MONEY MYSTERIES

Managing retirement savings.. times of india 06.08.2018

Retired life may last for decades. It is crucial to not let inflation destroy the value of your savings, says Dhirendra Kumar

A few weeks ago, I wrote about how conventional wisdom on retirement savings is condemning Indian savers to old-age poverty. During decades of retired life, inflation destroys the value of your savings relentlessly. And many people find that their savings are just not enough.

How can you prevent this from happening to you? The first half, which I have written about in detail earlier, is about saving enough during one’s working life and investing this money in equity-backed mutual funds. The second part, is to derive income from these savings once retired life begins.

If you have appreciated what I’ve been saying about inflation, then this should be self-evident: you must spend, at most, only that part of your investment returns which exceed inflation rate. You must preserve the real, inflation-adjusted value of your money, not just the nominal face value.

Please read the preceding paragraph again, carefully. It’s possibly the single most important input to having a financially comfortable old age. So how do you do this?

Suppose you retire today with a ₹1 crore corpus. If you put the money in a bank fixed deposit, a year later, it will be worth ₹1.07 crore. So you would have earned ₹7 lakh, which you can spend, right? Not really. Assuming a realistic inflation rate of 5%, if you want to preserve the real value of your principal, you must leave ₹1.05 crore in the bank. That leaves you with ₹2 lakh to withdraw and spend over a year, which is ₹16,666 a month. Is that enough? For a middle class person, surely not. It could be a little worse with some banks, and it could be a little better with, say, the Post Office Monthly Income Scheme, but this is roughly the calculation.

It’s important to understand that with fixed deposits (and similar investments), this calculation does not change even when interest rates rise because inflation and interest track each other closely. The real (inflation-adjusted) interest rate is not going to be more than 1.5-2% at best. If you need ₹50,000 a month, you need about ₹3 crore. Of course, at that level of income, tax also has to be paid. So, about ₹30,000 a year will go as tax. This is the best case scenario. In practice, it’s often worse, as there have been times in the past when the interest rate has been below the real inflation rate. Moreover, income tax on deposits has to be paid whether you realise the returns or not.

The situation is very different in equity-backed mutual funds. As these are high-earning, but volatile. In any given year, the returns could be high or low, but over five to to seven years, or more, these comfortably exceed inflation by 6-7%, even more. For example, over the past five years, a majority of equity funds have given returns exceeding 17%, with about a fourth crossing 20%. The returns may fluctuate, but it helps the saver in getting rid of fear of old-age poverty.

In such funds, one can happily withdraw 4% a year. Besides, there is no income tax and the capital gains tax is 10% on actual withdrawals. Effectively, for a given monthly expenditure through equity funds, you need just half the investment that you would in deposits. So, for a monthly income of ₹50,000 a month, ₹1.5 crore will suffice.

A small (but growing) number of people have begun to understand and appreciate this idea, and started implementing it. They tend to be those who have used equity funds as their savings vehicle anyway and are used to ignoring short-term volatility in the interest of long-term gains. Unfortunately, most retired people are still looking for the non-existent safety that fixed deposits provide and end up facing hardships as they grow older.

The author is the Founder and CEO of Value Research