Financial independence or retirement – A template

I have been asked by many readers as to how they should be organizing their money in retirement so as to get a regular income that stands the test of inflation over a long period. In recent times I am also asked the same question by people who want to be financially independent at an earlier age and are keen to set up a passive income stream that will last their lifetime. The interesting aspect to be noted here is that the solutions are pretty much the same, though the amount of corpus will necessarily differ.

Let me explain this a little. The whole idea of retirement, early or at 55/60 years, is to get some cash inflow from the money you have invested in different financial instruments or in other assets such as a house etc. This cash inflow should be able to take care of the cash outflows that your aspired lifestyle requires. Assuming that most people retire at 60 and can expect to live till 85 in today’s context, their corpus needs to last them 25 years. Now if you decided to take an early retirement at 45 then your corpus will need to last you 40 years. The key to this is also whether you are earning any active income in early retirement. For example, many of us earn some income through consultancy or other means and this will help. However, for the purpose of this post, let us assume that a person takes an early retirement at 45 and expects to live till 85.

At a very basic level you need to understand the following calculation:-

  • Assume an expense of 10 lacs per year at present without accommodation and any children related expenses.
  • For a period of 40 years assume zero real rate of return – this means your corpus invested in various instruments will grow at the same rate as inflation.
  • With the above assumption in place the required corpus is simply a producr of your annual expenses and the number of years. In this particular instance it will be equal to 10 lacs x 40 or 4 crores.
  • So if you are 45 years old and have an amount more than 4 crores and are unlikely to spend more than 10 lacs annually, you can take an early retirement.

What if you do not have this amount but are still interested in retiring earlier than the normal age anyway? Well, there are a few alternatives you can consider in the above example that we are dealing with :-

  • If you work for another 5 years the amount of money needed annually will grow to 13.38 lacs due to 6 % inflation and the amount needed will be 4.68 crores for 35 years. This may sound fantastic but is true – reason is your money is growing for less years and your expenses have increased.
  • Take this futher to 10 years working. Now your expenses annually will be 17.91 lacs and corpus needed for 30 years is 5.37 crores.
  • Before you are worried with these figures let me also give you the good news. Suppose you are 45 and had a current portfolio of 3.2 crores. Now you cannot retire at 45 but decide to work 5 years more. At 10 % growth in 5 years your portfolio value will be 5.15 crores.
  • With a time period of 10 years the portfolio will amount to 8.3 crores.
  • Bottom line is you can retire quite peacefully in either 5 years or 10 years.
  • Apart from working longer there are two more strategies you can look at – one is to believe that your expenses will reduce when you retire. In my experience this is rather tough to achieve and therefore you should ideally not aim for this.
  • The final one is to generate a real rate of return for your portfolio. This will ensure you need a corpus less than 4 crores to begin with. If you deploy your money well, this should be quite possible to achieve.

Let us take the limiting condition where you do have 4 crores and need to deploy it in a fashion so as to last for 40 years. For the sake of simnplicity I will assume that expenses double on an average every decade. In effect you spend 20 lacs per year in decade 2 etc. In such a situation how should you deploy your money? But before we get there let us see the cash outflows and strategy of withdrawal.

  • You need 1 crore in the first decade – this should be largely from interest from PPF/VVY/SCSS  or capital gains from debt funds.
  • Your 2 crores in the second decade should largely be funded by redeeming your Debt investments.
  • Your 4 crores in decade 3 will be mostly through SWP from Mutual funds.
  • Your 8 crores in the final decade will be through redeeming both MF and stocks.

Finally let us talk of the allocation now :-

  • 60 lacs for you and your spouse in VVY and SCSS, 40 lacs in PPF.
  • 1 crore in Debt funds so that you get returns of roughly 8 lacs a year.
  • With the above 2 crores your first decade cash flows are assured.
  • In the second decade you can redeem the debt investments and still have enough surplus to take care of some indulgences.
  • Out of the original 4 crores, put 1.5 crores in equity MF and 50 lacs in Blue chip stocks which are likely to give stable returns.
  • Your MF portfolio will grow to 10 crores in 20 years even at 10 % returns.
  • Spend 4 crores out of this in decade 3 and let the rest be invested.
  • In decade 4 you will have much more than 8 crores in MF itself.
  • Your stocks are really a bonus – leave it as your legacy by donating it to worthy causes.

So when do you want to retire and will you have enough when you do? I think this post has provided a good template for this. Apply it to your own situation and see how it wotks out for you.

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Retirement corpus structuring – A Reader query

From time to time I get queries from my Blog readers that will resonate with the larger investor community. One such query was sent by a reader recently after he read my recent posts on retirement corpus structuring. I wanted to address it as a post here.

His query was as follows:-

Taking portfolio 1 as the base, if a person retiring this year from a private firm, has a house to live and corpus of around 2 crore in the following manner –
Debt portfolio – 50 lakhs in EPF, 10 lakhs gratuity, 20 lakhs PPF, 25 lakhs from LIC (maturing in 2022, premiums paid) and 10 lakhs in liquid funds/FDs for emergencies.
equity – 60 lakhs in Mutual funds and 25 lakhs in Shares. How should the corpus be structured to provide regular income in retirement, taking care of inflation?
Let me only try to do a structuring of corpus here as I have already explained the broad principles in the earlier posts. The assumptions are a current annual expenditure of 7 lacs per year, life expectancy is another 30 years and expenditure being double and 4 times in the next 2 decades respectively.
Without further ado, let me give my suggestions now :-
  • Take the 60 lacs from PF and gratuity and put in in Vaya Vandana Yojana and Senior Citizen Saving Scheme. This will have to be done by the investor and his spouse separately. This will give 4.8 lacs per year as interest.
  • Use 20 lacs PPF to withdraw 2.2 lacs every year for the first 10 years. Along with the interest, this will take care of the 7 lacs needed in the first decade.
  • When the LIC money becomes available, invest it in equity balanced funds. This will amount to 50 lacs by 2028, assuming a return of 12 % annually.
  • In decade 2 the average expenses will be 14 lacs. This will be funded through:-
    • 4.8 lacs will be available as before.
    • 50 lacs from Balanced fund will be redeemed @ 5 lacs per year.
    • 60 lacs MF will become 1.8 crores in 10 years with a return of 12 % annually. Take 40 lacs and put it in some hybrid fund such as MIP or Equity Savings Funds. 4.2 lacs each year can be used for the remainder of 14 lac expenditure.
  • In deccade 3 the average expenses will be 28 lacs. This will be funded through:-
    • Stocks which will reach a value of 1.93 crores in 20 years
    • MF which will reach a value of 4.34 crores in 10 years from 1.4 crores base.

So at the end of 3 decades the couple will still have some amount left, which can last them a few more years. It is highly improbable that they will live beyond 95 years, so it is a very safe plan.

I hope the plan addresses the issue at hand. In case there are any queries on this, I will be happy to address the same.

Some real life portfolios in retirement

In the several posts I have written on retirement here, I have tried to give both my personal examples as well as those of others. Many readers who are considering retirement want to know if the money they have as corpus will be enough. Some think they have adequate money but are not sure of how to deploy it optimally. In this post let me give 3 examples of real life portfolios from retired people.

Before getting into the actual portfolios, it will be important to understand the pre-requisites, in order to be able to go for retirement in financial terms. These are :-

  • You should have a place to live in. This can be either your own house or a rented one where you are covering the rent from what you get as rent of your house elsewhere. This is important as rent is inflationary and must be taken care of.
  • All your major life goals should be over. Even if some goals such as children’s marriage are pending, you have separate funds for those.
  • You have an ongoing Health insurance that you will continue with. Get this before you and your wife cross 50 years, they get very expensive afterwards.
  • Your children are taking care of themselves in terms of financial expenses.
  • You may still be earning some active income through use of your time but that is not considered in these portfolios.

Portfolio # 1:

This is the simplest portfolio I have seen with hardly any real risk and yet catering to almost any future eventuality.

  • Tax free bonds of 1 crore invested in 2013 with an interest rate of 9 %. This yields an income of 9 lacs every year till 2028.
  • PPF corpus of 40 lacs and contribution of 1.5 lacs every year till 2028. This will grow to more than 1 crore in 2028.
  • Emergency funds of 10 lacs in Liquid funds.
  • MF portfolio of 20 lacs and stock portfolio of 10 lacs now.

The couple have expenses of about 7 lacs per year and stay at their own home. They put 1.5 lacs in PPF every year and pay no taxes. In 2028 they can use the money from Tax free bond principal to invest in Debt or hybrid funds. At this time they will start using the PPF amount for the next 10 years. Note that this is also tax free. By 2038 their MF and stock portfolio should grow to 2 crores plus even with a modest return of 11 % or so. With another 2 crores from Debt funds they should have enough for the last phase of their life.

Portfolio #2:

This is slightly more complex as equity and debt are both used. Let us first see the deployment here and we will then look at withdrawal.

  • 1 crore in PPF as the couple were not salaried people and invested in PPF regularly over a long period.
  • 50 lacs in various types of Debt funds at current market value.
  • 40 lacs in equity MF and 10 lacs in stocks at current market value.

Assuming 30 years of retired life and an expense of 8 lacs per year in the first decade, this is how the couple have decided to go about it.

  • Withdraw from PPF to the tune of 10 lacs for the first 10 years. This will still leave enough money after 10 years in the account.
  • The 50 lacs Debt fund will grow to about 1.1 crores in 10 years. This along with the remaining amount in PPF will serve expenses of second decade.
  • The Equity portfolio of 50 lacs will grow to 3.36 crores in 20 years. This should see the couple through the third decade, even though the expenses by now are about 32 lacs per year.

Portfolio #3:

As a final portfolio, let us look into a more complex situation. Here, the resource base is larger and the expenses are also significantly higher. 

  • Two PPF accounts of 50 lacs and 10 lacs in current value.
  • Tax free bonds of 24 lacs, maturing in 2028
  • Equity Mutual funds of 50 lacs paying dividend of 3 lacs a year
  • Equity Mutual funds of 50 lacs with growth option
  • Stock portfolio of 1 crore with annual dividend of 3 lacs
  • Debt funds of 1 crore with LTCG of 8 lacs every year

Assuming the current decade expenses will be 12 lacs at an average, 15 lacs in the next decade and 25 lacs in the last one, how should things be structured?

  • Current passive income from interest and Dividends is 8 lacs. Another 8 lacs is from LTCG of Debt funds maturing every year.
  • In the first decade the PPF accounts will be funded to the tune of 3 lacs every year.
  • In decade 2, PPF can be used for withdrawal. The two accounts will suffice for these 10 years even without any fresh contributions.
  • For the last decade stocks and MF can be redeemed to fund expenses.

So there you have it – while 1.5 crores plus is quite enough for expenses of 8-9 lacs in a year, if you want to spend more then you should look at higher corpus. But the real lesson is in the deployment of corpus and withdrawal strategies.

Will be happy to answer questions on this.

Retirement income framework – understand the allocation

I get a lot of queries in my blog and Facebook group about how to structure a corpus so that the retired person gets enough monthly income in retirement. Most of these people have a home and are not really extravagant in their spending. Ideally they would like to have regular monthly income with a degree of safety attached to it.

I have written earlier that a combination of Debt, Equity and Stocks should be the way to go for all stages of life, with the provision that the proportion changes in favour of debt as you grow older. However, there are many people who are worried about the volatility in the markets and clearly uncomfortable in a scenario where they might have to withdraw money in a declining market. At the same time, a debt only portfolio will work if the corpus is large enough to deal with inflation over a period of 3 decades.

Let us simplify it then in terms of different scenarios. The first scenario is where you only want to have Debt in your portfolio:-

  • Assume an annual expenditure of 8 lacs per year
  • Retirement period of 30 years conservatively
  • Real return from portfolio is zero as Returns match inflation
  • Corpus needed will be 2.4 crores
  • Rough assumption is that expenses will double every 10 years.

So you can see from here, if you have 2.4 crores corpus you can withdraw 8 lacs every year and not worry at all about markets and equity etc. But what if you do not have 2.4 crores but only 2 crores. How does that change the situation? Let us see below:-

  • Assume same expenses and longevity as in the first scenario.
  • Put 20 years amount into Debt and the rest in Equity.
  • So we have 160 lacs in Debt and 40 lacs in equity.
  • Assume that inflation makes expenses rise by 100 % in 10 years.
  • Assume equity returns of 15 % annually.
  • The Debt investment will be adequate for first 20 years.
  • The Equity part will become 654 lacs in 20 years at 15 %
  • Even if you take 12 % return on equity, the amount in 20 years will be 386 lacs.
  • Annual expenses after 20 years will be 32 lacs per year
  • So 10 year costs are 320 lacs.

As you can see the trick is to let Equity grow for a long time so that the differential return when compared to inflation really works to your advantage.

I hope with this you will be able to get your own situation in retirement mapped out. The basic idea is to deal with Debt in the first decade or two and have access to equity money for later on. Yes, if you have enough in Debt then you probably do not need a lot of equity allocation. Let us now look at the general formula then.

  • Expense of X lacs per year and longevity of Y years
  • You can be in pure debt if corpus available with you is more than XY lacs
  • If you have less than XY lacs then your allocation must be between Debt and Equity.
  • In general with a corpus of 75 % of XY lacs you should be all right.
  • Assumption is that your Equity portfolio grows at 12 % to 15 % long term and inflation is such that your expenses double in 10 years ( roughly 7.2 % )

All that you really need to do now is to plug in your values and check out the allocation required for a rich and productive retirement. I will do another post this week on specific portfolios and withdrawal strategies for 2 different levels of corpus.

Vaya Vandana Yojana is good for senior citizens

One of the good aspects of the current year budget has been the focus on senior citizens. While the tax slabs have not been changed, the exemption of interest income up to 50000 Rs is a good thing for all of them. Another benefit is the extension of Vaya Vandana Yojana for 2 years and changes in the terms.

The VVY was introduced last year and had interest payment up to 8.3 % annually on investment up to 7.5 lac Rs per senior citizen. Now it has been made 15 lacs maximum with flexibility of withdrawal in case of Medical emergencies. The monthly interest is 8 % and the annual yield goes to 8.3 %. You can buy it online or offline through LIC.

How should senior citizens use this? Well, you can invest up to 30 lacs in it now, for both you and your spouse. Along with the Senior citizen saving scheme, where you can potentially put another 30 lacs, this will give you a total interest income of 40000 Rs per month. While all of this is taxable, the tax incidence is practically zero for the couple.

This is something that all senior citizens should take advantage of. With a regular income of 40000 Rs per month assured, they can now think of putting the rest of their money in other mutual funds of different types to add to their income. In case they have a PPF account then there is also a possibility of withdrawing money from there in a tax free manner. With some intelligent structuring it will be quite possible to have an income of up to 80000 or so per month, with low tax incidence.

So, if you are a senior citizen and are looking at regular income, go for VVY. Yes, interest rates may rise but it will take a while to catch up to 8 % and a bird in hand is always worth more than two in the bush.

I will outline in the next post how a corpus of 1.5 crores including PPF can be structured for senior citizens to maximise income with low tax incidence.