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5 Steps The New Generation Should Follow To Plan Their Retirement


Time to read: 3 mins | May 06, 2017

With growing needs and increasing cost of living, people now-a-days, especially the youngsters are busy trying to climb the corporate ladder to earn a fatter pay-cheque.

It is quite natural that every individual would want to earn a higher income than what he / she earned the previous year; so as to meet their family’s financial goals such as children’s education and / or marriage , buying a house and so on.

Almost everybody is struggling and working hard to provide the best to their families. And while slogging out to achieve all such financial goals, there are some individuals who also wish to retire early and live their life in bliss after fulfilling their family responsibilities.

But it is noteworthy that how early you retire or how will your post retirement life be, depends upon the approach that you adopt today.

You see, even if you are not planning to retire early it is imperative to recognise that planning is paramount, especially if you are the sole bread earner of the family; because much depends on your income for your family to live a comfortable life once you are retired

So here is a step-by-step approach that youngsters can follow to plan their retirement:
1. Start early: The early start helps to make the optimum utilization of the power of compounding. With the concept of joint family declining and nuclear family increasing at a significant pace, many individuals would have to completely depend on their retirement corpus to fund their golden years. So it’s financially prudent to start as early as possible. To begin with, make sure to allocate at least 20% of your investments towards retirement. This percentage should go up with time. Get an estimate on the corpus required as per your current living standards. This would help in saving the right amount for your retirement.
2. Know your risk profile: One has to assess the risk taking ability before investing . In fact, it is the foundation stone to guarantee a stress-free retirement life. It is no point investing in stock markets, if you lose sleep over market fluctuations. However, most ignore this important step and start investing; ending up with bruises and burns. To minimise investment shocks, here is a simple question to know one's attitude towards risk: You enter a bet with a friend who flips a coin.
  • If the coin comes up heads, you win Rs 500. If it comes up tails, you win nothing
  • If you choose not to flip the coin, your friend will simply give you Rs 250 and the game is over
The expected outcome in each of these scenarios is an average of Rs 250. But depending on which option you choose, you understand what type of investor you can be. Spare a few minutes to introspect.
3. The asset allocation strategy: Based on the risk profile, here's an asset allocation strategy:

Option 1: You choose not to flip the coin and take Rs 250
If you choose not to play the game, and took Rs 250, or would take even less than Rs 250 as long as there was no risk attached; you are risk averse or conservative investor. The market fluctuations are bound to give you sleepless nights. Your composition to equity should fall as the time for your retirement nears.

If your Risk profile is Medium to High your ideal asset allocation should be
Years to retirement Equity Debt Gold
<=3years 5% 90% 5%
4 years 30% 65% 5%
5 years 35% 60% 5%
6-7 years 45% 45% 10%
8-10 years 60% 30% 10%
> 10 years 70% 20% 10%


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

Option 2: You are unable to make a decision between flipping the coin and not flipping the coin
You are a risk neutral or moderate risk taker if you are neutral between playing the game and winning Rs 500, and not playing the game and winning Rs 250. The ideal asset allocation composition should be as follows:

If your Risk profile is Medium to High your ideal asset allocation should be
Years to retirement Equity Debt Gold
<=3years 10% 85% 5%
4 years 40% 55% 5%
5 years 45% 45% 10%
6-7 years 55% 35% 10%
8-10 years 70% 20% 10%
> 10 years 80% 10% 10%


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

Option 3: You want to flip the coin and take the chance

If you would rather take the gamble for any amount more than Rs 250; you are a risk seeker or aggressive.

If your Risk profile is Medium to High your ideal asset allocation should be
Years to retirement Equity Debt Gold
<=3years 15% 80% 5%
4 years 45% 45% 10%
5 years 50% 40% 10%
6-7 years 60% 30% 10%
8-10 years 75% 15% 10%
> 10 years 85% 5% 10%


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

4. Review your portfolio on a regular basis: It is a prudent practice to review your portfolio on regular basis and take preventive measures. A strategy on rebalancing the portfolio helps to keep the weight of each asset class back to its original state by buying and selling portions of your portfolio.

If you are wondering how to go about it, here's an example to understand the concept better.

Say Mr Rishabh has Rs 100,000 to invest and being a moderate risk taker, he decides to invest 50% in Debt (Rs 50,000); 10% in gold (Rs 10,000); and the balance 40% in equity (Rs 40,000)

Rishabh's Portfolio at the start of the year
Asset Class Amount (Rs) Percentage allocated
Equity 40,000 40%
Debt 50,000 50%
Gold 10,000 10%
Total 1,00,000 100%


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

After one year, Rishabh's equity composition in his portfolio has outperformed his debt and gold investments. This has changed the allocation of his assets, increasing his percentage in the equity fund while reducing his allocation towards debt and gold. The revised portfolio composition looked as follows:

Rishabh's Portfolio at the end of the year
Asset Class Amount (Rs) Revised Allocation Return (%)
Equity 55,000 46.53% 37.5%
Debt 53,000 44.84% 6.0%
Gold 10,200 8.63% 2.0%
Total 1,18,200 100% 18.2%


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

The table above highlights that Rishabh's investment of Rs 100,000 has grown to Rs 1,18,200 giving a portfolio return of 18.2%. Equity was the biggest gainer and earned a return of 37.5% followed by debt with 6%; while his investment in gold disappointed by returning a mere 2%. Thus making the portfolio more skewed towards equities.

Seeing a deviation of +/-5% from his standard allocation, if Rishabh plans to rebalance his portfolio at the end of the year, then it would look as follows:

Rishabh's Portfolio at the end of the year
Asset Class Amount (Rs) Percentage allocated
Equity 47,280 40%
Debt 59,100 50%
Gold 59,100 10%
Total 1,18,200 100%


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

At this juncture, Rishabh might book some profit from equities and invest it in debt and gold, thus bringing back allocation towards equity, debt, and gold to 40:50:10. With this, he has eliminated some equity related risk by shifting to a relatively safer asset class like debt and gold.
However, he may decide to leave his portfolio as it is, without trying to rebalance the same, only if he is comfortable keeping a threshold of +/- 10% deviation from the standard allocation.
It is noteworthy that rebalancing is an important part of financial planning, which should not be ignored. Allowing your portfolio to remain the same over long term may not be a prudent way forward to achieve your financial goal.
The popular belief among investors is to look at historical returns before choosing a fund or an asset class. What had performed well in the last year may not perform as well in the future. But, they are induced by the returns and avoid rebalancing the portfolio.
Continuing with Rishabh's example, let us assume that at the end of the second year, equities performed badly losing 7%. At the same time, the Debt funds performed well appreciating by 12% and gold was relatively stable with a 6% increase.

Asset Class Rebalanced Ignored
Opening (Rs) Closing (Rs) Opening (Rs) Closing (Rs)
Equity 47,280 43,970 55,000 51,150
Debt 59,100 66,192 53,000 59,360
Gold 11,820 12,529 10,200 10,812
Total 1,18,200 1,22,691 1,18,200 1,21,322


(Note: The above table is for illustration purpose only) (Source: PersonalFN Research)

A rebalanced portfolio in this case would have generated better returns. However, if the stock market had rallied throughout the second year too, then the equity fund would have appreciated more, leading the ignored portfolio to probably realise better returns than the rebalanced one.

Although, individuals may be blinded by gains, rebalancing helps to maintain the risk-return tolerance level.

5. Withdrawal Rate: Once you retire, bear in mind, you only have the retirement corpus to fund your retirement. With the growing life expectancy and increase in medical costs, it would be a prudent practice to use the corpus judiciously. Make a practice to keep your withdrawals as low as possible. Make sure to follow the 4% withdrawal rule. It is a thumb rule to determine the amount of funds to withdraw from a retirement account each year. The 4% rate is considered a "safe" rate, with the withdrawals consisting primarily of interest and dividends. The success of the rule is possible only when a retiree sticks to the rule diligently year after year. The retiree may suffer from a cash crunch further in his/her retirement, if he/she violates this rule by splurging on big ticket purchases during this phase in life.

To Conclude…

The only way to ensure a stress-free retired life is through a well drafted financial plan that takes into account not only your financial goals, as well as your outlook towards money. You need tricks and advice from experts to maximise your savings and retire comfortably with peace of mind.

NOTE WORTHY

Start early with your investments, this helps to make the optimum utilization of the power of compounding.

 

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