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

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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:

CountryCentral Bank Rate
United States2.250 %
Australia1.000 %
South Korea1.500 %
Great Britain0.750 %
Canada1.750 %
Denmark0.050 %
Europe0.000 %
Hungary0.900 %
Israel0.250 %
Japan-0.100 %
New Zealand1.000 %
Norway1.250 %

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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About the Author M Pattabiraman author of freefincal.comM. Pattabiraman(PhD) is the author and owner of freefincal.com.  He is an associate professor at the Indian Institute of Technology, Madras since Aug 2006. Pattu” as he is popularly known, has co-authored two print-books, You can be rich too with goal based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management.  He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. Pattu publishes unbiased, promotion-free research, analysis and holistic money management advice. Freefincal serves more than one million readers a year (2.5 million page views) with numbers based analysis on topical issues and has more than a 100 free calculators on different aspects of insurance and investment analysis. He conducts free money management sessions for corporates  and associations(see details below). Previous engagements include World Bank, RBI, BHEL, Asian Paints, TamilNadu Investors Association etc. Contact information: freefincal {at} Gmail {dot} com (sponsored posts or paid collaborations will not be entertained)
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11 Comments

  1. Hi Brijesh,
    Nice new outlook to be aware of by people deciding to retire early considering the present interest being paid by banks, etc.
    However, i have the following observations in your write-up which have not been considered…..
    1. Those who were 55 years in 1993, the life expectancy in India was 60 years. Most of them would be up in the heaven long before now. It is possible that a 10 – 15% still tick on.
    2. The initial years from 1993 to now would have seen the corpus rise continuously till 2008 or so and would have started decline. Would have lasted till about 2019 or 2020.
    3. All those who are 80 years or so do not go to hotel to celebrate their own birthdays to eat Masala Dosa and Coffee. Even if they do, it would be with others and therefore the cost would for at least 5 or 6 persons.
    4. When interest rates fall even the annuities and other related returns are set to follow them. Not to talk of inflation!
    5. Those countries where you have mentioned in the list about interest being low has -ve or NIL inflation.
    6. When the inflation is low, even the expenses would tag in those line.

    However, not to take the trophy away from you for thinking differently, kudos to you. Yes, this can also be kept in mind and workout different scenarios before jumping into the “Early Retrirement” bandwagon like me!

    ps: I am sure the Pattu’s mind is racing to get a calculator in place with historical data and projecting them into the future and see how much the corpus would need to be accumulated using various scenarios….

  2. An Eye-Opener for the younger generation, especially for those dreaming of early retirement after reading so many things about money compounding. However, I personally think that in the last paragraph you should definitely have hinted about investing in Equity to really see the actual compounding.

  3. Good article to highlight influence of Inflation All Around in Retirement years.
    But a holistic or alternate view of investment at time of Retirement in 1993 could have created miracles,But may be that would be a sequel to this post.
    No doubt ,better to be safe than sorry.
    Being 57 years of age ,fully appreciate facts described as I have been witness to it.

  4. I’m not sure what you mean by fixed deposits. It would be rare for a US retiree to have a portfolio that wasn’t a blend of stocks and bonds. Usually about 50% of each. Is that not typical for Indian retirees as well?

    1. Stocks or Equity/Index MFs in an Indian retirees portfolio is completely Atypical. Most (95%) will have zero equity exposure and 100% invested in Fixed Income even today, which of course is the problem Pattu is trying to highlight, apart from the fallacy of assuming that current interest rates will continue into the future. Sadly along with the interest rates the inflation too was at 12% levels in the mid 90’s so it was no paradise even then.

      1. Thank you, like many Americans I am embarrassingly ignorant when it comes to other cultures but I asked because it was a chance to learn and I appreciate you responding!

  5. I just did retirement withdrawal calculation with above figures mentioned in article.
    Initial Corpus 12,00,000
    Rate of Interest 10
    Inflation Rate 8
    First Year Annual Expenses 60,000

    At the end of the year 2008, the corpus left would be around 20 lakhs after deducting expenses with inflation.

    In current year 2019, the corpus left would be 3.6 lakh and expenses would be 4.43 lakh. So, the corpus would be vanished by next year.

    Total years in retirement will be around 27 years till the corpus lasts.

    The initial corpus was just 20x of total first year annual expenses so it couldn’t last for 30 years.

    If the corpus was between 25x to 30x which many people consider as a basic FIRE figure, the person could have survived easily for 35 to 40 years.

    I have done above calculation from 1993 so the rate of return is considered 10% on an average.
    Rate of return will be same as inflation for a person retiring today. Real rate of return will be 0 in today’s terms.

  6. I think this article is an eye opener for people thinking about retiring early like in their 40s. Surely they will maintain their current lifestyle into their 60s, so the chances are there will be trouble then.
    But if you are late 50s, then the lifestyle will not be the same in your 70s and 80s. This is particularly true if you have a prudent lifestyle today. Your mobile phones will last much longer, your diet will change for the better (else you will not live long) and you will not take those leisure trips often.
    In any case it’s better to be safe than sorry with your estimations.

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