How inflation can affect your retirement portfolio

Last week, on my way back to Bengaluru, I met Kartik Patel at the Chhatrapati Shivaji Maharaj International Airport. We spoke about our respective professions over a cup of coffee. Kartik is working in an auto ancillary company and his wife Juhi is an architect in Bengaluru.

Being a finance professional, my conversation centred around personal finance, and we touched upon a few personal finance concepts. I am explaining one such topic related to inflation and its impact on retirement portfolio.

Kartik and his wife, both 40 years old, plan to retire by the age of 55.

The couple’s combined monthly income is ₹4 lakh and expenses are around ₹2.5 lakh.

For retirement by the age 55, Kartik’s plan was to build a corpus of around ₹7.2 crore as per his current lifestyle and expenses. However, the biggest mistake he was committing was not to consider the aspect of inflation in retirement planning.

At the time of retirement, necessary expenses for a month wouldn’t be ₹1.9 lakh; they would be around ₹4.5 lakh.

The simple definition of inflation is reduction in the purchasing power of the rupee. Suppose, value of ₹1,000 in 2019 becomes less than ₹100 in the next 40 years. In this case, what Kartik is able to purchase with ₹1,000 today, he would be able to purchase 1/10th of it in the next 40 years.

And, hence, the monthly expense at the age of 55 would be around ₹4.5 lakh per month. Similarly, by the year 2050, the couple’s monthly expenses would be ₹11.5 lakh.

Hence, if Kartik is planning for a portfolio of around ₹7 crore at the age of 55, the chances of his retirement portfolio drying up by the age of 65, would be rather high.

Now, if Kartik is considering the aspect of inflation in his retirement planning, his portfolio would be around ₹18.5 crore. The way to reach this goal of ₹18.5 crore is based on Kartik’s assets and goal planning.

Here, based on Kartik’s risk profile, we can create bucket strategy for his retirement planning.

In this, we will consider safeguarding his retirement fund corpus with return of 5 per cent per annum. This may seem a little low as per today’s standards. But this conservative approach is being taken because we are not aware about risk-free rate of returns (for simplicity, fixed deposit returns) in the next 15 years down the line.

And, hence, Kartik’s retirement portfolio would earn an interest of around ₹9.2 lakh in the first year of his retirement (year 2034). In the same year, Kartik’s monthly expense will be around ₹4.5 lakh and the surplus amount would be carried forward. Under this approach, Kartik’s interest income would reach its peak in 2047.

In case Kartik fails to create a portfolio of ₹18.5 crore, then the couple may need to compromise their lifestyle at the later stages of their retired life.

This is how deeply inflation can affect a person’s retirement plan. Many of us make the same mistakes. As per general belief, based on our current lifestyle and expenses, we should have a fund of ₹5-7 crore for retirement.

Hence, we should start planning for retirement well in advance, giving due importance to the impact of inflation.

The writer is a Senior Manager - Investment Advisory, Capital Quotient

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