Real Returns. Making thumb rules work for your nest egg

Most Indians of this generation will have no monthly pension coming their way when they hang up their boots.

This gives rise to a lot of insecurity about how much money they really need to save for a cushy retirement. Arriving at the size of the kitty you will need to ‘safely’ retire involves complicated maths. Given that complicated maths makes most people’s heads spin, financial folks in the US have come up with some easy thumb rules to arrive at the ideal size of your retirement kitty. What are these and will they work for us Indians? Let’s see.

10 times income

Analysing long-term data, money management giant Fidelity came with a handy thumb rule on one’s retirement kitty based on income levels.

It found that if you have 10 times your annual income on the eve of retirement, you’re set for life. It also tells you that, to get to that goal of 10 times your income, you need to have one time your income saved up by the time you’re 30, thrice the size at 40, six times at 50 and eight times at 60.

Now, you may rejoice at this thumb rule because it looks so easily doable. If you’re earning ₹12 lakh a year (₹1 lakh a month) at 40, it is not too difficult to imagine a portfolio of ₹36 lakh. But following this thumb rule can leave Indians well short of an adequate retirement kitty, because of Fidelity’s assumptions, which are set to the American context.

The calculation assumes that a person retires at 67, parks at least 50 per cent of his savings in equities and will need to replace only 45 per cent of his income post-retirement, thanks to social security. In India, there’s no social security and you’ll have to fend for yourself.

4 per cent rule

In a 1998 paper, three finance professors from the Trinity University tried to find out what would be the safe withdrawal rate for a retirement portfolio made up of stocks and bonds, using live data on the US markets. They came up with the famous ‘4 per cent rule’.

This rule says that if you can withdraw and live on just 4 per cent of your portfolio in the first year of retirement and adjust that amount for inflation thereafter, you are unlikely to run out of money, despite bumpy returns from equities in your portfolio.

25 times expenses

Financial planners often back-work from this 4 per cent rule to say that if you have 25 times your annual expenses invested by the time you retire, you can look forward to a safe retirement.

For this, you must first estimate your annual expenses after retirement, which are usually assumed at 70-80 per cent of your spending in your working years.

So, applying this rule, if you spend ₹12 lakh on regular expenses at 60, you need to have a ₹2.10-crore portfolio (₹8.4 lakh x 25) to fund your retirement.

But this rule is again based on US inflation rates and market returns.

Indian markets feature at least twice the inflation and much higher stock-market volatility than US markets.

Tweaking for India

So, given that these American thumb rules end up under-estimating the retirement kitty for an Indian investor, how much should you have invested on the eve of your retirement?

Running a simplistic excel calculation for an Indian investor, assuming a retirement age of 60, longevity of 90, an inflation rate of 7 per cent and a post-tax return of 8 per cent after retirement, we found that a retirement portfolio of about 28 times your annual expenses at 60 may be a good starting point.

Slightly tweaking those inflation and return numbers suggests that, to be safe, you should target 30-33 times your annual expenses at 60.

This would work out to roughly a 3 per cent withdrawal rate.

If younger, don’t forget to project your annual expenses for age 60 by adjusting for inflation.

You can back-work from your expenses to estimate your retirement corpus based on your income. But using expenses is easier as it eliminates guesswork about your savings rate or lifestyle.

When using any thumb rule though, caution is in order. It’s easy to make multi-year projections on expenses, inflation, returns, et al, on a spreadsheet. Real life often throws many googlies at you that can upend those calculations.

Therefore, re-visit your portfolio assumptions often both before and after retirement.

If you aren’t qualified, hire a good financial planner to do it.

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