22 May, 2011

Equity bonus for retirement corpus

This will ensure that your kitty does not get exhausted before your lifetime.

The idea of retiring had terrified Tanmay. He was unnerved at the thought of no regular income, unsure if his retirement accumulation was good enough to see him through his golden years.

He consulted a financial planner, Seshadri. He, then, suggested a certain amount in mutual fund (MF) schemes and equities, even after retirement. His point: if the corpus is fully invested in debt-oriented instruments, the growth would be miniscule or negative after considering the inflation and taxes. Hence, there was always a chance of the corpus running out before one’s lifetime. Especially since, one cannot anticipate the inflation during retirement years and expenses.

Corpus on retirement (Rs) 58 lakh
Tanmay’s post-retirement lifetime (years) 25
Wife's post-retirement lifetime (years) 30
Debt # Debt + Equity #
Return on retirement corpus (annual) (%) 8 9.4
Rrate of inflation (annual) (%) 7 7
Real rate of return (annual) (%) 0.93 2.24
Annual expenses after retirement (Rs) 2.75 lakh
Corpus will suffice for (years) 23.6 28.9
*Assumed return: debt=8%, equity=12% # Debt (100%) , Debt (65%) + Equity (35%)

However, Tanmay wasn’t sure of this. He had invested in equity in 1992-93 and burnt his fingers. But Seshadri simply pulled out his laptop and started punching the numbers. He showed Tanmay that if he invested only in debt instruments, his corpus would last just 23.5 years (before his estimated lifetime and well before his spouse’s lifetime).

Instead, if he allocated 35 per cent of his corpus to equity-oriented assets, the corpus would last for about 29 years. Since after his lifetime (25 years ), the expenses would reduce, the corpus would be sufficient to cover his wife’s expenses (assuming she outlives him by five years) as well. After seeing the calculations, Tanmay felt Seshadri’s argument was logical.


In the calculations, Seshadri had assumed a 12 per cent return on equity-oriented assets. Tanmay wanted to know how this could be so blithely assumed. After all, one can easily lose money investing in equity.

Not one to give up easily, Seshadri showed him how equity had given returns of almost 18 per cent on a compounded annualised basis, over 30 years. He explained that equities gave good returns over time, though they are volatile and can also give negative returns in the short-term. He asked Tanmay why he couldn’t invest a portion of his corpus in equity if the time period into retirement was in decades.

When Tanmay confronted Seshadri with the fact that he had lost money in 1992-93, Seshadri analysed the shares Tanmay had bought. They were all momentum stocks, bought on tips and hearsay. He infact told him that Tanmay would have made about four times the money he’d lost even if he had invested in fixed deposits. And about 7.5 to 8 times if the money had been invested in equity-oriented assets returning 12 per cent yearly.


He then proceeded to explain about MFs and their functioning. MFs invest in a good bouquet of companies, due to which there is good diversification. There is a fund manager to take care of the funds. A normal investor need not worry about stock picking and keep monitoring the portfolio. As he is not equipped to analyse companies, the sectors and their future prospects. Or one could simply invest in index funds and participate in the broad growth of the economy, without being exposed to a fund manager’s calls and also pay lower expenses.

He also advised Tanmay that that he should have sufficient medical cover. Tanmay had a medical insurance of Rs 2 lakh each for his wife and himself. Seshadri advised this cover be increased to Rs 5 lakh each. Also, he suggested that another Rs 5 lakh be set aside for incidental expenses on medical grounds. This seemed reasonable to Tanmay.

All this happened over two years ago. Tanmay has since then started trusting Seshadri’s view implicitly. He feels that he is doing extremely well financially because of Seshadri’s advice. Better late than never, he consoles himself now.

Article by - Suresh Sadagopan / Business Standard / Mumbai May 22, 2011, 0:48 IST

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