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.