If there is one phrase that dominates any discussion in the space of personal finance it is ” Retirement planning”. Children’s education comes close but cannot quite match up to it. A lot of discussions in all financial blogs center around this topic and there are a myriad of calculators that are a source of endless use and debate. I think most of the retirement calculators do not serve the purpose they are built for as they do not give you a real picture of how your finances will be in retirement.
Do not get me wrong here – a lot of people have put in a lot of man-hours in building these and as an academic exercise I do not have any quarrel with these. It is just that in computer terms the usage of these calculators can be characterized as GIGO – Garbage In Garbage Out. I will explain why I say so but before that let me explain briefly how most of the retirement calculators work, so that people not familiar with their operations will get an understanding of the same.
Most retirement calculators work in the below principle:-
- They ask you to look at your current expenses and come up with an annual figure say X.
- The next step is to ask you what % of this will you be expected to spend in retirement. Let us say you get Y.
- Y will be projected into the first year of retirement with the current inflation rate to arrive at a figure Z.
- You can now divide Z by a safe rate of return from debt instruments ( let us say 7 % ) to arrive at the corpus needed at retirement, say W.
- To arrive at the corpus W, you may now use an SIP calculator which will give you the monthly SIP amount, say V.
I know that many of the financial planners, whether offering paid or voluntary services would have advised you in exactly the same fashion. You are also religiously investing the SIP amount every month, thinking that you have got all of your retirement worries dealt with. Sorry to spoil the party here, but you really have not. You may be way off the mark, either way, and even if the investment amount is correct it is purely fortuitous, not because of the calculations or approach.
Why do I say this? Let us start at the beginning. You simply cannot take a % of your current expenses, project it to your retirement year based on inflation and say that will be your expenses in retirement. In order to take away the subjectivity, let me discuss my specific situation with the approach of the financial planners and retirement calculators.
- My current expenses in this FY will be X. Most advisers and calculators will say that I need to plan for at least 70-80 % of these expenses.
- Such generalizations unfortunately do not work. In my case about 50 % of my current expenses are due to my children. When I retire, let us say in next 8 years or so, these costs will definitely not be there.
- I plan to shift to a lower cost city like Kolkata, from the current high cost city of Hyderabad.
- I plan to travel more for the first 10 years of my retirement and take up some hobbies.
- You will see from the above how hopelessly inadequate the retirement planning process and associated calculators are to deal with my situation, indeed to deal with any real life situation.
Obviously, in some cases you will be saving less and that is a problem as you will simply not have enough money in your retirement years. However, even if you are saving more than required, it may be a bad idea if it is preventing you from doing the things that you want to get done today.
Apart from estimating retirement expenses, the way most planners estimate the corpus is also wrong. It makes no sense to imagine that we will put all our money in a 7 % FD or similar instruments, There are far better ways of doing this and if your financial planner is unaware of those or lazy to do some real work, do not do business with him.
Now that we have understood the problem and what will not work, how can we get into a workable solution? I will address this in the next post.