If you are planning to retire in the next 10-20 years, even a small deviation in your investment or withdrawal plan to generate a monthly income in the post-retirement period can have a massive impact. This is why you need to plan well so that you do not get last-minute surprises at a point when a course correction becomes difficult.
One such critical factor in retirement planning that you must take seriously is the annual return that your retirement corpus generates during the post-retirement life. If you are able to generate a higher return, you would need a lower retirement corpus; however, if your returns are expected to be lower, be prepared to build a bigger retirement corpus.
The situation becomes more challenging for you as the country may transition from a phase of high economic growth to a phase of lower growth in the long run. This can impact the returns from your retirement investment.
Have you done your calculations and are you ready for any surprises?
Rs 1 lakh monthly income: You need bigger retirement corpus for any fall in annual return
If you wish to get Rs 1 lakh as monthly income after retirement but want the amount to rise 4% each year to take care of inflation, and if the expected annual return on this corpus is 12%, you would need a retirement corpus of Rs 1.443 crore for the corpus to remain intact after 25 years of retirement life. However, if the expected return falls by 2%, to 10%, the retirement corpus will have to go up to Rs 1.75 crore, which is Rs 32 lakh more. In case the annual return falls a further 2%, to 8%, you would need Rs 2.24 crore as corpus, which means Rs 48.75 lakh more that what you needed when calculating with an annual return of 10%.
Particulars | Case 1 | Case 2 | Case 3 |
Annual return on retirement corpus | 12% | 10% | 8% |
Annual rise in monthly Income | 4% | 4% | 4% |
Post–retirement life expectancy | 25 yrs | 25 yrs | 25 yrs |
Corpus required to last without loss | Rs 1.43 crore | Rs 1.75 crore | Rs 2.24 crore |
Extra corpus needed after 2% lower return | Rs 32 lakh | Rs 48.75 lakh |
Assumptions: Corpus generate returns to provide monthly income for 25 years without any loss of capital.
Can you count on high returns during your retirement?
While high returns in the post-retirement period would make life more comfortable, it is easier said than done. When you stop having an active income from work and depend only on your savings, your risk appetite comes down and your asset mix will tilt towards safer debt products. But even that will not make life easier.
Some of the high-return instruments that we often take for granted may not deliver the expected returns after a long period, like 20 years. An annual return of above 8% on fixed income instruments and 12% on equities is often taken as a given today, but will the return be the same when you retire or when you are in the middle of retirement? This will primarily depend on the country’s economic path and its speed of its growth. Returns from equities and debt are often high in a country that is in a phase of high growth, but that does not last for a prolonged period. A lot will depend on how long this high-growth phase will continue in India.
“Every country experiences periods of high economic growth that can be sustained if planned well. For example, the US continues to show solid growth despite being the world’s largest economy. India’s growth will depend on its planning. If India aims to become a developed country by 2047 and plans well, it can continue to experience high economic growth. However, it’s uncertain whether this growth will lead to high equity returns in the long term, as equity markets tend to factor in developments at a faster pace,” says Anand K Rathi, Co-Founder of MIRA Money.
What matters more for you is whether your investment will generate a high return for a long period or not. While most people are sure about the returns in the short to medium term, it is difficult to predict these numbers over a long run. “I am confident about the next 10 to 15 years, and I believe that we could see high equity returns, similar to those of the past 12 to 15%, over the next decade. Beyond that, it will depend on how well the economy is managed and how effectively the current plans are executed. If we can deliver on our plans, it’s likely that the bull market could continue for a longer period,” says Rathi.
Some experts anticipate an extended period of higher growth. “India is at a sweet spot today. It has favourable demographics, a stable macroeconomic environment, and a growing middle class. The combination makes it possible for India to sustain a high economic growth rate for the next 30 years. Equity markets will deliver the rate at which the Indian economy grows in the coming years, making Indian equities the right asset class to participate in India’s growth story,” says Manish Kothari, Co-Founder and CEO, ZFunds.
Direction of inflation decides the returns of debt and fixed income instrument
The interest rate in a country largely depends on the level of inflation it has. “The Government of India has prioritised low inflation over the past decade. If future governments continue to keep low inflation as a priority, the rate of interest in India will come down in the next 10-20 years,” says Kothari.
While many advanced economies like the US and Europe have kept inflation around 2% for a long period, it may be a challenging task for India to bring inflation to this level and keep it there for a long period. “I don’t anticipate a significant drop, but we could see inflation remaining around 4% for a more extended period, and it may decrease further if we effectively manage the supply chain. It won’t be a significant decrease but is expected to follow a downward trajectory,” says Rathi.
The government’s focus on lowering inflation is likely to bring inflation down in the long run. “If the government of India continues to prioritise low inflation and sticks to its current policies, it is expected that India will continue to see low levels of inflation over the next 10-20 years,” says Kothari.
Why interest rate is likely to come down significantly after 10-20 years
Interest rates in India have gradually fallen and the trend is likely to continue. “Interest rates in India have shown a trend of ‘lower highs and lower lows’, indicating a gradual decrease in the upper range of interest rates. In 2018, the interest rates were around 8-8.5%, but now they are reaching a maximum of 7-7.5% and are expected to go below 7%. Meanwhile, the lower end of the rates has been closer to 5% and even below 5%,” says Rathi.
Over the long run, interest rates are likely to fall further. “I believe that in the future, we won’t see the same high fixed returns on investments that we see today. Currently, many banks are offering 7.5% returns, but I don’t think this will be sustainable. It’s important to understand that the real interest rate, which is the interest rate offered by banks minus the inflation rate, is typically kept positive in India. Currently, it’s quite high, at more than 2 to 2.5%. But historically, it has been around 1.5%,” says Rathi.
What it means is that safe debt instruments and other fixed income instruments are unlikely to deliver high returns after 10-20 years.
High returns can continue during accumulation phase of investment phase
If you are planning to retire in the next 10-20 years, there may not be much to worry about as far as building your retirement corpus through regular investment is concerned. “When investors are in the accumulation phase of their life, they should always look at investing in instruments that deliver higher returns year on year. This will enable them to build a higher corpus,” says Kothari.
The high-growth phase of India is likely to benefit equity investors with high returns at least during the next two decades. “During the accumulation phase, it’s important to consider a consistent rate of returns because there is a risk involved, and the return should ideally compensate for that risk. While the returns may fluctuate, the overall growth should be positive during this phase. That’s why a focus on consistent returns is beneficial during the accumulation phase,” says Rathi.
Be ready to factor in lower returns during withdrawal phase or tweak your investment
Once the retirement phase starts, people prefer stability. “After retirement, this corpus should be deployed in a way that delivers constant returns, thereby making withdrawals predictable,” says Kothari.
As the withdrawal phase will come after a long gap of 10 to 20 years and may continue for the next 25 years, the returns’ dynamics would change significantly by then. Rather than regretting that you had taken a poor investment decision years ago, it is better to plan for low returns and save a higher amount as retirement corpus. “Once investors have reached a stage where they are not earning, they should focus on the safety of capital. This entails having a low-risk portfolio, which means they will get low returns on their portfolio. Hence the need to build a large corpus when they are at the accumulation stage,” says Kothari.
Even a low return on the debt part of your investment may not be bad news. A lower inflation would mean you will not need to raise your monthly income sharply every year. “Instead of focusing on the absolute interest rate numbers (like 5%, 4% or 7% for fixed deposit interest rates), we should consider the real interest rate, which takes into account inflation and interest rate changes. This means that as inflation decreases, so will interest rates, and it may not significantly impact our investment portfolios until real interest rates are 1% or higher,” says Rathi.
Smart planning and an intelligent asset mix can give you the best of both worlds — high returns and safety. “You could allocate your money into three buckets: short term, medium term and long term. The short-term bucket would primarily consist of debt; the medium-term could include some debt and a small amount of equity, and the long-term would mainly involve equity. As the post-retirement life could span 25-30 years, including some equity in the portfolio makes sense. If you agree with this approach, you could continue using a consistent rate of returns,” adds Rathi.