Do not make these mistakes while planning your retirement!!

Do not make these mistakes while planning for retirement

Published: October 3, 2019 at 10:56 am

Last Updated on

A lot of people start contemplating retirement because a ‘back of the envelope’ calculation shows them that they now have created a corpus high enough to meet their annual expenses. Fed up of the high-stress job, fed up of grinding away alone in ‘Gulf’ with family back in India, having built a home, children now almost independent, they plan to come back / retire, put the money in an FD, and live out of the interest earned – Happy retired life. This post is meant to give a perspective of what is in store for them.

This is a guest post by Brijesh Vappala, a SEBI registered fee-only financial planner and member of my list of fee-only financial planners. To know more about Brijesh, you can consult his first guest post:  A high income will not make you RICH!! He followed this up with solutions: Worried about finding money for your goals? Here is a simple way out. If you would like to work with Brijesh and get your money management in order, please contact him via his website: bvare.com. Now over to him.

Before proceeding, please answer this question – “What is the interest % on Fixed Deposits that you get in India?” The figure that you might now have in mind will be somewhere around 7%. We are in 2019. Let’s for a moment, assume that we have a time machine at our disposal. And in that time machine, let’s travel back 25 years to the year 1993.

Had I asked the same question to someone in 1993, what do you think the answer would have been? The response would have been in the range of 12% to 14%. Refresh your memory if you are old enough or ask somebody older if you are not.

Now let’s assume that a person decided to retire in 1993. He was 55 years old then. He calculates his monthly expenses to be Rs.5000/-. (Yes. In a non-metro city in India in 1993, a person with their own home, with non-dependent children could lead a reasonably comfortable life with Rs.5000/- per month)

Rs.5000/- per month means annually he would need Rs.60000/-. He now checks his corpus. He has Rs.1200000/- saved for retirement. Even though he knows that the interest rates are in the range of 12% to 14%, he conservatively assumes only 10%. Which means he will get Rs.120000/- as income per year. Rs.120000/- income Vs Rs.60000/- expense. Income is almost double the expenses. Conservative estimate. No risks involved.

The decision was taken. Retired. That 55-year-old person then will be 80 years now and still living. Many of them would be. Now let’s come back to 2019 and look at the graph below.

inflation vs income from 1993 to 2018The red line is how his annual expense has progressed between 1993 and 2018 considering the actual inflation figures released by the Government for each of the years during this period. To maintain the lifestyle worth Rs.60000/- in 1993, he would have needed Rs.3.15 Lakhs in 2018.

The blue line is the income he would have received in each year between 1993 and 2018 considering the actual interest rates in India during each year. The corpus of Rs.1200000/- which earned him Rs.132000/- in 1993 would have earned him only Rs.87000/- in 2018.

(Rate considered is the highest rate prevalent for any calendar year offered by State Bank of India. Senior citizen special rate has not been considered. That 0.5% would not have made any material impact on the outcome of the graph anyways.)

Let’s now use the same time machine to travel 25 years ahead into the future. Year: 2044. In the year 2044, what do you think the state of India would be? Would we be living in a more developed country than now or vice versa?

If this question brings any political perspectives to your mind, that is not my intention. Between 1993 and 2018, India has been governed by a multitude of political coalitions and in spite of that, the developmental direction pointed only one way.

Going by that, we have reasonable cause to believe that India in 2044 will be a much more developed country – irrespective of who rules in between.

Now, when a country becomes developed, what do you think happens to its’ inflation and interest rates? While the reasons are beyond the scope of this post, the general direction is that inflation and interest rates are likely to come down as the country develops.

Let’s look at the current Central bank interest rates in some of the developed countries:

Country Central Bank Rate
United States 2.250 %
Australia 1.000 %
South Korea 1.500 %
Great Britain 0.750 %
Canada 1.750 %
Denmark 0.050 %
Europe 0.000 %
Hungary 0.900 %
Israel 0.250 %
Japan -0.100 %
New Zealand 1.000 %
Norway 1.250 %

The question that you probably want to ask now is “Are you saying that the interest rates in India would be 1% – 2%!!”

The person who retired in 1993 would have asked a similar question if someone had told him in 1993 that the interest rates in India would be around 7%, a couple of decades later. This is the impact of recency bias.

While we cannot predict what would be the interest rates in 2044, at least the direction should be clear for us. (There may have been exceptions in some countries, but in our own interest, it will be wise to expect the rule than hope for the exception).

In the above example, we considered only 25 years. In the current reality, considering early retirement and long life spans, a post-retirement life can stretch into 35-40 years. The impact is self-explanatory.

The above figures itself can make people who are contemplating early retirement, rethink.

Let me add two more points relevant to this subject.

1) The divergence between official inflation and on-ground inflation:

The inflation figures used in the graph above are government released figures. In reality, the on-ground inflation which we face is 3-4% higher than this. Presently, though the official inflation rate is around 4%, we assume 7-8% as on-ground inflation.

If I re-work the above graph considering the on-ground inflation by adding 3% to the inflation rate each year, it will look like this.

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inflation vs income from 1993 to 2018 with real inflation added

To maintain the lifestyle worth Rs.60000/- in 1993, he would have needed Rs.6.3 Lakhs in 2018 considering real inflation against an income of Rs.87000/-.

2) “Just Inflation” Vs “Lifestyle Inflation”:

The above graphs assume that the same lifestyle is followed. In reality, this is not so.

Let me explain this with an example:

In 1993, let’s assume that your family’s concept of a birthday party was having an evening outing in your town’s most famous restaurant.

Family of Four. 1 Masala Dosa and one filter coffee each. Masala Dosa – Rs.20/- each, Filter Coffee – Rs.5/- each. Rs.25/- per person. Rs.100/- for the family.

In 2018, the restaurant is still there. Price of one Masala Dosa has now become Rs.60/- and that of filter coffee has become Rs.20/-. Per head Rs.80/-. Total Bill – Rs.320/-.

This is “Just Inflation”, and the above graphs accommodate this.

But, what if now the concept of a birthday for your family is an outing to Barbeque Nation? Family of Four. Total Bill – Rs.2500/-.

While the increase from Rs.100/- in 1993 to Rs.320/- in 2018 was “Just Inflation” the difference between Rs.2500/- and Rs.320/- is “Life Style Inflation” which is apart from what the graphs above are showing.

You can’t be blamed since there was no Barbeque Nation in your town in 1993. If you look around, you will see many similar conveniences, lifestyle changes which were not there a couple of decades ago.

As the country develops, as the cities become smarter, you will see many such amenities adding up in the decades to come. All of these are going to add to your expenses.

This post is not intended to frighten a person of his retirement life. But to ensure that these aspects are kept in mind so that the decisions become more considered.

While calculating the retirement corpus, the future living expenses after inflation and the resultant corpus needed to sustain the lifestyle post-retirement often look overwhelming. The figures look too high to be true. Sometimes, we might start thinking whether we would really need that high an amount or are we just being paranoid.

The high figures will no longer look high over the years. Refusing to accept this reality will only make us ostriches trying to hide our heads in the sand.

Sources:

1) Historical Inflation Rates

2) Historical FD Rates of SBI

3) Global Interest Rates

Also, by Brijesh: A high income will not make you RICH!! and Worried about finding the money for your goals? Here is a simple way out. If you would like to work with Brijesh and get your money management in order, please contact him via his website: bvare.com.

 

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