Retirement Investing : Approach Over Timing

An overriding notion when it comes to investing for retirement is that the major reason why most people do not end up creating a corpus for retirement that is large enough to allow them to retire at the time of their choice is because they may not have begun planning for their retirement early enough. This is not entirely true. The approach that we follow towards investing for retirement matters a lot more to our chances of success than how early we begin investing for retirement. And most of us lack a clear approach when investing for retirement. Putting a few thousand rupees into our retirement portfolios every month is simply not enough to ensure a successful retirement. So today, I will be putting forth a clear framework which we can use when investing for retirement. I also hope to be able to show why investing for retirement is a much bigger and more complicated challenge than we usually appreciate.

If putting away a few thousand rupees into our retirement portfolios is not enough, then just how much should we be investing for retirement each month? To answer this question, we need to begin by looking at our monthly expense list. For the purpose of retirement planning, we may exclude expenses incurred on behalf of other members of our family (amounts spent on children, dependent parents, siblings and so on). Our focus must only be on those expenses which are essential, recurring in nature and are likely to persist for as long as we live. This includes items like groceries, rent, utilities and so on. Next, total up these expenses. Lets call this amount E (representing expenses). Our first target when investing for retirement should be to invest anywhere between 75% and 100% of E. Therefore monthly investments for retirement (let's call this RI) should be equal to 0.75E or E. This can be understood with an example as shown in the graphic that follows.

Investing between 0.75E and 1E every month for retirement would put us on course for a normal retirement (retirement between the ages of 55 and 60). Those of us who wish to retire early must look to invest an amount equal to anywhere between 2E and 4E for retirement every month. As our income grows over the years, we must look to keep our essential monthly expenses constant and increase our investments for retirement by at least 10% every year. Anything more than a 10% increase in our investments for retirement every year is highly appreciable and perfectly welcome.

Let us now look the ideal asset allocation and assumptions around which to make our investments for retirement. First off we need to set our inflation rate expectations. In the Indian context, the minimum inflation benchmark that we need work with is a rate of 8%. For someone who begins planning for retirement at a reasonably early age (say mid 20s to late 30s), the ideal asset allocation strategy for a retirement portfolio would be 60% equity and 40% debt. The product choices within each asset class do not matter as long as the overall asset allocation is maintained and coupled with regular portfolio rebalancing. But for the sake of convenience we may provide for the equity portion of our portfolios with a single large cap index fund that has adequate liquidity and is offered by a reputed mutual fund house. The debt portion may be provided for through a combination of liquid funds, short duration debt mutual funds, and defined retirement contribution schemes offered by our employers (such as EPF or NPS), if any.

As far as setting return expectations is concerned, a reasonable assumption would be to expect a long term return of 10% post tax on the equity portion of our portfolios. We may realistically expect a long term post tax return of 7% on the debt portion of our portfolios. This would give us a long term portfolio return of 8.8% with an asset allocation of 60% equity and 40% debt. That is, (60% * 10%) + (40% * 7%) = 6% + 2.8% = 8.8%. This translates to a long term real return of 0.0074%, meaning our portfolios would marginally beat inflation over the long term. Working with professional fee only financial planners for better clarity on the ideal inflation benchmarks and asset allocation strategies for our bespoke needs is also a perfectly viable option.

Tax planning and optimisation is undoubtedly another important aspect of investing for retirement. But an essential drawback in the way that most of us plan our taxes is the fact that we place on minimising our tax payouts. Firstly, we must understand that tax optimisation does not only mean tax reduction. It only means ensuring that we don't pay more taxes than we actually need to. Secondly, most tax saving investments are not oriented towards long term growth. And given that growth is an essential prerequisite to have a chance of success in case of a long term goal such as retirement planning, it makes very little sense to place undue emphasis on tax planning. This means that we don't need to benefit from every possible tax break or hold every possible tax saving investment product in our portfolios. It is more than sufficient to pick a couple of tax saving investments and focus on investing in them consistently. Tax benefits should only be viewed as an additional bonus and not the central crux based on which to make our investment decisions. Having to pay a nominal amount as taxes every year should not make us deviate from the much larger and more important goal of creating enough wealth for ourselves.

The inflation benchmarks we assume when investing for retirement and our ability to consistently increase our investments over time are the two factors that have the biggest say on our chances of enjoying success in our retirement investing endeavours. The inflation benchmarks we assume may not always be accurate in light of our lifestyles. Some of us who live relatively more extravagant lifestyles may have to work with inflation benchmarks as high as 10%. And in such cases, the real returns from our portfolios with the usual 60% equity and 40% debt would be negative. Also, we may not be able to increase our investments every year on a consistent basis especially in the later years when we work with higher base amounts. Comprehending and making peace with the risks involved when investing for retirement is also quite a challenge. This is why retirement planning and investing is widely regarded as the most complicated challenge in personal finance.

But this should not dissuade us from making an honest and consistent effort to invest for retirement. We need to get over the tendency where we view achieving anything less than our intended targets when investing for retirement as a failure. As long as we make a start and are disciplined in our efforts we can rest assured of being on the right track. And following a process driven approach when investing for retirement would give us a perfectly fair chance of success. And this is realistically the best we can hope for when investing for retirement.