actual inflation can be and is preposterously high.
- Assuming that one will an average return of 14% from equity
- Assuming debt instruments will not be volatile,
- Assuming PPF and long term capital gains from equity will be tax-free forever
- Ignoring tax on pension/annuity etc. etc.
These limitations on the numbers associated with a retirement plan/calculation are disturbing but unfortunately inevitable.
We do need some foothold after all. Besides, most people simply cannot afford to plan their retirement with an inflation of 10% and equity returns of 10%. Never mind that these are assumptions that are more realistic.
If you do not understand what I am trying to say, use 10% for inflation and 10% for equity returns on any retirement calculator (any of mine for instance!) and see what you get!
While we must be aware of such limitations, there is no need to lose sleep over them.
None of the above-mentioned factors will influence your retirement planning as much as YOU would!
Yes, you, me …. Us!
A retirement plan is founded on one crucial assumption that we often ignore with time. The calculation is based on your current expenses and therefore lifestyle. The idea is to determine the amount of corpus/nest egg need to provide a post-retirement income proportional to your current expenses and therefore present lifestyle. We assume this income would increase with some reasonable rate of inflation each year in retirement. The key requirement is that the retirement corpus should at least last as long as the individual.
All very well to state this on paper and compute it mathematically with reasonable assumptions. What most people fail to realize is that the key requirements of a retirement corpus intended for a future lifestyle, imposes constraints on the individuals present lifestyle.
What constraints, you ask? Well, the retirement calculation assumes that your present lifestyle will change each year … but only at an average rate of inflation (should be chosen as high as possible).
Suppose we believe in constantly ‘upgrading’ our car, television, mobile phone etc. every few years; suppose, over the years, we develop more and more expensive tastes (clothing, accessories etc.) and habits, it is quite likely that our annual expenses increase at a rate much greater than assumed inflation. Unfortunately, these additional expenses would increase with inflation too!
Most people do not realize that many so-called one-time purchases come with regular expenses tagged! One common example is maintenance charges and other expenses associated with a bigger house (often got with a second home loan!)
Nothing wrong with this, everyone wants to enjoy the pleasure of life as they earn more. However (there is always a however!), any increase in annual expenses (other than that caused by inflation), must be immediately taken into in the retirement plan.
Of course, an increase in annual expenses obviously means we need to invest more each month for building a bigger retirement corpus to account for our present lifestyle.
Why, you ask? Well, let us see.
Suppose you are now using an Apple I-phone 5 or Samsung Galaxy S4 (perhaps you are reading this post in one of those!), what phone would you like to use when you retire?
The I25, S24 or perhaps would you settle for the future cousin of the Nokia 1100, because you are retired?
If you had to settle for a 1100 variant, are you likely to be pleased as punch?!
It is obvious that a retirement plan that allows a present smart phone user to afford only a 1100 variant could hardly be called as successful.
The point is, we will have to recognise that most lifestyle changes are difficult to reverse and factor that while planning for retirement.
If we do not, it is almost certain that our future lifestyle will not be as comfortable as our present one.
Therefore, beware of you!
You are in control of your destiny. The choices that you make today can influence your future in ways you cannot possibly imagine.
An upgrade in your lifestyle must be accompanied by an appropriate upgrade in your investment earmarked for retirement.
If not, you can safely consider your retirement plan a failure and YOU are responsible for it.
Therefore, beware of you!
Update: My 1616 broke down. So I now own a Nokia 105.
pps. I can certainly afford an Apple I5 now and am reasonably sure that I would be able to afford the Apple I25 when I retire. Simply because I make sure, I invest for retirement as much as I can, certainly much more than I spend. I am unlikely to buy either model 🙂
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