This generation of Indians has an extremely difficult task in supporting their retirement. Recently, every conversation about retirement in India has devolved into a dispute about whether the New Pension System or the Old Pension Scheme is preferable. However, this topic is meaningless to 96% of Indians because the Central and State governments employ just approximately 4% of the country’s workforce. So, let us keep aside this debate for a while and concentrate on the core theme of retirement.
More than 50 crore Indians employed in non-government job fields today would need to save a sufficient amount during the course of their employment period to support themselves after retirement.
Most of them are unaware that this could prove to be a herculean accumulate funds for their retirement due to high rates of inflation, low actual returns from debt-oriented instruments, and increased lifespan (thanks to medical advances, which is a great improvement!). Insufficiently funded retirement savings are one of the most serious issues affecting the present generation of Indians. Yet, surveys reveal that current generation people are not taking their retirement challenge seriously on their stride.
Unachievable FIRE numbers:
With the FIRE (Financial Independence, Retire Early) trend gaining traction in India, many youngsters want to know how much money they’ll need to retire at the age of 40 or 45. The statistics that financial advisors provide are so staggering that people tend to forgo the concept of FIRE and brace for a lengthy slog.
If FIRE is out of grasp for most people, even those who aim to work until they are 60 find it difficult to construct a retirement fund that will outlast them as needed.
Imagine our hero Karthik to be a 25-year-old person (this is only for illustrative purposes, as Karthik is no longer a 25-year-old child!), earning Rs. 50,000 per month. He plans to retire at the age of 60 and live off his gathered savings at that time. To figure out his retirement corpus, Karthik has to first calculate his expected living expenditures after retirement. Let’s suppose he estimates it at Rs. 40,000 each month (as the present value levels), or Rs. 4.8 lakh annually. Making adjustments for 6% inflation over the next 35 years (as this is just a pessimistic assumption, as inflation may cool down once India moves into a developed economy in upcoming decades), Karthik would require an impressive Rs. 36.9 lakh for his living costs in his first year of retirement.
According to the financial experts in the western countries, the recommended withdrawal rate (from the retirement corpus) to support a 30-year retirement is 4%. This indicates that when Karthik reaches 60, he would require a retirement corpus of Rs. 9.22 crore (Rs. 36.9 lakh multiplied by 25).
Getting to that corpus through debt routes such as the PPF with a 7% return will be nearly difficult, as he would need to invest more than Rs. 50,400 every month for the next 35 years. He has a greater chance of reaching that retirement corpus if he seeks a 12% post-tax return with an equity-only approach. (But Karthik needs to offer regular prayers and puja to the stock market gods to make it work). In this equity-only scenario, Karthik would be required to invest Rs. 14,400 each month in equities funds for the next 35 years.
(Please remember the term post-tax return, as many feel that the returns shown by mutual funds are the returns that they get. But this is not the case as we need to pay taxes for the returns, and currently you may be in the lower tax slab, but as time progresses and your income increases, you will move into the higher tax slabs.)
Returning to Karthik’s story, he will now need to set away roughly 29% of his salary (29% of Rs. 50,000 = Rs. 14,400) for retirement alone. His living expenditures, in addition to emergencies and other goals such as house loan repayment and dependent care, will have to be packed into the remaining 71% of his income.
The Indian scenario:
However, a recent study report claims that the 4% withdrawal rate criterion cannot be implemented naively in the Indian context.
Using actual data on inflation, FD rates, and equities returns in India over the previous 25 years, the study concludes that the sustainable withdrawal rate for the ordinary Indian intending to fund a 30-year retirement is approximately 3%. They argue that a 4% withdrawal rate in India will result in an elevated likelihood of failure (where the person outlives their retirement corpus) due to erratic stock returns and a high inflation rate, which greatly reduces the actual returns on secure choices such as fixed deposits.
This greatly increases the requirements for our hero, Karthik. To support retirement with a 3% withdrawal rate, Karthik would require a corpus of ₹12.3 crore (36.9 lakh x 33.33) at the age of 60. This will necessitate monthly contributions of around Rs. 19,100 in equities (assuming 12 percent annual post-tax return) for the following 35 years. That would consume more than one-third of his present salary (almost 38% of his current income to be precise).
Most Indians prioritize goals such as buying a house, purchasing a car, education of their kids, etc., with retirement planning coming later in their forties or even fifties. This could make their path to retirement an even uphill daunting task.
Conclusion:
Given the ambitious retirement objectives they confront, Indians should manage their wealth in a balanced way, since debt-oriented financial products would not enable us achieve our retirement corpus, forget about early age FIRE. Investors should instead focus on equity vehicles such as mutual funds or the National Pension System (NPS).
As demonstrated in this blog post with some number crunching, Indian investors, regardless of their risk appetite, have no alternative but to invest in equities to achieve long-term goals such as retirement. Contrary to the popular belief that equities are for the wealthy, it is lower and middle-income households really require them to get a respectable real return, at least enough to cover their retirement and hence a peaceful golden years.
