“Retirement is when you Stop living at Work and Start working at Living”. If you are already retired or close to retirement, you need to find a way of generating revenue without the need to work. The only way to earn without work is to invest your money in something that works.
There are several mandatory obligations to be satisfied with your retirement corpus. You must create an emergency fund in the first place, and then you have your day-to-day expenses, and after, all these commitments your personal desires which give the satisfaction of living.
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Retirement life is a beautiful time to relax with peace of mind. But today, peace comes with a price. This article will unveil you about how to invest the retirement corpus in a customized way to suit your unique requirements.
But wait! What is the need for customization, when you can get a guaranteed regular income from a fixed-income scheme at the highest rate of 8% per annum?!
This article is not just about blindly showing you the ‘where’ but about educating you on ‘how’. If you can’t find a justification, we hope it is mandatory for us to enlighten you about the downsides of such investments first.
Are you worried of the impact corona has created on your retirement corpus?
This may fall hard especially on retirees who are living on a fixed income. Pension plans and savings accounts may generate lesser than they did. Your pain and pressure can be understood. Hence we give you some tips to help you overcome this crisis to meet your retirement goals.
1. You can create a coronavirus financial contingency plan
This is the first thing to do before anything else. A contingency plan will make you prepared to meet crises and mitigate the risk.
“An ounce of prevention is worth a pound of cure” – Benjamin Franklin
This is the list of things to do:
- Prepare for emergencies
- List your mediclaim policies,
- Ensure family and COVID 19 coverage,
- Create an information vault.
To know more read: coronavirus financial contingency plan.
2. What should you do with your investments?
Due to the panic, you would have planned to
- a) Withdraw to avoid further losses and
- b) To time the market bottom.
“Panic implies that there is no rational thought taking place. That we are frozen and incapable of adjusting. Powerless to logic, and subject to seemingly unthinkable behavior”. -Anthony Scaramucci
Yes, so do not make decisions in a Panic. Your investment strategy requires rational thought hence keep fear and anxiety away. Do you want to make any significant changes to your financial plan in a moment of panic? No? Then it’s better to stay invested. If in a need, you can use your debt investments, emergency funds, and as the last option, you can use the EMI moratorium facility.
For more info read: How to take advantage of the coronavirus crash.
3. Steps to recover faster and better from the Stock market crash.
a. By a portfolio revamp
Test how your funds perform, If you have poor performing funds, it is better to move them into better-performing funds before the stock market recovers. This is also called as portfolio optimization. Experiments on portfolio revamping worked. To know if you should redeem and reinvest, read: How to revamp for faster and better results.
b. By a portfolio rebalance
“An asset allocation plan is based on your personal circumstances, goals, time-horizon, need and willingness to take risk”. -Michael LeBoeuf
After the stock market crash, your asset allocation would have changed. Then you are supposed to bring it back to the original asset allocation. This is portfolio rebalance. This allows you to buy assets at a cheaper rate and sell them at a higher rate. This reduces risk and helps you reach your financial goal.
For more, read: How portfolio rebalance is done.
c. Choosing on SIP
You can either stop, continue, or increase SIP.
“The strongest principle of growth lies in human choice.” -George Eliot
So to find the best choice, two experiments with three investors were conducted, each of them chose an option. One to stop, another to continue and another to increase SIP (all during the market fall). Who do you think earned the highest portfolio value?
In both the experiments, it was the one who chose to increase his SIP during the market fall.
- a. The one who stops his SIP incurs a loss.
- b. The one who continues his SIP gains better.
- c. The one who increases his SIP gains the highest.
Hence increasing SIP will help you recover faster and better.
For more, read: How to play smart with your SIP.
“Lost time is never found again”. – Benjamin Franklin.
Yes as the quote says, If you want your portfolio to recover faster, then do these before the market recovers. This is the right time to do it, as the time lost is always lost. You can achieve your financial goals by adhering to the above steps. These will help you reduce your risks and also help your portfolio recover when the market recovers.
The common advice & common mistake
To better understand about retirement let’s take a common example throughout this article, Ajay and his retirement corpus of 1 Crore.
Ajay believes that a fixed income investment is the safe place for his hard earned money and puts it in a fixed income scheme which pays the highest interest of 8% per annum. The amount accumulated in a year will be 1.08 Crore.
Ajay takes out the interest of 8 Lakh and handles his expense for the first year after retirement. But within a few years, Ajay will not be able to compensate for his day-to-day needs with the 8 Lakh interest due to the inflation rate which is at 4% now.
If Ajay begins using the full interest for his expense it would become a habit, and eventually, the habit will turn into his lifestyle. Naturally, he would want to maintain his lifestyle and he might begin to withdraw from his capital in addition to the generated interest. To elaborate on the effect of inflation in detail look at the table below,
|Year||Corpus size on the beginning of the year||Interest Gained (8%)||Inflation rate (in %)||Rise of expense due to inflation||Amount extra needed||Corpus size on end of the year|
Over a period of 7 years, due to inflation, he would need around 2.5 Lakh more than the interest from his corpus, to maintain his lifestyle!
So he will obviously be forced to withdraw money from his capital of 1 crore for compensating the inflation, which will reduce the return of next year which is again not sufficient and consequently break down the capital more and more. If he withdraws from the capital like this, he may end up outliving his retirement money.
To avoid such an unfortunate event like the one happened to Ajay, you have to preserve the real value of your capital and consume only what your investment earns over and above the inflation rate, which means you need to generate revenue for your expense plus the inflation rate.
One message that is clearly conveyed through this example is that you should not simply invest your full corpus in a fixed-income scheme for your living. Thus, it is preferable to create your own investment portfolio that is flexible as per your requirements.
How to create your own investment portfolio?
Our after retirement investment strategy is built in 3 basic steps. They are,
- Configuring the Retirement corpus
- Building a Retirement Portfolio
- Conservative withdrawal
Now let’s begin to work out on your personalised retirement portfolio in detail.
Step 1: Configuring The Retirement Corpus
You must have come across many hardships to consistently build & protect your retirement corpus during your employment. Now is the time to consolidate all your retirement schemes and measure the full weight of your retirement corpus to create your retirement foundation.
Full size of your retirement corpus should be known before even beginning to draw your plan. Regardless of the order of priority, we need two more important figures to sketch a strong configuration for your retirement. Your life-expectancy and expense estimate.
The outline of our plan is like this. Your retirement corpus should be configured to produce a regular income to manage your essential & discretionary expense until or over your life-expectancy.
The retirement corpus configuration involves three stages –
- Consolidating the retirement corpus
- Estimating life-expectancy
- Estimating Regular expenses
We will discuss in detail about how these pillars support your retirement.
Consolidating the full retirement corpus:
Consolidating the corpus is the foremost work to do as discussed before. We can categorise the platforms for retirement savings into two,
- 1. Employer-sponsored retirement funds
- 2. Self-made retirement funds
The employer-sponsored retirement fund is partly contributed by both the employer and the employee like gratuity and provident fund. The self-made retirement funds are those you create for your retirement like shares, fixed deposits and other retirement policies.
Also, retirement is the right time to recollect the money that you’ve lent to friends/relatives.
You might be holding some investments that are underperforming for a long time like a real-estate property you bought in the outskirts. If you feel like it is right to liquidate such assets, then you can sell them and add the money to your retirement corpus.
Download the Retirement Corpus Reliability Checker for free here.
Once you reach the full size of your retirement corpus, the next task is to estimate your life expectancy.
Estimating your life-expectancy is an important factor to take into account while planning your retirement.
A person retired at the age of 60 or 65 is likely to live until 80 – 90 years or even more, with all the modern medical facilities available today.
Who would say no, if given a chance to live for an extra 5 years? Everyone would take it, wouldn’t you?
So you need a retirement plan to generate income for longevity.
Note: Don’t forget to take into account the life expectancy of your spouse or other dependents. In short – plan for a long retirement.
Estimating Regular Expense:
Regular expense planning should be done with the maximum accuracy possible. Visualize your post-retirement lifestyle in mind first and then pen down your expenses from it.
You might miss some expenses in a rush, so spend at least a month of time to precisely estimate your expenses.
For your ease of estimating, categorise your expenses into daily, monthly, and yearly expenses. The daily expense includes food, transportation, etc. The monthly expense includes house rent, electricity bill, and etc. The yearly expense includes your car insurance, family vacation and things like that. In the end, sum up all the expenses to get the net annual expense value. Download the Expense Calculator for free here.
An extra 5 – 10% of the estimated expense can be added to it as a precaution.
Apart from your living expenses, it is highly recommended for retired individuals to hold Health Insurance and an Emergency Fund. A good financial planner should always expect the unexpected and be prepared for it.
At this point, you can make use of the Retirement Calculator shown below. Put all your estimated amount and get to know the amount you need to save each month.
In case of an unfortunate medical complaint you would be forced to break the retirement corpus. It can potentially reduce the size of your corpus which will reduce your returns simultaneously. Mostly health issues are unpredictable and now with health insurance, you have one less problem. So you must have a Health insurance plan that covers all of your family members.
Can you predict your car breakdown in advance? Or do you know when surprise travel would call for? These are such little unexpected expenses that can alter your expense estimation. So, you must always have 4 to 6 months of expense in case of an unexpected event or expense. This fund should preferably be in the form of cash-equivalents like Liquid fund that provides high liquidity and high returns than a bank savings account.
We’re done with configuring your retirement corpus, and now time to start building your portfolio.
Step 2: Building Your Retirement Portfolio
Your risk tolerance capacity and return requirements are the important factors to consider while building a retirement investment portfolio.
I hope you remember the story of Ajay we discussed a while ago which justifies why you should not invest your full corpus in a fixed-income. What can you do to earn more income in a more safe and organised way? Go ahead, read.
Set your priority:
You can create a list of the possible issues a retiree could face, and then prioritize the issues based on your expense requirements and risk-taking ability.
I’ve mentioned the general set of problems a retiree might face and prioritised it from a commoner perspective.
- The first problem is you are not going to get a salary in the retirement life. You cannot spend for your daily needs from the retirement corpus. So you have to generate a regular income through the retirement corpus to pay for your regular expense.
- The second problem is to protect your retirement corpus money. If you do not have any other assets to generate income, then you only have the retirement corpus for the rest of your life. There are many fraudsters who can trick you by promote schemes with high returns and loot your lifetime saving. You must be very careful of such attempts and secure your corpus through a safe investment like fixed-income.
- The third problem is inflation, which is typically out of sight. After finding a way to generate a regular income for your daily expense, you need to find a way to defeat inflation. Even if your lifestyle hasn’t changed and got adapted to your regular income, it will not be sufficient in a few years because of inflation. So a corpus growth technique should also be implemented. You can also use it for your discretionary expenses.
To address these major problems for a retiree, we have designed a three-phase retirement portfolio that is shortly listed as,
- i. Income Generation in Retirement
- ii. Retirement Corpus Protection
- iii. Retirement Corpus Growth
These are the major purposes of using the corpus, but all of them cannot be given equal priority. The level of priority given to a particular purpose varies depending upon the retiree’s financial conditions/requirements and risk taking capacity.
i) Income Generation in Retirement:
You have already estimated your expenses while creating the foundation. Now we have to create a regular income which should equate to your estimated expense. Essential expenses cannot be compromised at any cost and so it is highly recommended to invest the income generation funds (the sum of money specially allocated to generate a regular income) in a risk-free investment like debt.
For example, we will take Ajay and his 1 crore retirement corpus. Assume that his net annual expense is 6 Lakh which is 6% of the corpus. It is easy to generate 8% return from the corpus through a fixed-income itself.
We have handpicked some of the most preferred & standard fixed-income plans with satisfactory return and safety to the capital. Like all other things, they also have their plus and minus. We’ve attempted to cover all of them and tabulated it with the key features.
|FIXED INCOME SCHEME||LIC Varishtha Pension Bima Yojana||Fixed Deposit||Senior Citizen Savings Scheme||Post office Time Deposit||Debt mutual funds|
|Rate of interest||8%||6 – 8%||8.5%||7 – 8%||7 – 8%|
|Investment tenure||15 years||7 days – 10 years||1 – 5 years||1 – 5 years||91 days – 5 years|
|Lock-in period||15 years||Same as tenure||5 years||Same as tenure||Same as tenure|
|Minimum investment||Rs 63,960||Rs 1000||Rs 1000||Rs 200||Rs 500|
|Maximum investment||Rs 6,39,610||Rs 15,00,000||Rs 15,00,000||–||–|
|Penalty on premature withdrawal||2%||Interest rate is reduced by 1% from the original||1-1.5%||According to the scheme||1 – 3%|
|Tax status||Taxable for income generated||Taxable for income more than 3 lakh||Taxable for income more than 1.5 lakh||Taxable for income more than 50,000||20% for >3years.
As per slab for <3years
|Recommendation||Can be considered||Can be avoided||Can be considered||Can be avoided||Can be considered|
The above table clearly explains that it is better to distribute your retirement savings in LIC Varishtha Pension Bima Yojana, Senior Citizens Savings Scheme & Debt Mutual Funds.
With that, you have an investment to generate a regular income for your essential expenses and now we will discuss the necessity of securing the corpus.
ii) Securing the Retirement Corpus:
Your retirement corpus is the only thing that makes up for your living. So remember you should never risk your living for a little extra return.
There are a bunch of stories of financial frauds which teach us many lessons. One such crucial lesson is not to fall for the trap of high returns. Since you are a retiree, people around you know that you have a big piece of retirement corpus and would try to drain your brain with suggestions like a hot business idea, share market, and other investment options promising huge returns. You should be very much aware of the consequences of any financial decision you make in retirement life.
A fixed-income scheme is the only option that could give you steady returns for your living for the predefined amount of time. Don’t compromise your corpus safety for a little money.
But we also know from the story of Ajay that you cannot invest your full corpus in a fixed-income which will defeat the purchasing power of your money.
So, where should you invest the retirement corpus?
You should split your retirement corpus into two pieces, and allocate one big piece to fixed-income and the other small piece to equity.
So we will use a mix of fixed-income and equity investment in an optimal ratio to protect the real value of your corpus. Research says that the optimal ratio to secure the corpus while still in a safe zone is 70% allocation to fixed-income and 30% allocation to equity.
The 70:30 (debt: equity) ratio is considered as the minimal risk ratio of investment to fight inflation.
Equity investments have higher fluctuation/risk in the returns, but when you see the average return they produce, the fluctuations are easily smoothed out in a long-term. The returns are truly unmatched by any investment in the long-term.
iii) Retirement Corpus Growth:
The main purpose of corpus growth is to compensate for the downfall of the purchasing power of your retirement money due to inflation. The gains from equity will be added to your capital investment in fixed-income which will increase the size of your corpus.
For better understanding, we will see how this ideology works for our friend Ajay and his 1 crore retirement corpus.
As per the optimal ratio to protect the corpus against inflation, we will allot 70% (70 Lakh) of Ajay’s retirement corpus to a fixed-deposit scheme which can produce 8% interest, i.e. 5.6 Lakh per year.
The balance 30% (30 Lakh) in Ajay’s retirement corpus should be invested in equity. After a period of 5 years with approximately 12% return, your 30 Lakh would have become 50 Lakh, i.e. the earning would be 20 Lakh.
Now, we will take the gain of 20 Lakh from equity and drop it in your fixed-deposit scheme and leave the 30 Lakh in equity itself. Now the size of Ajay’s capital investment in fixed-deposit will become 90 Lakh. Simultaneously it raises Ajay’s annual income from 5.6 Lakh to 7.6 Lakh.
This way, his corpus size will grow in-line with inflation while being conservative at the same time.
Apart from the funds allocated to equity for corpus growth, a small portion of the corpus can be allotted to equity for discretionary expenses of the investor. You will thank yourself in the long term for choosing equity as your back-up.
I hope you got the picture of how the corpus grows. The next step is about withdrawing your returns.
STEP 3: Conservative Withdrawal
The way of withdrawing your income can also affect your finances. It is something that must be planned in advance. Financial analysts have found the most efficient way of withdrawal for retirees without affecting the actual size of the capital.
It is advisable to withdraw your returns annually for your essential expenses from the fixed-income scheme. Begin to withdraw only 4 – 5% of the capital, from the next year you can increase the withdrawal amount to 5% of the previous year’s return.
In the case of Ajay and his 1 crore retirement corpus, the retirement portfolio has a fixed-income allocation of 70 Lakh. The first year of withdrawal should be within 5% i.e. 3.5 Lakh. By the next year, you can withdraw an extra 5% of the 3.5 Lakh which is around 3.7 Lakh. You can repeat this every year and keep increasing your withdrawal rate.
Also, you should watch out yourself from withdrawing more than 6% of the capital at any time in a year. Because this can affect the actual size of your capital and reduce your income. Precaution is better than cure.
Systematic Withdrawal Plan (SWP)
Is offered by Mutual fund companies gives you a more convenient and profitable way of withdrawal. It is typically designed to favour retired investors in mutual funds. It provides a convenient withdrawal option in weekly, monthly, quarterly, semi-annual, and annual basis.
Market value might rise and fall consequently over the years. Just as a precautious reason, you should take into account the effects of market fluctuations when deciding the amount of withdrawal. But moreover, during years of strong performance in the market, the appreciation in your capital will build sufficient backup to smooth out the variations in return.
A good retirement plan would have these key points. Make sure you don’t miss any of these while investing for retirement.
- Accommodate longevity in your retirement plan. At least for a minimum of 30 years.
- Remember – Inflation is a serious problem.
- Allocate 4 -6 months of expense as Emergency Fund.
- Invest 70% to fixed income for expenses.
- Invest 30% to equity for growth.
- Withdraw in a conservative manner.
The happiest thing about retirement is that you have a 7 days weekend. To enjoy the days with financial freedom, you must pick a smart investment option. A good retirement plan should cover these two crucial objectives.
Primarily, it must generate a regular income from the corpus and then the corpus itself should be encouraged to grow. The hitch in accomplishing the objective is inflation. The pesticide to kill inflation is none other than, equity.
Avoiding equity in retirement is really not a wise choice. A minimum percentage of exposure to equity will be your helping hand.
I believe that with age, comes wisdom and now the ball is on your side. The time has come to play your life the way you want.
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