Archive for retirement planning

Planning for a financially secure retirement – why?

May 8, 2008 at 10:29 am · Filed under Financial Planning Process, financial planning, retirement planning

The moment we join employment force, be it on hire or self employment, the retirement clock starts ticking.  We are certain that we retire from employment after several years.  Also, those of us who are employed know the year in which we retire by default.  Some may choose to retire early and some may be willing to accept extension of retirement age through contracts. This implies that we have ample time to plan for this important event in our life.

 

While it is important to know how to plan for retirement, it’s equally important to understand why to plan for retirement.

 

Once up on a time, Government job was much sought after for retirement benefits it entailed.  How times have changed!  Under the current dispensation, a government employee has to contribute her money for retirement fund, similar to a private sector employee.  Job related social security benefits like provident fund, family pension and gratuity will never be able to fund substantially the retirement corpus.

 

Modern health care and increased financial resources have contributed to increase our longevity.  We not only live longer than any time in our history and lead an active life too – so much so that our retirement life would be longer than our period of employment.  So we have to fund a longer retirement period through shorter earning period!

 

Then there are unforeseen medical and long term care expenses.  Old age typically brings medical problems and increased healthcare expenses. We may also would like to pass on inheritance to our children.  Without a well planned retirement corpus, we may be forced to sell off the assets to generate the required cash; even worse we may become financial burden to our children during old age.  Many families have adopted single child policy and this makes us even more vulnerable during old age.

 

Last but not least, inflation has a killer effect on our standard of living.  If not taken in to account while planning retirement needs, inflation will punch holes to our best plans.

 

Who does not want retire comfortably?  But we need to find out what is “comfortable retirement”?

The goal of Retirement Planning is to allocate the financial resources available so that we can plan for a financially secure retirement.

 

After understanding ‘why’ of retirement planning, let us look at ‘how’ of it.  When we start planning our retirement, we have to answer the following questions:

 

Ø  How Much Will I Need?

Ø  Where Will My Money Come From?

Ø  How To Investment For Building A Nest Egg?

Ø  What Are The Tax Implications And Effect Of Compounding

Ø  What’s Importance Of Asset Allocation And Diversification

Ø  How To Review And Perform Course Correction

A Certified Financial Planner is specially trained to look in to our financial future and plan for such eventualities.  He has the wherewithal to peek in to the likely future based on our risk appetite, time horizon, existing asset base and such several variables.

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A portfolio for a salary earner

January 7, 2007 at 8:19 am · Filed under financial planning, investment planning, mutual funds, retirement planning

Is it difficult to become a millionaire? I am not talking about dollars but Indian Rupees. If you save every year a lakh of rupee and invest that amount in such a way that it earns a return of 8% every year, you will become a rupee millionaire (Rs.10.63 Lakhs actually) in about 8 years. If you extend this calculation further, how much you would have accumulated had you started investing at age 30 and continued upto retirement at 58 years? The answer is Rs.1.04 Crores. Astonished? It simply is the power of compounding which makes you a millionaire many times if you save Rs.1 Lakh every year and invest the same at 8% year on year. Any salary earner would know the significance of the figure Rs.1 Lakh. It’s the exemption available to him/her under the famed Section 80C of the Income Tax Act. Which are the financial instruments one can invest to avail the exemption under the section 80C? The list is fairly long: At the top of the heap is the amount employee contributes towards provident fund account. Every employee who is covered under the Provident Fund regulation is required to contribute 12% of basic salary to her PF account and her employer would also contribute a similar amount (i.e., another 12% of basic salary) into the PF account. The next most popular savings instrument is life insurance policy. Though I would not advice some one to club insurance and investment, there are millions who do it (traditional/ULIP etc). Equity Linked Saving Scheme (ELSS) is gaining popularity now owing to the kind of returns given by some of the funds. Inherently, investing in equity, directly or through mutual funds has high risk, that is loss of capital. If the investment period is long enough, the risk would come down and it might be possible for the investor to earn a higher risk adjusted return.

Other savings instruments/investment options which are eligible for exemption are NSC, PPF, 5-year bank fixed deposits, infrastructure bonds etc.

The purpose of writing this write-up is not as much about the selection of instruments but about the fact why many salary earners do not become crorepatis or multi-crorepatis by the time they are ready for retirement? In the above example we have seen that even at 8% annual return, some one can become a crorepati, if she invests Rs.1 Lakh every year. And a salary earner definitely maximises the savings under the section 80C by investing either compulsorily or voluntarily. What happens then? Answer lies in many issues which bother your savings/investment habits. Salary earner’s main concern seems to maximise the tax exemption through savings without any long term goal being set. This leads to leakages from the corpus once the lock-in period is over. Lock in period is as low as 3 years in some cases and a salary earner would withdraw the capital to reinvest than adding to the corpus. This short sighted view on savings and investments hinders the growth of the corpus. In the case of statutory savings like provident fund also, there are withdrawal options available. For example, one can withdraw a certain portion of the PF corpus for the needs like marriage, education, purchase of plot, construction of house property, medical expenses etc. thereby reducing the corpus. Some times the wrong choice of instruments also inhibits the growth of corpus. It’s a fact that many traditional insurance products like endowment plans and money back policies give a low return and do not provide adequate risk cover. A short sighted view that aims only at maximising tax exemption actually does not serve the purpose. If you are investing in ELSS and select dividend payout option, then also, the corpus would be lessened because the dividend paid out is used for purposes other than savings/investment. One should have a clear goal / purpose for savings and investment and getting the exemption should really be a second priority.

Finally, to end this discussion, here is a question for you.

If you are in the highest tax bracket of 30%, what’s the amount of tax you save if you invest Rs.1 Lakh in the instruments listed under section 80C?

Answer is Rs.30,000/-.

Now, if you start investing Rs.30,000/- every year when you are aged 30 years upto the retirement age of 58 years, any guess what’s the corpus created if your investment earns a return of 13% annually?

Answer is Rs.68.38 Lakhs

Incidentally, NSE Nifty Index has given a return of 13% per annum since it’s inception!

Narendra K N

CERTIFIED FINANCIAL PLANNERCM

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Inflation – The Silent Killer

December 30, 2006 at 3:30 pm · Filed under Financial Planning Process, certified financial planner, financial planning, retirement planning

If you have watched Amitabh-Hema starrer “Bhaghban”, you would have sympathised with the retired couple and their travails. In one of the early scenes in the movie, when the character played by Amitabh is to avail a loan from his provident fund account, when he is asked about the appropriateness of his action, he quips that his children would take care of him! Personally, I think “Bhaghban” is an ideal guide for planning your retirement or rather how not to approach your retirement planning with such a casual attitude. And in the movie Amitabh plays the role of a banker!!

More than retirement planning per se, I want to highlight how the deadly silent killer called inflation would play a spoilsport with your retirement plan.

Inflation is variously defined by economists but for our discussion, it could be defined as a situation wherein there is an increase in the overall level of prices over an extended period of time.

As an individual you will have no control over inflation; however you will be greatly affected by it, more often adversely.

During your earning period, there are several ways you will be able to mitigate the effect of inflation, rising wages being one of them. However, it’s during retirement period, the effect of inflation would be magnified because your income is not automatically adjustable for inflation; you need to plan for this event.

Let’s suppose that during the first year of your retirement, you will need Rs.2.5 Lakhs to meet your needs. If there is an inflation of 5% in the economy, the general level of prices would increase by 5% in the next year. However, this will not happen abruptly let’s say on the first day of the New Year but very gradually. That’s why inflation is a silent killer. In the next year you will need Rs.2.62 Lakhs to maintain the same standard of living because all prices have gone up 5%. But returns from your investment (typically you would have invested in those investments which give a fixed and/or assured return) will not increase by 5% to offset the effect of increase in price level. This means, you will need to dip into your corpus (capital invested) or reduce your standard of living or a combination of both. You will not be happy with lower standard of living and if you dip in to your capital, you may end up with a situation with no corpus left out. It’s scary to be in this catch-22 situation. It’s even scarier because you have absolutely no control over the unfolding economic situation because you are neither the finance minister nor the governor.

How one would break this catch-22? Financial planner knows that inflation is a fact and it can not be wished away. One can not live with the situation also. So it’s to be managed carefully. Like an orchestra, many things have to happen simultaneously.

There are several strategies a retiree has to adopt in such a situation. Estimating impending inflation is easier said than done, that too when the plan is to be put in place several decades earlier to actual retirement. Other option would be to attempt to create a big corpus wherein the returns would be always more than the needs. Question is can this be achieved by all? What if the resources are limited? It is here the attitude of the investor plays a major role. With the help of financial planner, she must chose the type of assets she will own during her retirement period carefully so that overall income generated by the assets is always ahead of inflation. There are several such assets that are likely to generate a return adjusted for inflation – equity, growing annuity etc.

There is no substitute to the awareness of the fact known as “inflation” and being prepared to face it squarely with the help of your financial planner. Investor must also know the importance of ‘inflation-beater’ assets and should make them part of the overall portfolio both during the wealth accumulation/growth phase as well as wealth erosion/depletion phase.

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Early Rise

December 16, 2006 at 2:01 pm · Filed under financial planning, retirement planning

Planning for retirement – Early to rise

At an elementary level, retirement planning involves identification of retirement goals (how much corpus is needed) and channelise the resources to meet these goals (accumulation and growth).  For formal sectors like government employees, contribution to pension fund is compulsory under the new pension system proposed during the Union Budget, 2003-04 and approved by the Union Cabinet on 23rd August 2003.  What about the private sector employees?  Other than the in-built meager pension option of the provident fund, contribution to pension fund is not mandatory for private sector employees.   Onus is on the private sector employee herself to provide for her retirement.  By the time the employee realises this, she would have lost the advantage of rising early.  

Why starting early is so important? 

Answer lies in understanding the way power of compounding works.  Let’s try to analyse the power of compounding using a very simple example.  Let’s suppose that a person joins for government service at age 21 and she would retire at 58 years of age.  This means, she will have 37 working years.  As the contribution to pension fund is mandatory, let’s suppose that she will start contributing Rs.12,000/- per annum totaling a contribution of Rs.4,44,000/- spread over 37 years.  If the fund is likely to earn a return of 8% per annum, she will accumulate a corpus of Rs.24.37 Lakhs by the time she retires.  A private sector employee also would be able to do the same for herself if she starts contributing to a pension plan in a similar way. In the next step let’s see what happens if the private sector employee were to delay the process by 10 years, i.e., she would start contributing at 31 years instead of 21 years.  If she contributes Rs.12000/- per annum for the next 27 years, the corpus created at 8% return will be Rs.10.48 Lakhs only.  You may say that the amount contributed also is less.  Now let’s assume that she makes up for the lost time and contributes a higher amount of Rs.16444.45 per annum (totaling Rs. 444000/-).  In this case, the corpus, at 8% return, would be Rs.14.37 Lakhs only which is less by a whopping Rs.10.00 Lakhs when compared to the corpus created through the mandatory contribution by a government sector employee.  It’s very clear from the above analysis that starting early will always help to reach to target with lesser amount; conversely, the corpus would be higher if one starts early. 

In this simple case study, we have not looked at the adequacy of the size of the corpus itself.  A financial planner would be able to estimate the amount you will need to lead a comfortable retired life.  Once you decide the kind of lifestyle you would like to maintain during your retirement period, a financial planner will be able to tell you how much you need to save each month depending on your risk appetite and attitude towards investment, risk & reward. A financial planner would also be able tell you how to inflation-proof your retirement needs. It was told about a farmer that early to bed and early to rise, makes him healthy wealthy and wise.  In the same vein, an “early rise” in planning your retirement will definitely make you the wealthy person you would like to become.

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