A case study from recent AIFW post

It always surprises me a little to see the reactions of people in Facebook groups when a group member asks a simple query. Some members assume that the questioner needs to get knowledge by reading blog posts of some other members first, others advise him to go to a fee only financial planner and even give him a list, yet others tell him that one should just keep working and not think of retiring.

To come back to the recent query, here are the salient facts shared by the person who wanted advice on whether he will be able to gain Financial independence in 6 years:-

• He has 1.2 crores in FD and another 30 lacs in equity etc
• Can invest 20000 per month for next 6 years
• Has a child in class 7, who should be going to college in 6 years
• Has his own house and loans will be paid for by the time he is 50.
• Current costs are 1 lac per month, 15000 for child and includes loan repayments.

Let me come to the question as to whether he will be able to be financially independent by the time he is 50. For this we will calculate his Financial Independence Number (FIN) in the following manner.

• His base cost at 50 will be lower than 1 lac as child cost will be gone and so will the loan repayment. However, let us take it at 1 lac to take care of inflation etc.
• For retirement of 30 years his cost will be 3.6 crores at zero real rate of return
• For child higher education we can take 20 lacs
• For asset replacement etc we can take 20 lacs
• Total FIN therefore comes to 4 crores.

Fortunately, in real life we do not need to go with financial planner and/or calculators blindly and can use some experience and common sense. It is difficult to tell others what to do as they will have their own goals and ways. However, if I were in his place, I would be doing the following:-

• As his child’s college education is 6 years away, I will put 10 lacs in an Aggressive Balanced fund like HDFC Prudence. This amount will take care of the 20 lacs that will be required for the child’s graduation.
• I will redeploy the 1.1 crore left in FD to different types of Debt funds. Assuming a CAGR of 8 % this will grow to an amount of 1.75 crores.
• His current equity investment will grow to 60 lacs if we take 12 % CAGR over 6 years.
• 20000 SIP @ 12 % returns will grow to about 21 lacs in 6 years.
• So at 50 years he will have 1.75 crores in Debt and 81 lacs in equity

Let us now look at deployment of corpus. In the first 10 years of retirement, his strategy can be the following:-

• Interest from Debt portion will be to the tune of 14 lacs @ 8 % returns. This is definitely possible if he is into good quality Debt instruments.
• As his child is in college and he is still relatively young, I will not reinvest this 2 lacs but spend it in discretionary expenditure such as travel or asset replacement.
• At the end of 10 years, he will be 60 so the activities will reduce and on the balance his medical expenses may grow. I think an annual expense of 18 lacs will be enough. There is no need to calculate this by inflation formula – makes no sense at all to do so.
• Assuming a 12 % return on equity his equity corpus will be 2.51 crores.

In the next decade his deployment can be as follows:-

• Keep using the interest from Debt instruments and take out the remaining required amount from redeeming the principal.
• Even after you finish the decade you will have some amount left in Debt instruments. I suggest you donate it to a charity of your choice.
• Your equity investments would have grown to more than 7 crores by now and will be more than enough to last your life as well as live a legacy.

So to come back to the basic query – will you have enough to retire at 50? You bet you will. Now just shut out all the negative people with negative comments from your mind and go ahead with the plan. Honestly, if you are able to get the selection of instruments done on your own, you do not even need a Financial planner.

Will be happy to receive comments, feedback and criticism on the post.

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An MF portfolio for Retirement

Most of us are familiar with creating and investing in an MF portfolio during our active earning years. We start off in a small manner, keep increasing our investments as our incomes keep rising over the years and hopefully get to a stage of having sufficient corpus in hand when we retire and no longer have an active income. This post is about the aftermath – what happens when we retire and id there a way in which we can deploy the corpus through MF? 

Firstly, let us examine whether it will make sense to be invested in equity as an asset class after retirement. My view is, unless your corpus greatly exceeds your needs, you will need some amount of equity growth to take care of unexpected circumstances which can impact any of us. This can be a sudden illness, some other emergency in the family or simply having the good fortune of living longer than what you had estimated. Being invested in only debt instruments and drawing out of it, may result in a situation where you run out of money when you need it the most. I. therefore, am a big supporter of being invested in equity to the extent feasible even in the retired stage of life.

Secondly, the question arises as to how should you be invested in equity then? Well, the ideal way will be to keep having your 3 portfolios of Debt, MF and Stocks even in retirement. You start realizing money out of these portfolios in the same order so that your equity investments have the maximum chance to grow. However, as many readers will surely point out, what happens when you do not have sufficient corpus that allows you to follow this strategy? One way will be to invest in equity through MF which carries a lower risk by their hybrid nature. You are now not in a growth phase of your corpus but in the drawing down phase. At the same time, you want to ensure some decent growth as this will ensure the longevity of your corpus.

The following portfolio is again taken from Investors Guide and has been suggested by Dhirendra Kumar of VR Online. The idea is to put most of your corpus, save some emergency money, into the following funds:-

1. FT Dynamic PE Ratio fund
2. HDFC MIP
3. Reliance MIP

Note that the choice of funds ensure that the risks are contained either through Debt investments for 2 and #, or through market actions in the case of 1. Let me take an example to illustrate how this will work in real life.

• Consider a person who will retire in the next 2-3 years and has about 1.5 crores with him. He can put 50 lacs in each of these funds.
• For taxation issues, investments in 2 and 3 should be ideally done 3 years prior to the first year when money has to be withdrawn.
• The growth of the portfolio will be about 10 % on an average.
• Withdrawal rate can be about 6-8 % of the portfolio value, depending on the need.
• In the first year this will give about 9-12 lacs which is sufficient for most of us to run their annual expenses. I am assuming here that the investor already has a home.
• The surplus can be invested in some safe avenue or reinvested in these funds if some risk is OK.
• In case the corpus is 1 crore, the withdrawal will be 6-8 lacs in a year.
• Assuming a 6 % inflation, this will last about 20 years or more with a reasonable degree of comfort.

Note that depending on the corpus available, you can have more complex bucket strategies but this is probably a simple hassle free way to achieve what you need.

The million Dollar question of retirement

One of the great imponderables in the personal finance space is the question – how much do you need in retirement? There are several ways which are commonly used to arrive at an answer. In the US context, one figure that many planners throw around is 1 million Dollars, provided you have your own house. Of late, I am seeing a lot of people in India suggesting this figure for retirement in India also.

Now, in something like a retirement corpus, the more is always the merrier. As such, there is absolutely no problem in investing more for retirement, in fact it should really be a goal to invest as much as you can. However, two aspects are critical to examine in terms of how this figure may not be a good thing. Firstly, many investors will be hard pressed to invest beyond their means to arrive at such a corpus, thereby creating a situation where they have to compromise on living a good life today. Secondly, while a focus on saving and investing for this amount can be worthwhile, it will seriously limit any risk taking ability of the investor, thus limiting oneself in many cases to a job or career that one may not be overly excited about.

My principal objection to the above figure is that it is in another currency. So while the $ was at 50, the figure was 5 crores and today it is at 6.7 crores etc. This can be seen as a good hedge for our inflation but there are obviously far better ways to address that. Also, it is not a good idea in general, to have a moving goal post. Now, let us come down to what an amount of 1 M $ will mean for retirement corpus in real terms:-

• Let us assume a corpus of 6.7 crores, zero real rate of return and 30 years of retired life for which you need income.
• The amount you can theoretically spend each year will then be about 22 lacs. Note that this is in current prices.
• I am sure there are some people who have an expense of 22 lacs a year today, but it will be safe to say that their numbers are minuscule.
• If you assume an annual expense of 10 lacs then the corpus comes to 3 crores, which is less than half of the 1 M $ figure.
• If the real rate of return is 2 % then you will need much less than 3 crores.

The reality is most of us spend far less than 10 lacs a year, exclusive of accommodation expenses. So a far better way will be to estimate your monthly expenses at retirement, bump it up by a few percentage points and arrive at a corpus. As an example, if you are spending 7 lacs per year today, you can inflate it by 15% and look at 8 lacs as your annual expenditure. Remember, it is not the amount you are spending at your peak level of expenditure, it is the amount you will need when you are retired.

To take my personal example, for the past few years my annual expenses have actually been at the range of 20 lacs plus. However, a large part of this is due to the educational expenses for my children. When I do retire completely, these expenses will not be there and my estimate of 8 lacs annually should hold quite comfortably. As such, while I am probably going to be quite close to the US figure, I do not think I need so much.

Do not get swayed by fads that do not have any substantive basis. Your situation is unique – look at it and deal with it accordingly.

Building a passive income stream from scratch

This post is inspired through a discussion I had yesterday with a long time friend. He is considering to get out of his current corporate job and wanted to set up a passive income stream that will take care of his regular expenses. When I pointed him to my posts on this topic he said that, while he had read those posts and understood the situation from my context, he needed to set this up from scratch.

The discussion set me thinking and I wanted to look at a situation which many people may be facing when they are nearing retirement or are considering an early retirement. While generalization is always difficult, a typical situation of such a person may be as follows.

• The person has an own home which is fully paid for by now.
• He has a PPF account for a long time but has not contributed the maximum in a regular manner. Current balance in the account is 24 lacs (say).
• His children are either independent or in college. In the latter case he has made arrangements for the remainder of their education expenses through FD etc. This is not linked to the passive income that he wants to have.
• Fixed deposit amount is 20 lacs, PO MIS is 9 lacs in a joint account.
• PF and gratuity will come to 1 crore when he withdraws it.
• MF portfolio is 20 lacs and stock portfolio is 6 lacs.

Based on this, how should the money be deployed so as to get a passive income of about 7 lacs a year? There may be many ways but the framework suggested below is a good one:-

• Keep the current MF and stock portfolio intact for the long term. You may need it for situations such as long term care, beyond the age of 80.
• New investments in PPF are not needed but keep the account active by paying a small subscription every year. This is your fall back mechanism if you suddenly need money for some unforeseen event. Also the interest of 2 lacs a year is tax free.
• 9 lacs of PO MIS will give an interest of 75300 every year. Use this for your income.
• FD of 15 lacs can be put in Senior citizen scheme if you are eligible. The interest from this will be about 1.35 lacs.
• Divide the 1 crore obtained from PF and gratuity as follows:
  • 30 lacs in tax free bonds. This will give you an income of 2.3 lacs per year.
  • 30 lacs in some dividend paying debt scheme such as Monthly Income Plan or Balanced funds. This will give you an income of 2.4 lacs odd.
  • 10 lacs in a Liquid fund. Income from this will be about 70000 a year.
  • Rest 30 lacs can be put in FMP or other Debt MF (short term) in the Growth option. After 3 years you can use the capital gain for consumption and reinvest the principal amount. This is mainly for discretionary expenses such as a vacation abroad etc.

What about inflation? Well, you have enough hedges in the plan for that. PPF can be drawn into, LTCG from FMP or debt funds are there and equity part will hopefully grow. Also over a period of time the 7 lacs needed in current terms may not suffer as much from inflation as we think. However, even if it does, the plan above is likely to cover it.

Note that the above is a low risk plan where your passive income is pretty much assured. Other options where you put more money into equity are possible but they come with a higher risk. You do want peace of mind when you are at this stage in life!!

So with an overall asset base of 1.79 crore (plus house), you can comfortably generate a passive income of 7 lacs and take care of the future also. I hope this convinces people that you do not necessarily need 5-6 crores to have a decent retired life. More importantly, you can lead the life you need to lead at the right time for yourself and your family.

An asset base of even 1.5 crores, deployed creatively, may well be enough for this person to retire. Take this framework as a reference and arrive at your own plans for that.

Retirement spending -use PPF intelligently

In the cyber world feedback is instantaneous. Within hours of writing my post on how the retirement corpus could be much lower than what people normally think, two of my friends called me. One was excited that his current investments were much ahead of the number I had stated, while his expenses were in line with my post. The other expressed doubts whether 40 lacs in PPF would go a long way for retirement usage.

Well the proof of the pudding is in the eating, so I decided to do a basic spreadsheet on it. This is something I normally do not do – after all, if you are clear about something fundamentally then where is the need to prove the obvious? However, the assumptions and results are as follows:-

• With a starting amount of 40 lacs, deposit of 1.5 lacs for 10 years and withdrawal of 4 lacs every year for 10 years you will still have 50 lacs at the end of 10th year.
• In the second decade you can withdraw 6 lacs every year without any deposits and still be left with 21 lacs at the end of 20th year.
• Note that all withdrawals are tax free and you will get 80 C benefits on the deposits for the first 10 years.
• Interest rate assumed is 8 %, which is probably what it will average out as over the years. Conservative investors can use 7 %.

The bottom line is this – using PPF in an intelligent manner will stretch your money as well as make it tax free which is an ideal combination. The other key idea is to let your equity grow till the third decade of your retirement. You may well need great amounts of money for long term care, should you survive beyond 80 years and equity is the best bet.

So, no matter whether you are just starting out, are in your thirties and do not have a PPF account or have one which is kind of dormant, you must fully fund your PPF account. It will be a hedge in times when you do not want to redeem equity for your goals and it will also serve as a great tool for retirement planning when the time comes.

Many people confuse PPF with equity investments which is comparing apples and oranges. You do need equity in your portfolio but PPF is clearly the best debt instrument available which must be your first choice. Look at debt MF etc only after you exhaust your PPF contribution – preferably for both you and your spouse.

You will be glad in your retirement years that you took this seemingly dull but eminently sensible approach.

 

Retirement planning – understand the basics

I keep reading in various posts in Facebook groups and other blogs about how one simply needs crores in order to have any hopes of a comfortable retirement. Now, I am all for having more money as it does give you the ability and freedom to do things that you would like to do. At the same time, getting obsessed with some huge figures, worrying about the same and therefore not spending on the stuff that you need to spend today, does not really make sense for me.

How much do you really need for retirement? Well this depends on many factors, some of which like retirement duration, monthly expenses, likely inflation etc we are aware of. What we miss out is to understand how to spend our retirement. Let me make it simple – we can assume that a person retires at 55 and will live for the next 30 years. It can be divided as:

• First 10 years where he has a fairly active life and will continue to spend similar to his last monthly expenses.
• Next 10 years where his activities like travel etc get reduced and his medical expenses may increase.
• Final 10 years where medical and long term care costs may be high whereas other costs get reduced significantly.

Once you understand this division it will be easy to deploy the available money in a manner so as to take care of all 3 decades. Let us take a case of a person retiring today with the following asset base:-

• Own house in native place where they will be comfortable.
• Current expenses of 6 lacs a year.
• 40 lacs in PPF, 25 lacs in older tax free bonds, 35 lacs in FD
• 40 lacs in Equity MF and 20 lacs in stocks.

Now at first glance the portfolio does not seem adequate in any manner but let us take a closer look. He can plan as follows:-

• Interest from debt products will be 8 lacs per year. He can continue to use 6 lacs adjusted for inflation as his yearly consumption. Rest of the amount can keep shifting to PPF as interest there is tax free.
• In the second decade he can redeem part of the principal from his debt products and keep the equity still growing.
• By the third decade his equity assets would have grown significantly and will about 4.8 crores even with 10 % returns annually.
• His annual expenses will be about 28 lacs or so assuming 8 % inflation at the start of the third decade.

You can give it a name like bucket strategy etc but the fundamental mechanism is very simple. In the first decade try to spend out of the interest and dividends. In the second decade use the interest and principal redemption of your debt instruments. Finally, in the last decade use your equity assets to fund your regular as well as long term care needs.

In reality you can probably do with a lower amount of money too, but I will leave the readers to work it out on their own.

Retirement corpus deployment – A case study

This post is about a recent interaction I had with a lady who wrote to me about their current retirement plans. Her husband was running a small business and is about 53 years old and they have one son who is settled. For some reasons, they want to retire and wanted to understand if their current money availability would be enough for about 30 years or so.

Now my first inclination was to say – as your annual expenses are 6 lacs, you need about 2 crores assuming some other expenses like replacing car or furniture etc. That would be sufficient to take care of their retirement needs, unless there was a requirement for assisted living beyond 80 years of age or so. They would just have to hope that their son chipped in for it.

When she said that they did not really have 2 crores in cash, it came as a surprise to me. I guess we are so used to talking in the blogs and face book forums about the need of at least 5 crores and above if you hope to retire, that we forget there may be many who do not have such amounts. Does it mean they cannot retire or they necessarily need to depend on their children for their retired life? I decided to take a closer look at what they had, before I came to any conclusion that I could suggest to her.

Their assets, financial and otherwise was as follows:-

• They had a 2BHK flat in Chennai which they could now give out on rent as they were moving back to their native town in Tamil Nadu. The rent would be around 1.5 lacs per year.
• They had no PF but their 2 PPF accounts over the last 20 years was having a total of 55 lacs.
• All their other assets were in debt instruments and the total amount was to the tune of 70 lacs or so.
• They had no investments in equity at all.

While the individual deployment of cash would be something they have to be comfortable with, there are several financial options possible.

1. They can potentially sell their apartment and bolster the retirement corpus. However, as it is possible that the apartment may appreciate in value and the fact that the rental income is inflation adjusted, I did not recommend this.
2. Assuming they needed 4.5 lacs every year adjusted for inflation (after the rent ), the best way will be to withdraw it from the PPF every year. Right now the interest will be more than 4 lacs per year and they can continue to withdraw for more than 15 years till the amount in both the accounts get exhausted.
3. As they are uncomfortable with equity, they can put all the other 70 lacs in the debt funds. In 15 years even at a very low interest rate it will become about 1.8 to 2 crores. This can be deployed properly to get by for the next 15 years or so.
4. If they are willing to take some risks then part of this 70 lacs can be put into Balanced funds in the hope of greater growth.
5. Under current tax rules they will not really have to pay any taxes on the utilization of 6 lacs per year.

As expected, the lady wanted to go with the debt option and like all Indian parents, had the thought of leaving the apartment to their son. Of course, if they live beyond 85 or so the plan may need to be tweaked a little.

I hope this will be useful for people who may be near retirement and are feeling constrained by the fact that they do not have the kind of resources that financial planners and bloggers seem to suggest they should have. There is no problem if you have a lot of course – but if you do not then look to deploy what you have intelligently and you will probably get by quite well.