Monday, 1 August 2016

Retirement Planning : Beating the Inflation Blues

"Make sure you have more than provident fund and gratuity to bank on at Retirement"

How-to-Do-Retirement-Planning
Image Source : Economic Times
I am sure most of you have seen Amitabh Bachchan starrer Baghban. One sympathies with the retired couple and their torment in the film. The movie is a classic example of how one should not approach their so called "golden years", or retirement period.

In one of the scenes, Bachchan avails a loan from his provident fund account and when asked whether his action is appropriate, he confidently makes a statement that his children would take care of him. Little did the actor realize what stood for him in the future.

The film clearly explains the need for one's retirement planning in today's world of nuclear families. It was indeed surprising for a banker to have made such a blunder. We need to pose this question to ourselves — is there something to learn from the film or we still want to continue being ignorant to such issues?


It is through this movie one could understand the disasters and helplessness of not having a planned retirement. I want to draw your attention to inflation which will play the most important role in your retirement period. 

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Inflation, in simple terms, means the increase in the over all level of prices over a period of time. It cannot be controlled by you as an individual but it surely affects you in great way. Inflation adversely affects retired people as the income is not in appropriation with inflation.

At the same time it does also affects people who are earning, but there are several ways in which they can mitigate the effect, rising wages being one of them. Retired people usually have fixed income. This income could be in the form of interest from fixed deposit or pension funds. These income does not change in respect to inflation.Moreover, they invest in debt products, which usually have a time frame of 3-5 years. With rising inflation it becomes more difficult for retired people to meet their expenses with the limited resources.

Let us understand with the help of an example, Mr Shah current age 35 years is having a yearly expense of Rs 420,000 (Monthly expense of Rs 35000 X 12). Assuming if he retires at 60 years of age how much corpus would he require to have the same lifestyle.
But as mentioned earlier inflation is the devil , all goods and services which can be bought today in Rs 420,000 will not be possible for them to buy after 25 years. There is a formula which derives the future value of present value which is shown below.


Future Value of Rs 420000/- after 25 years at an Inflation of 7% would be
FV = 420000 X (1+7/100)^25 = Rs 22,79,522/-
In order to maintain the lifestyle which Mr Shah is maintaining today he would require Rs 22,79,521 yearly starting in his first year of retirement and to generate that income he would require a corpus of 2,85,17,899.


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But the story doesn't end year, even after retirement he may live up to 70 or 80 years and after 60 years it is his investments which are going to provide income.
Let us understand with an example how a corpus of Rs 2.85 Cr will not be sufficient if Mr Shah lives up to 70 years
In the below table I have assumed 5% inflation from 60th Year and return on investment at 8.5% if invested in a FD or Debt fund.


Year Corpus Generated Income NeedsSuprlus / Deficit
612851789924240212279521144500
622994379424240212495316-71295
633144098424240212620082-196061
643301303324240212751086-327065
653466368424240212888640-464619
663639686924240213033072-609051
673821671224240213184726-760705
684012754824240213343962-919941
694213392524240213511160-1087139
704424062124240213686718-1262697

From the table is clearly seen that in 62nd year he will have to start erode his corpus. I have not factored high inflation which takes place once in a decade like we experienced in 2008-2009 recession.
The whole math would go haywire for Mr Shah, while his income is stagnant and his expenses are growing by every year passed even though he has the same standard of living.
This means that he would have to start using his corpus or lower his standard or a combination of both.It is a scary situation with no control over unfolding economic situation. 



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One cannot live with this situation but there is a solution for it. You need to factor in your expected life expectancy after retirement at the time of retirement planning with the annuity formula mentioned below
PVA = A * [ {(1+r)^n -1} / { r * (1+r)^n } ]
Where
PVA = Present value of Annuity (Amount you need to have at your retirement)
r= Rate of interest you expect to get
n = Number of years you want the Yearly Income.
or moneycontrol link here


From the above formula you would require 38453980 i.e approximate 3.85 Cr to live the same life up to 70 years.
If 3.8 cr is invested in bank FD of Liquid funds generating an income of 8.5% per annum, you would be able to get a yearly payout of Rs 3,080,000 vis a vis required payout of Rs
22,79,522. The surplus in addition  to existing corpus again is re-invested at 8%.
Let us do the maths now 

YearCorpus + Surplus Reinvested Needs (A)Income (B)Surplus/ Deficit ( C )
61385000002,279,5213080000800,479
6239,300,4792,393,4973340540.715947,044
6340,247,5232,513,1723421039.427907,868
6441,155,3902,638,8303498208.166859,378
6542,014,7682,770,7723571255.268800,483
6642,815,2512,909,3113639296.344729,986
6743,545,2373,054,7763701345.13646,569
6844,191,8063,207,5153756303.493548,789
6944,740,5943,367,8913802950.518435,060
7045,175,6543,536,2853839930.602303,645
7145,479,2993,713,1003865740.457152,641
7245,631,9403,898,7543878714.937-20,040

From the above table it would be easy to manage monthly outflow till the age of 72.

For those who have already reached their retirement age and there is not much that they can go back and do, there is still some room to fight this battle with inflation. You should have a right asset mix or a diversified portfolio, which includes debt assets as well as growth-oriented assets. One, at this point, would definitely ask about the risks involved in the growth assets. I would say that the growth assets are less risky compared with inflation. Also, the risk involved in them reduces over a long-term horizon. This is definitely better then risking your corpus by the silent killer `inflation'.

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There are several such assets that are likely to generate a return adjusted for inflation equity, growing annuity etc. One would also wonder with the kind of equity market volatility whether it would be a right asset class for the retired people who have a limited corpus.
I am reiterating that the volatility has very minimal effect in the long-term.
 

One must understand the importance of 'inflation-beater' assets and should make them part of the overall portfolio both during the pre-retirement phase and retirement phase.

I hope you enjoyed reading the article , it takes time to write  articles with facts and figures, request you to please spread the word. A good way to start is to share this page on your social circle using floating social share bar on the left.

Who doesn't like a financial healthy life,In case if you want one contact me for Financial Planning, please do drop an email to me at vipuls1979@gmail.com. I would be happy to assist you

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