In India, the defence forces always emphasise training and strategic planning during peacetime, highlighting the need to prepare well in advance rather than waiting until the enemy is at the doorstep. This principle also applies to preparing for retirement, where many people only realise its significance when they are about to retire. This is because human nature tends to prioritise short-term needs over long-term goals. Furthermore, a lack of financial awareness regarding potential challenges during retirement years often causes a delay in action.
Many investors commonly assume that their contributions to provident funds or traditional investments will adequately meet their retirement needs. However, the reality is that contributions to these funds are often modest, and the low-interest rates they offer can barely outpace inflation. Additionally, with advancements in medical care leading to increased life expectancy, individuals may require more funds than initially estimated. Therefore, a comprehensive financial plan is essential for achieving financial independence during retirement which is a three-step process. First, it is crucial to address and minimise existing debt. Then, setting clear financial goals and finally investing smartly to reach the financial goal.
Warren Buffett wisely said, “If you buy things you don’t need, you will have to sell things you need.” Individuals who accumulate unnecessary debt through excessive spending often find themselves ensnared, facing difficulties in achieving a peaceful retirement. By minimising unnecessary expenses and paying off debts, one can create a solid foundation. There are two common mistakes people often make. First, they forget to consider inflation when figuring out how much money they need for retirement. Inflation manifests in two forms: General Inflation, affecting prices of essentials like food and oil, and Lifestyle Inflation, wherein spending rises with increased income, leading to upgrades in possessions like transitioning from a bike to a luxurious car or opting for expensive branded clothing. Figuring out general inflation is easy, but it is tricky to predict the pace of lifestyle inflation (and it usually happens fast). Hence, when calculating how much money you will need for retirement, consideration must be given to both types of inflation.
That is one reason why investing in equity as an asset class is better than choosing investment avenues like bonds or gold for retirement. Over the long term, equity has done better than most other investment avenues. So, when planning for retirement, experts usually opt for equity-oriented offerings to create a retirement corpus. But, here is the catch: as you get closer to retirement, a pure equity portfolio can be risky and very volatile. Hence, it is suggested to transfer the corpus created to a debt or hybrid offering such that the corpus is not affected by equity market volatility.
In the retirement planning journey, the most important step is to start early. When starting to save from a younger age, you have more time until you retire. This means you can take more risks with your investments, especially by putting more money into equity. The advantage of starting early is not just about earning higher returns; it is also about benefiting from the power of compounding.
Let us take an example. If a 30-year-old wishes to accumulate Rs. 5 crores for retirement by the age of 60, assuming a return of 12%, the person needs to invest Rs. 16,000 every month through a Systematic Investment Plan (SIP) to reach this goal. However, if the same person delays starting by just 5 years, the required monthly SIP amount jumps to Rs. 26,000. Most often individuals start to think about retirement around the age of 50. Even with the same expected returns, the monthly contribution to the SIP at that point would be approximately Rs. 2.25 lakhs. This demonstrates the power of compounding and the significant advantage of starting early. Moreover, if someone starts early and increases their SIP amount every year as their income rises, they can achieve their retirement goal sooner.
In essence, if you do not carefully plan for retirement, you may end up without enough money to live during the retirement years. Further, with increased life expectancy, the retirement span can extend over several decades. Effective planning ensures you have stability and financial independence throughout this extended period.
The views are personal and are not part of the Outlook Money editorial Feature.