Over the years I have planned my financial independence, where I would have no need for an active income. This entailed creating the 3 portfolios of Debt, MF and stocks. If you are interested you can search my blog to read about my financial planning, there are quite a few posts on it. The important thing to understand here is that for me and anyone else, the amount of money needed in retirement will be a function of the lifestyle you want to lead.
For example, you can say that you just want to have a simple lifestyle in your home town without too many activities such as entertainment, dining out or travel. In this case, your expenses are likely to be reasonably controlled and maybe a figure of 6 lacs in current prices will suffice annually. On the other hand you may be a person who wants to have a vacation abroad every year, visit your children once in 6 months, have a car and driver to take you places etc. In such a scenario even 15 lacs per year may not be adequate.
So how do you go about estimating the kind of cash flows you would need in order to be able to have the lifestyle you want? One of the major assumptions I will make here is that your retirement period is 3 decades. Since most of the people retiring today are unlikely to do so before they reach 50 and almost many will look at 60 years or close by, this is a reasonable assumption. The mistake most people make is that they feel the expenses will be constant over the period of these 3 decades. In fact many people I know spend less initially as they are worried about inflation and their money running out.
If you look at this in a logical manner, you will probably do far more activities in the first of the three decades. Let us say you have retired at 55 years – now till you are 65, you will probably be in good health and therefore be in a great position to indulge in your hobbies and passions. The second decade will definitely see a reduction in the physical activities, for example your frequency of travel will reduce significantly. The third and final decade will probably see very little activity outside home.
Now, if we have to provide a framework for all the cost elements that are required to be funded in retirement, it will probably look like this :-
- Accommodation : Most people having their own house or apartment will need to have maintenance costs. Even if you are having a property somewhere and can fund your accommodation expenses through it’s rent, you are in good shape. In case you need to rent that will prove progressively more expensive with each year and therefore need a fair amount of assets.
- Running costs : These include daily living costs such as food, help expenses, utilities, maintenance, entertainment, clothing etc
- Insurance : Term insurance should be junked in retirement and you need to have Medical and home insurance for as much as you can possibly afford.
- Asset replacement : You will need to replace some furniture, quite possibly several white goods and also your car, once or more in these 3 decades. It is best to be prepared for it, very often we do not take it into account.
- Children related : I hope the higher education of the children and maybe marriages are over by the time you retire. Even if they are not, you need to keep a separate fund for it. Do not mix it with your retirement goals or plans. Also, while it is perfectly all right to give gifts to children, in your retirement you r children should not be needing monetary support from you in any manner.
- Travel : If you are a travel crazed person, like I am, you better estimate these expenses in a proper manner. Travel abroad is obviously expensive but even travel within India is getting there, especially if you account for the fact that at an advanced age you will need to travel in some comfort.
- Hobbies : Whether it is Golf, attending live music shows or visiting literary or theatre festivals, hobbies can be expensive. However, at this stage of your life you do need to indulge in them and therefore you have to plan accordingly.
- Health related : Even with health insurance, there is no guarantee that all mishaps will be covered adequately. As the decades go by, whatever you reduce in travel and hobbies should be kept for this purpose.
We can keep adding other categories but the above are good enough to arrive at a reasonable basis for our retirement expense calculations. How do you do it?
- Take your running costs based on your current expenses at the time you retire. Let us say this is X.
- Take other costs as a factor of X. For example if you are a frequent traveller then you may want to keep 0.5 X as your costs here for the first decade. Remember it is also a function of what X is. For example if you live frugally then X may be 4 lacs and you may need to keep 3 lacs for travel, especially if you are looking to travel outside India.
- Some costs are not annual in nature. For example asset replacement may well cost you 5X BUT it will be only once in 10 years or so.
I hope you have understood the concept by now. Doing this for 3 decades will tell us what is the total cash flows that we need at current costs. You can then check as to whether you have adequate inflows either from your assets or other sources.
The proof of the pudding is always in the eating though, and I will explain this framework with my personal situation in the next post.