Article by Mr. Misbah Baxamusa, CEO, NJ Wealth Financial product Distribution Network
Retirement is a critical phase in every individual’s life, and it’s essential to start preparing for retirement early. How does one define early? Is it 10 years or as long as 20 or 30 years?
In today’s world inflation is growing at a fast pace. The 25-year average rate of inflation stands at 5.55% (RBI, 2023). Inflation reduces purchasing power and erodes the value of your savings. Just to give you a perspective, if you are 30 and your monthly expenses stand at ₹25,000, 30 years later, when you retire at 60 and continue with the same standard of living, your monthly expenses will be ₹1.26 lakh. Factor in the increasing cost of medical expenses, and you will see, that the retirement kitty needs to be huge to sustain oneself.
Moreover, with the advancement in medicine, life expectancy is increasing. Over the last 25 years, life expectancy has increased by 14.56% from 61.47 in 1998 to 70.42 in 2023 (Macrotrends, 2023) and is expected to grow in the coming years. Furthermore, parents can’t rely solely on their children due to changing cultural norms with a shift from living in large joint families to living in nuclear families. In such a situation, one can achieve financial independence and retain their self-respect by preparing for retirement in advance.
Given all these factors, the retirement kitty need is often huge and can’t be accumulated in a short period of time. If started early, one can take the benefit of the power of compounding which works wonders in the long term. Hence, experts recommend to start saving for retirement years before retirement and the earlier, the better.
The most common tool to build a retirement plan
In India, people have relied on traditional investments for their retirement planning. A popular tool for building a retirement fund is the public provident fund (PPF). However, the rate of return on PPF stands at just 8.51% (National savings institute, 25-year average, 2023). Moreover, it is difficult to tailor the size of the retirement fund because the maximum investment limit is capped at Rs 1.5 lakh. Another common tool used by investors is fixed deposits. The returns generated by fixed deposits are even lower than that of PPF at just 7.28% (RBI, 25-year average, 2023). The real rate of return, net of inflation, of these instruments is just 2.80% and 1.64% respectively. Factoring in the tax effect, the returns might just barely beat inflation. So, is there a better way to build a retirement fund? Historically, equity mutual funds have delivered attractive returns and have even delivered double-digit real returns.
Source – PPF and FD returns are 25-year average shared by National savings institute & RBI, respectively. Mutual funds returns are 25-year average returns for available select MF equity funds based on internal study.
Saving For Retirement with SIP…
One of the best ways to save for retirement is through a Systematic Investment Plan (SIP) in equity mutual funds. SIP is a method of investing a fixed sum of money at regular intervals, such as monthly into a mutual fund. The idea behind SIP is to make investing in mutual funds more accessible and manageable for the average person by breaking down the investment into smaller, regular contributions. Investing in SIP provides flexibility to investors and the power of compounding amplifies the returns, resulting in better risk-adjusted returns.
Due to inflation, a falling trend in interest rates in traditional investment avenues coupled with growing aspirations, there is a need for higher post-tax real returns which is crucial for building wealth and not just protecting wealth. In the long run, equities as an asset class and mutual fund SIP, are the way of investing and seem to be a perfect fit to the needs of our times.
Let us get some estimates as to the size of the retirement kitty required and how much SIP will be needed to accumulate the retirement kitty.
|Retirement Age: 60 years||Life Expectancy: 85 Years||Monthly Expense: Rs.50,000|
|Inflation: 6%||Returns on Retirement Kitty: 8%|
|Case 1||Case 2||Case 3|
|Years to Retirement||30||20||10|
|Retirement Kitty Need||₹6.89 crore||₹3.85 crore||₹ 2.15 crore|
|Monthly SIP Amount Required to Accumulate Retirement Kitty|
|Returns @ 12%||₹ 22,400||₹ 41,850||₹ 95,900|
|Returns @ 10%||₹ 33,150||₹ 53,150||₹ 1,06,650|
|Returns @ 8%||₹ 48,600||₹ 67,200||₹ 1,18,500|
We can infer a lot from these estimates. To start with, we can see that the monthly SIP amount required increases significantly as we delay our investments and reach closer to retirement age. Hence, it would be better if one starts early. Also, important to note is the choice of asset class. One has to significantly save a higher amount if the expected returns are lower. This stark difference is more apparent if the investment horizon is long. Thus, for asset class delivering 12% returns (read equities), your savings would be less than half of what you would be required to save for 8% returns (read debt). If one can start early, one can enjoy the advantage of the power of compounding in the long run.
Now, the question arises, what if one cannot save the required SIP amount starting today? Well, in such cases, Top-up SIP can be a saviour. With Top-up SIP, one can commit to increasing the SIP amount at a set frequency, say yearly. In our example, assuming a return of 12%, a 30-year-old person would only need a starting SIP of ₹11,500 with a yearly top-up of ₹ 1,500. For a 40-year-old person, a SIP of ₹27,000 with a yearly top-up of ₹2,500 would be adequate. However, with SIP top-up, a lot more can be achieved and its’ impact can be huge in the long term. One can smartly use it to also achieve other goals and build even greater wealth.
To summarise, SIP and especially SIP with Top-Up can be a great way to save for retirement. The discipline and consistency of SIP help investors to save and invest regularly over a long period of time in the right growing asset class like equity, with reduced risks. The benefits of rupee cost averaging in SIP can help to mitigate the impact of market fluctuations and volatility on investment, making it a more stable option for investing. In addition, the convenience, flexibility, liquidity and tax benefits of mutual funds also add to the appeal of planning for retirement through mutual fund SIPs. All these elements would be essential to building a sustainable and adequate retirement corpus.