Mutual Funds For Retirement Planning

Retirement planning is divided into two distinct parts: first is the accumulation stage and second is the distribution stage. Under the accumulation stage you save and invest for your retirement corpus. The article provides guidelines on how you can go about it

For a majority of working Indians, it seems that retirement planning is not as important as a child’s marriage or even the lifestyle expenditure. According to a survey done by PGIM India Mutual Fund Retirement Readiness Survey 2020, most of the participants of the survey did not have a retirement plan. According to the findings, 51 per cent of the respondents had not made any financial plans for their retirement and priorities such as children and spousal security and even fitness and lifestyle ranked higher than retirement. Although retirement is not a priority, Indians are more anxious about their future and worry about their cost of living, healthcare issues and the lack of family support in the future. One of the reasons why many Indians do not plan for retirement is lack of knowledge on how to go about this. There are various ways in which you can save and invest for your second innings; however, in the following paragraphs we will walk you through in a systematic way on how to do this with mutual funds.

Retirement Planning

Retirement planning is divided into two distinct parts: first is the accumulation stage and second is the distribution stage. Under the accumulation stage you save and invest for your retirement corpus. It is always better to plan early and start investing. This will help you to reap the benefit of compounding. In the initial years, the contributions made account for most of the value of the corpus. Over time, the earnings form a greater proportion of the final value. Take the case of two people, Ashok and Akbar, who want to have Rs 1 crore each as their retirement goal. Both want to retire at the age of 60. Ashok starts at 25 years of age and Akbar at the age of 35. Assuming the rate of interest to be 12 per cent per annum, the following table shows their contribution. 

You can see from the table that Ashok needs to invest only Rs 6.46 lakh to accumulate Rs 1 crore while Akbar has to invest Rs 15.8 lakh, more than double of what Ashok invested to accumulate same amount. Investment made at the accumulation stage should be done in growth-oriented assets such as equity. Even within equity you can have more weightage for mid-cap and small-cap-dedicated funds as they generate better returns in the long run compared to large-cap-dedicated funds. Depending upon the weightage to different categories, going ahead we can expect 10-12 per cent annualised return from equity investment.

After retirement your distribution stage of retirement starts when the corpus created in the accumulation stage is employed to generate the income required to meet expenses during the phase of retirement. There are various options available to invest at this stage including buying annuity, investing in senior citizen savings schemes and other debt funds. Investment made at this stage should be in safer instrument which can primarily generate income. Retirement planning involves the following steps:

1) Calculate the retirement corpus required.
To arrive at the above figure, you have to first determine the amount required to maintain your current lifestyle and then compute the amount that may be required to generate such income during your retirement. Normally around 70 per cent of the income before retirement is required to maintain the lifestyle of the individual after retirement. However, this number may be lower if a large part of the pre-retirement income was going into savings.

To continue with the above example, if Ashok, who is of 35 years, earns Rs 12 lakh per annum and his income is supposed to rise by 5 per cent every year, he would require income replacement of 70 per cent. In such a case, at the age of 60 when he is supposed to retire, his income per annum will be Rs 82.2 lakhs. Assuming 70 per cent of pre-retirement expense remains, he needs to have Rs 57.5 lakhs every year after retirement.

Once we arrive at the annual income we will require after retirement, we now have to calculate the corpus required to generate such income. The three aspects that come into play while calculating corpus are inflation, expected rate of return from your investment and your life expectancy. In the above example, assuming Ashok’s monthly expenditure is Rs 70,000 and inflation rate is 5 per cent, at the age of his retirement he will need Rs 1.98 lakhs every month. Now we will arrive at the retirement corpus assuming his life expectancy of 85 years. Ashok needs to accumulate Rs 4.72 crore to maintain his lifestyle post retirement.

Now this corpus of Rs 4,72,16,558.81 will be invested at Ashok’s 60th year in instruments that generate 8 per cent of return to generate a monthly income of Rs 1,97,537.40. The monthly income required will go up through the period of retirement as a result of inflation, which is already considered while calculating your retirement corpus.

2) Determine the periodic investment required.
Once the retirement corpus is estimated, you need to work backwards to finalise the saving and investment plan. The amount of saving required will depend upon the corpus required, which we have already calculated (Rs 4.72 crore), the time available to accumulate the savings and the return that will be generated by the instruments where we have invested. The selection of investment avenues will depend upon the risk appetite of the investors. For a conservative investor, large-cap-dedicated funds or aggressive hybrid funds may be appropriate. Nevertheless, for investors having a risk appetite, small-cap and mid-cap-dedicated funds would be preferable.

In the previous example, what is the monthly saving that Ashok must make to create the retirement corpus if he expects a return of 12 per cent per annum on his investments?

The above table shows that assuming Ashok will require Rs 4.72 crore after his retirement, he needs to invest Rs 24,881 every month for the next 25 years to get the required amount assuming 12 per cent return generated by these investments annually. The table below gives you what is the amount you need to invest at various combinations of rate of return given by your investment and the amount of retirement corpus required by you.

3) Decide the asset allocation.
There are various products that can be used to build your retirement corpus such as NPS, PPF and gratuity, among others. Nonetheless, we will concentrate on using mutual funds to plan your retirement. This is because they offer a wide range of investment solutions for different investment needs and risk appetites. If you are starting your retirement planning at a young age, you can have maximum exposure to equity, including riskier equity sub-categories like mid-cap and small-cap funds, which can potentially generate high returns in the long term. And as you near your retirement age, debt should form a majority of your investment. Following are the generalised asset allocations that you can use for your retirement planning.

In the example above where Ashok’s retirement is still 20 years away from now, he can start a systematic investment plan (SIP) in the following proportion.

4) There should be continuous review and monitoring.
In fact, the most important task of reviewing and monitoring your investment periodically should be given serious attention. Retirement planning is a journey and hence it needs to be monitored frequently to check if you are on the right path. You should review regularly to make sure that the estimates for income and expenses in retirement are relevant or need to be changed.

Conclusion

The rise of the nuclear family and increase in life expectancy has definitely made retirement planning one of the most important financial priorities of our time. Most of us do not realise this and sacrifice retirement plans for the sake of children’s higher education or marriage. Mutual funds are one of the best products that give solutions for retirement planning, while meeting your other financial goals at the same time.