Are you on course to retiring comfortably?

So you manage your own money. But how do you know if you are on course to retiring comfortably? This is a question that we have been asked on several occasions by individuals who manage their own finances. In this article, we discuss how you can periodically monitor your portfolio to ensure you are on the path to achieving financial freedom.

Annuity argument

The amount you need at retirement is a function of several factors such as the number of years you are likely to live, expected inflation during your retired years and your monthly expenses post-retirement.

Suppose you start your retirement savings at 30 and plan to retire by 55, your investment horizon is 25 years. The benefit of a long investment horizon is that your portfolio has enough time to accumulate wealth and also recover losses, if any. The flip side is the uncertainty involved in the long years ahead. You may not know if you are on course to accumulating the wealth you require.

Your objective post-retirement is to have a stable income to meet your household expenses. Some of you will receive pension from your employer. Often though, the pension is not enough. Your investment portfolio should bridge the gap in the required monthly cash flow. If you do not receive pension, the investment portfolio has to provide for the entire amount.

One way to determine whether you have enough money in your retirement portfolio is to check every year if you can buy life-time annuity from an insurance company to hedge your longevity risk. This is the risk that you may not have enough money to meet your household expenses till you live. The purchase price of the annuity is the minimum amount your portfolio should have for you to retire comfortably.

Suppose Rs 1 lakh of purchase price can buy you Rs 7,100 of annuity every year for life time. If you require Rs 6 lakh a year to meet your household expenses post-retirement, the purchase price will be Rs 84.51 lakh. Cushioning for inflation during your retirement years and possible changes in your lifestyle during that period, let us suppose you need Rs 1.5 crore to retire.

Now, annuity rates are a function of the prevailing interest rate in the economy at the time you purchase the annuity. So, higher interest rate translates into higher annuity. As you will gradually build your retirement portfolio through your working years, it is only at retirement that you can accumulate Rs 1.5 crore. How much should your portfolio value be during the intermediate years?

Assuming you have 20 years to retire, your objective will be to accumulate at least 5 per cent of your retirement amount by the end of five years, 15 per cent by the 10th year, 40 per cent by the 15th year and, hopefully, the entire amount at retirement.

It is important to check at each stage whether your retirement money can help you buy annuity. That is, if 10 years have passed since you started your retirement savings, you should be able to buy Rs 90,000 in yearly annuity, 15 per cent of Rs 6 lakh of desired annual annuity flows.

Annuity laddering

If you are on course to achieving your desired retirement wealth, you can consider buying immediate annuity at each five-year intervals. Such a process is called annuity laddering, because you buy annuities at different rates at different time periods.

You should reinvest the annuity in equity or bonds depending on your risk appetite because you do not need the cash flows till retirement. What if your portfolio is not on course to accumulating the desired wealth? You should not increase your equity investments to bridge the gap. Rather, consider extending your retirement age, if possible.

(The author is the founder of Navera Consulting, a firm that offers wealth-mapping and investorlearning solutions. Feedback may be sent to >knowledge@thehindu.co.in )

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