Understanding How Retirement Calculators Work

Published: August 16, 2014 at 10:17 am

Last Updated on

The first brush with a retirement calculator is typically memorable, if not unforgettable(!) for pretty much all investors – including ones who do not take them seriously.

The typical responses would be,

  • ‘Why do I need such a huge corpus for retirement?’
  • ‘How do you expect me to invest this high an amount each month?’

Here is how retirement calculators go about calculating the corpus and monthly investment required.

For ease of understanding, I will consider the case of a 55 year old man, 5 years away from retirement. You can input desired values in the attached Excel sheet.

Haddock
Photo Credit: Que Sera Sera

So here goes,

Name: Captain Haddock

Age: 55

Years to retirement: 5 (age 60)

Year in retirement: 5 (He does not expect to see his 65th birthday, thanks to a livelong association with the bottle!)

Current annual expenses:  Rs. 5,00,000

Inflation: 10%

Net post-tax rate of return from the Captains portfolio (equity + debt): 10%

Annual increase in monthly investment: 10%

 

how-retirement-calculators-work

Expenses in the 1st year of retirement:

Age 60

Expenses: E1 = Rs. 8,05,255

Let us treat this as an independent goal.

Captain Haddock must invest an amount X1 so as to have Rs. 8,05,255 after 5 years with a return of 10% and monthly investments increasing each year by 10%.

X1 = Rs. 8,333 (see image; ignore right most column)

Expenses in the 2nd year of retirement:

Age 61

Expenses: E2 = Rs. 8,85,781

Treating this again as an independent goal, we determine the amount of investment required, X2  (10% return, monthly investment increasing each year by 10%)7

X2 = Rs. 9,167 (see image; ignore right most column)

Similarly,

E3 = 9,74, 359 and  X3 = 10,083 (expenses for 3rd year in retirement)

E4 = 10,71,794 and  X4 = 11,092 (expenses for 4th year in retirement)

E5 = 11,78,974 and  X5 = 12,201 (expenses for 5th year in retirement)

The total initial  monthly investment required is,

X1 + X2 + X3 + X4 + X5  = 50, 876 (see image; two red rectangles)

This investment is assumed to increase each year by 10%.

The total corpus requires is,

E1 + E2 + E3 + E4 + E5  = 49, 16,162 (see image; two blue rectangle)

This is the corpus required if is not invested anywhere.

Thus in the above scenario, each year in retirement is treated as an independent goal.

Obviously, we can do better than this.

The corpus is invested so that it earns a net post-tax return of 10% (for the sake of illustration!), and at the start of each year in retirement, a sum equal to the expected monthly expenses is redeemed. The rest of the corpus is allowed to grow.

For example, at the start of the first year, a sum, E1 = Rs. 8,05,255 is redeemed. At the start of the second year, a sum, E2 = Rs. 8,85,781 is redeemed and so on.

At the end of the 5th year in retirement (the duration assumed in the example), the corpus is reduced to zero (black rectangle in the image).

Using these assumptions, the corpus required is back-calculated to be Rs. 40,26,275 (orange rectangle in the image).

Notice that the corpus

Has reduced from 49, 16,162  to 40,26,275. Obviously because Captain Haddock now choose to invest the corpus!

Play around with this calculator with more relevant numbers to get a feel for how retirement calculators work.

Download the Year-on-year Retirement Calculator  (a. xls file after a long time!)

Do share if you found this useful
Share your thoughts on this topic at the  Reddit freefincal_user_forum

Reach your financial goals like a pro! Join our 1600+ Facebook Group on Portfolio Management! You can now reduce fear, doubt and uncertainty while investing for your financial goals! Sign up for our lectures on goal-based portfolio management and join our exclusive Facebook Community. The 1st lecture is free!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (will work with any index!) or you buy the new Tactical Buy/Sell timing tool!
About the Author Pattabiraman editor freefincalM. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman 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. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association. For speaking engagements write to pattu [at] freefincal [dot] com
About freefincal & its content policy Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on developments in mutual funds, stocks, investing, retirement and personal finance. We do so without conflict of interest and bias. Follow us on Google News Freefincal serves more than one million readers a year (2.5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified from credible and knowledgeable sources before publication. Freefincal does not publish any kind of paid articles, promotions or PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications

You Can Be Rich Too with Goal-Based Investing

You can be rich too with goal based investingPublished by CNBC TV18, this book is meant to help you ask the right questions, seek the right answers and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now. It is also available in Kindle format.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want Gamechanger: Forget Start-ups, Join Corporate and Still Live the Rich Life you wantThis book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at low cost! Get it or gift it to a young earner

Your Ultimate Guide to Travel

Travel-Training-Kit-Cover-new This is a deep dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, how travelling slowly is better financially and psychologically with links to the web pages and hand-holding at every step. Get the pdf for Rs 199 (instant download)
Free android apps