Tuesday, October 4, 2016

Retirement Planning

This is an article I wrote for a local magazine. Please read on.

Many studies show that Indians are least prepared people for retirement. No need to look hard to find proof. Nowadays, many youngsters are not even convinced the need of retirement planning.

Why Indians are so unprepared for retirement? There are many theories. For one, the traditional belief that our kids will look after us. If our kids will look after us, why should we accumulate money for our retirement? However, these equations are changing fast. In the nuclear family, there are many hindrances to work this out, even if we consider kids will outlive their parents. For example, the kids should be willing to support their parents through their old age. And, they should be financially strong enough to support parents.

Retirement is not only about money. During old age people need tremendous emotional and mental support. While you can depend on your kids for this support, it is better to relieve them from the financial burden.

Secondly, Indians have many more goals in life, than a typical westerner. Indians have to take care of their kids' marriage (costlier, if it is a girl child), kids’ education and also, they have to look after their parents. In contrast, a westerner has only one goal, his retirement. Kids' marriage is kids' business, it is not done with parents' money. Primary education is free, and for higher education, children work part time or get scholarships or go for educational loans. Whatever it is, it is not parents' head-ache. So, having overloaded goals, Indians tend to ignore retirement.

Why is it so Hard?

There are a few factors which makes retirement planning extremely difficult - a few factors which are not in our control. For example, how long will we live after retirement or what will be the percentage of return we will be getting from our investments or what will be the rate of inflation after retirement. These factors make retirement planning difficult, even for seasoned financial professionals.

When to Start?

People in central and state government jobs are forced to start their investment for retirement from the month they join their job. On the other hand, people in private sector have no restrictions like this. This gives them the luxury to delay (or even never do) the retirement planning. But delaying retirement planning will cost a lot, you will see soon.

Just like in sports, Start early is the motto in retirement planning also. Why? We need time to take benefit of compounding. To explain this, just imagine someone starts with an investment of just Rs 1000 and gets a consistent return of 10%. So, in the first year this 1000 becomes 1100 and second year it becomes 1200? No, in the second year you get the interest of Rs 1100 (principal + first year interest). So it will be Rs 1210. For long periods of time, this makes a big impact on your returns. In order to take benefit of compounding you need to start early and should be invested for a long time. Do you know that this Rs 1,000 will turn to Rs 17,500 in 30 years’ time? That is power of compounding.

Where to Invest

The next question related to retirement is where to invest. Not only for retirement, but for any of your goals, thousands of investment products are available in the market. It is very important to select the right tools. Most of the available investment tools can be broadly categorized into five categories. This categorization helps to understand these tools better.

1. Fixed Income

Also known as Debt, Fixed Income tools are most safe and predictable. It is like you are lending money to someone, and he returns the money with interest when the tenure ends. The best example is Bank Fixed Deposits. You lend money to bank and bank return money with interest. Other examples are Public Provident Fund (PPF), Debt Mutual Funds and National Service Scheme (NSC).

These tools are inherently safe, but the disadvantage is that the returns will be always below inflation rates. What is inflation? It is the phenomenon in which money loses its value due to hike in prices over time. For example, if you have Rs 100 today, you can buy things worth today's Rs 100. You keep that money for one year, and next year can you buy same thing? Normally, no as the prices go up. If the inflation is 5%, you can buy things worth today's Rs 95 only next year. So, simply by keeping you lose money. Now imagine, you invest that money. If you get 7% return, how much do you gain? It is only 2%, after inflation. Now, think the government charges 20% Tax on return. So, you will again lose 2% of your principal. From this example, you can understand that the real return in Fixed Income products can be negative. Fixed Income products have no risk of losing, however it has the risk of inflation.

2. Equities

One of the oldest investment method was to buy shares of a company. As a shareholder the person, who purchases the share, has an equity stake in the business. That is why shares are also known as equity. Equity investments outperform Fixed Income investments in long term, and also can give return above inflation rate.

Investing directly in stocks needs lot of knowledge and time. What if you cannot spend that much time? Still you can make benefits of equity investments through Equity Mutual Funds. Mutual Funds operate in a way they pool money from many investors to buy stocks. This way, you can buy equity even for small amount as Rs 1000. Fund managers do the job of monitoring and switching stocks for you.

Still, biggest problem with equity investments are volatility nature of stock prices. Stock prices go up and down in a zig-zag way. One way to harness this volatility is through Systematic Investment Plan (SIP). SIP means investing a fixed amount in mutual funds regularly (say monthly). As you buy for fixed amount, if the prices go up you end up buying less and if prices go down, you buy more. After a long time, if average rate is up, you will make profit. Possibility of making loss through SIP for a long time is minimal. Needless to say, SIP is an ideal tool for retirement.

3. Real Estate

The common man's favorite investment method is not a big star among financial experts. Why? The high risk, inflexibility (you cannot invest small amounts), unregulated market (who decides the prices?), low liquidity and need to leverage (getting loan and investing is known as leveraging) make Real Estate a bad investment choice.

Having said that there is a scenario where investing in RE for retirement is a prudent decision. In case you want to settle down at your home village after your retirement, it is a good idea to invest in a house in the home village. However, think twice or thrice before making such a decision. Because, a few factors can easily make this decision wrong - like if you want to stay with your kids or your health situation demands you stay in city.

4. Commodities

The gold, silver, diamonds, paintings - all come under this category. Only return from this category is capital gain. Capital gain is the increase in the value. That means if you buy at low price and sell at higher price, your return is the difference in price. On the other hand for Real Estate you may get rent and for equity you may get dividends other than capital gain. But for commodities only return is capital gain.

5. Cash

This is not an ideal investment for retirement, unless you are in the last stages of your working life and planning to retire soon. By cash it is not only means the hard cash, but also money kept in savings accounts. The cash gives you highest freedom. Some people prefer to keep a small percent of their investment in cash so that if any of the new investment opportunity unfolds, they can easily grab it.

Which is the best investment for retirement?

As I told you about five common investment categories, the question now is which one is the best investment method. Unfortunately, there is no such thing as best investment method. Diversification is the key here. Everyone should consider factors like time duration, their risk appetite before choosing an investment method. Anyway, it is better to avoid putting all eggs in one basket.

You may be wondering why I did not mention insurance as an investment tool. After all, it is the favorite investment method of Indians. But, it is not a good idea to mix insurance and investment. Insurance should be used only for covering unexpected risks like death, hospitalization, etc. By mixing insurance and investment one will not get benefit of neither insurance nor investment. It is better to treat both separately.

National Pension Scheme (NPS)

I think the discussion on retirement planning will not be complete without mentioning NPS. The National Pension Scheme (NPS) was started by Government of India in 2004. Initially started for new recruits of central government (excluding armed personnel), in 2009 it is opened for all citizens in a voluntary basis. Currently it covers all central Government employees (excluding army) and most of state government employees. Kerala government also follows NPS as part of contributed pension.

NPS allocates the invested money to three categories - equity, fixed income and government securities. Currently it has a limitation that up to 50% only can be invested in equity. This allows you to invest in NPS in accordance with your risk appetite.

Should I go for NPS or not? It is always better than the pension plans provided by insurance companies. However, you need to consider a few drawbacks before making a decision. Drawbacks like only 50% allocation to equity allowed, limited tax benefits, restrictions on maturity (like you need to invest 40% of maturity amount in annuity), need to wait until 60 years to withdraw (not for people who plan early retirement). Having said that considering lack of other investment tools for retirement, especially which involves equity, NPS is a good choice.

How much to Invest

Once you decide where to invest, next question is how much to invest. People love to hear a fixed percent of their income to invest monthly, so that they can spend rest of their money without guilt. Unfortunately, there is no such a magic number. Financial experts say as much as possible to invest. The reason is the unpredictability of our retirement life. As I said in the beginning, there are factors outside our control. One may be forced to retire early than planned due to health situation or lay off.

However, if you really want a number to start investment for retirement, I would say 10%. People who are in the beginning of their career can start with 10% of their take home salary. However, if you are starting the planning at your 30s or 40s, it is better to invest as much as possible and also to invest any additional incomes like bonus, lottery win to this purpose.


People always think future will be brighter than today, whether they prepare for it or not. It is a characteristic of a human brain, which helps us to be optimistic and inspires us to live forward. However, this prevents us from activities like retirement planning. We may get lost in day to day issues, and may ignore important things like retirement planning.

If we want it or not, we cannot work for ever. One day will come when we are forced to stop working. Retirement planning is all about how we live after that point. A person spends 20-25 years for education. Next 40-45 years he will be working. The rest of his life should be supported by the earning he does during his work life. So, consider retirement as your ultimate goal of working.