Wednesday, September 24, 2008

IS 1 CRORE ENOUGH TO RETIRE ON?

As more and more people are thinking of taking an early retirement, being sick of the hassles of participating in a never ending rat race, it automatically begs the question " what can be a sufficient corpus for retirement?" In this post I've tried to examine the feasibility of a couple with two kids retiring on their grand savings of Rs.1 crore.

Certain assumptions have been made in order to simplify matters. These are

  1. Using a mix of debt and equity, the investor can earn a steady 12 % per annum after taxes over his life span.
  2. Inflation grows at a steady 7 % per annum.
  3. Monthly living expenses are Rs.75,000 at present.

From the above assumptions the investor will generate Rs.12 Lakhs in the first year and spend Rs.9 Lakhs. He will reinvest the balance 3 Lakhs at the same 12 %. Considering inflation and reinvestment of surpluses the situation at various time periods will look somewhat like this:

Year, Corpus Rs. (Crore), Annual Expenses Rs. (Lakhs)

Year 1, 1.03, 9.00

Year 5, 1.11, 11.02

Year 10, 1.05, 16.52

Year 12, 0.94, 18.90

Year 15, 0.59, 23.14

Year 18, Negative, 28.33

As we see from the above working, the investor would start eating into his capital from the 12th year and from there on his capital would rapidly get eroded. Under the above conditions 1 crore would not be sufficient to last for even 20 years of retirement.

The result would be somewhat different if the figures in the assumption are tweaked somewhat, but what I would like to highlight is the corrosive effect of inflation on savings and its potential to destroy value without our realising it.

13 comments:

Manish Chauhan said...

Hi

Dont you think You should consider more than 15% return considering the investments are made for long term. The other assumption which i didnt like was 75k per month , I dont think an average person who needs 1 crore at the end will have that high expenses, One having 75k as monthly income will require more than 5-6 crore at the time of his retirement.

Just want to make sure that i understood exactly what you wanted people to understand . Please clarify

May be you would like to read my article on Creating Wealth for Retiremant : http://finance-and-investing.blogspot.com/2008/08/creating-weatlh-we-are-going-to-discuss.html

Mahendra Naik said...

Hi Manish,

Your argument is quite valid, however my logic behind the assumptions are as follows.

1. Since the investor is dependent on returns from his investment to finance his lifestyle expenses, he cannot afford to put all of it in equity. He has to have a mix of debt to provide him regular income & equity to provide the growth. Also returns are post taxes. Therefore I have considered a 50:50 debt: equity allocation with 8% return on debt & 16 % on equity giving an average of 12%.

2. 75K monthly expense is considering EMI on loans etc. What I am trying to point out is that 1 cr is not as huge as it seems when you consider the effects of inflation. 75K is a hypothetical figure. You might work with another figure for monthly expenses e.g 50K might take you further, but you have to consider aspirational effect which makes an investor want to upgrade his lifestyle after a few years. He might be happy with a compact car now but later will aspire for a mid size sedan. 75K also takes this effect into account. I'll discuss this in a new post.

Will check out you article soon.

Regards

Rohit Chauhan said...

manish
making 15% per annum is not easy. The only option is to do via equity. however equity returns are lumpy ..you could make 30% in a year or lose 30%. so a 12% or lesser return would be a good assumption.

mahendra
a good rule of thumb used by financial planners is 4% of capital can be spent. that keeps the principal protect from inflation. so for 1 crore it is around 4 lacs ..which come to 35000 roughly. so an expense of 75K would require around 2cr + capital
regards
rohit

Mahendra Naik said...

Hi Rohit,

This is precisely what I'm trying to convey. My interaction with people reveals that Rs.1 crore is generally considered the ball park figure when one talks about retirement. It gives investors the impression that it will generate Rs.12 lakhs of income per annum. I'm trying to show that certain other factors need to be accounted for in estimating a corpus. I'm aware that 4 % is generally the figure financial planners consider, however this is in the US scenario. For India maybe we need to run some more figures to arrive at a number more relevant to us.
Regards
Mahendra

Ninad Kunder said...

Hi Mahendra

There are some cultural issues that are in play in India.

Unlike in the West in India we take responsibility of our childrens eductaion, marriage etc and by default tend to leave porperty behind for the children.

Property is the biggest asset in the balance sheet that most people tend to build in a lifetime and Indian's dont look at living off home equity.

The flipside of it is that more often than not children tend to take care of their parents not that i am advocating living off your children :-)

This is a qualitative aspect and hence would be incorrect to map US capital depletion rates in the Indian context.

Ninad

Manish Chauhan said...

@Rohit

I understand that making 15% in a year not easy , but i was considering investment for long term in Equity which can most probably give returns of 15% or around 14% .

Manish Chauhan
Bangalore
http://finance-and-investing.blogspot.com/

Mahendra Naik said...

Hi Ninad,

You have pointed out an important fact which I had not taken into account, about children's marriage etc. This would skew the picture even further, demonstrating that 1 crore is not as much as it sounds.

Regards

Mahendra

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Investologic said...

I dont think so!

Anonymous said...

Todays one crore will be worth one third of it's value in twenty years. Our lives are ridden by mismanagement of the State and global manipulation.The correct answer is the state should have a pension fund where everyone contributes.Which corrects for dearness. Finally it is the state which has to hold the inflation down and it invariablly messes it up. Almost Every Government is failing on this front.

burntout said...

Absolutely agree. I think it will be difficult to retire on 1 crore, unless you are willing to leave extremely frugally

Commodity Tips said...

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VALUE STOCKS UNDER TWO DOLLARS said...

Do not be overly concerned with retirement.