There are two important phases of Retirement money management. The first phase is called the “Accumulation Stage” when you are accumulating money for retirement. The second phase is called the “withdrawal” stage. We are talking about phase 1 — the accumulating stage. When you are young (say below 50 years of age) you just know that you need some amount of money for retiring. However, when you are about 50 years of age you know more clearly how much you require.
The thumb rule is you require about 30 to 40 times your annual expenses. Annual expenses when you are 60. However, there are some people who take a more conservative estimate. They say that all the money that you will ever spend wh i l e in retirement should be available with you by the time you retire. The two types of investing are called — Safety First Investing, and Sustainable Withdrawal Rates – I am not sure how many of us have heard of these two words.
Here is a brief introduction with a common example. Safety First Investing means you have to have created such a size of the corpus that there is no need to take equity market risk. How does this work? Well, let us say the expenses of Mr. Raju is Rs 5,00,000 per annum at the age of 60. Mathematically speaking he needs about Rs 1.5 crore (30x his annual expenses) for his retirement. However, on an assumption that inflation is 6%, the total amount that he needs (by just adding up all his expenses over 30 years) that amount is Rs 4 crore (actual Excel calculation will show this as 3.95 crore).
So if he just put Rs 4 crore in an ultra-short bond fund portfolio – say in four fund houses — in two names. Mr. Raju and Mrs. Raju. As a couple, they can withdraw Rs 5L each (tax-free) and not worry AT ALL about market fluctuation. This gives huge comfort for the person who does not understand equity markets at all. In a mutual fund he will pay far less Income tax than in a bank f ixed deposi t . It is a more tax efficient way of investing.
What if they have Rs 10 crore to invest? Well put Rs 4 crore in ultras h o r t b o n d fund and the remaining in equities, debt, and say gold. Honestly, that money is going to be inherited by your children. Let them have a say, but there is no need to give it away when you are 60. However, when you are 80, your liquid fund will be booming — you may have drawn less, or it would have earned a good rate of interest. At this stage you can look at the second bucket and decide to distribute a little.
Remember the first bucket may be more than enough even if you live to 100 years of life! This is what is called “safety first investing”. Another way of Safety First Investing is by creating a direct equity portfolio where Mr R’s dividend is Rs 10L at the age of 60. On an assumption that the portfolio is well managed, dividends will take care of inflation, and excess if any, will be invested in a liquid fund.
FINANCIAL ADVICE
PV SUBRAMANYAM
writes at www.subramoney.com and has authored the best seller ‘Retire Rich - Invest C 40 a day’