Invest in equities to save for your retirement





Adequate savings and investments that beat inflation are a must to build a big enough corpus for a comfortable retirement. Investment in equities is essential

A cousin of mine will retire in the next three years. He lives in his own house and his children are married and well-settled. He will receive about `30 lakh as settlement amount. His simple question was: Is this money enough? In retirement planning, this is the critical problem to solve. Retirement planners call this problem the adequacy of corpus.

To my cousin, `30 lakh seemed like a lot of money, until I pointed out that, going by his current earnings, it was just five years' pay. My cousin is addressing the retirement problem too late. Even if he finds that he has not saved enough, there isn't much he can do at this stage. He quickly pointed out that he would spend much lesser. Retirement is associated with frugal living and careful spending since investors reconcile to managing within the wealth they have accumulated. He told me that he will learn to `manage' but needs ways to invest it `safely'. Outliving the wealth is a fear most retired investors face, which is also the reason why they like to protect what they have.

Adequacy of corpus can make all the difference to post-retirement welfare and choices. Retirees are vulnerable. Retired investors fall prey to financial scams when they discover that their corpus is unable to fight the growing expenses. They make risky choices with their money, much like the daily wage earners who buy lottery tickets out of sheer desperation to get rich.

How do we ensure that we have enough before we retire? There are several calculators that can help with the math. Is there a common sense approach to solving this problem? Since inflation is the villain in this piece, let us build our case around it.

First, consider the income during the earning years. If it is has grown at a rate that beats inflation rates, it is a positive factor. Technically, there is an opportunity to build wealth only when incomes match or exceed inflation.

Second, consider the amount of income set aside as savings. Inflation hurts the money needed for expenses every year. Savings should persist and increase even after inflation. This needs both adequate income and controlled expenses.

Third, savings have to be invested at a rate that exceeds inflation. Since only a portion of the income is saved, it needs to work hard to become a large number that will provide for future expenses.

To secure retirement, all these three factors should move favourably over all the earning years: income should grow at a rate higher than inflation so that expenses can be met; savings should be positive and grow even if inflation increases the expenses; and investment return should exceed inflation rates so that savings grow in value over time. Consider a case where out of every `100 earned, `20 is saved. Assume that the inflation rate, the income growth rate and the investment return are all identical. This investor will not have an adequate retirement corpus. Why? It takes four years of savings to make up for one year's expense. And savings are not growing enough to beat inflation. Unless the years in retirement are fewer compared to the earning years, this money will not be adequate. Adequacy of corpus needs savings that cover the income in shorter number of years, and investments that grow at higher rates over a long period of time. What are the steps to take? First, ensure that the growth rate of income always exceeds the rate of inflation. Families with more earning members, professionals that up-skill themselves to earn more, and those who work towards enhancing their earnings are in a better place when it comes to retirement. Second, make it a habit to save since your life actually depends on it. As incomes move up, saving rates should also move up. Essentials needed for the household form lower and lower proportion of income, as income increases. Higher savings rates ensure a higher corpus. Third, take charge of the assets that have been built with your savings to make sure that they grow at a higher rate.

Many investors are careful with their income and their savings, including my cousin. However, the risk he runs is in the manner in which his wealth is being held. The `30 lakh he will get only represents the money he accumulated in his provident fund after allowing for withdrawals to buy a house and to conduct his daughter's wedding. He has a three-bedroom house in which he lives, worth about `1 crore in today's value. His investments in bank deposits, PPF, mutual funds and savings certificates amount to `20 lakh. Has he secured his retirement? Maybe not.

He may have assets, but they are not available for his retirement. As long as he lives in that house, he will not earn any rental income. He plans to leave the house behind for his son. It looks like my cousin has spent his earning years accumulating assets for his son, even if he fails to see it as such. It is tough getting him to see the house as the white elephant.

Retirement cannot be secured if investments are made in assets that cannot be actually used. Households that do not have financial assets expose themselves to this risk. However much may be the appreciation in value, real estate and gold represent assets that are not easily sold off. Rental yields can be too low, maintenance costs can be high, and unless properties enjoy prime location, they may not earn a steady income to help in retirement.

Many see equity as a risky asset. But they fail to see the risk of lower corpus, if they do not invest in equity during the earning years. A diversified equity portfolio including an equity index can catapult the retirement corpus to a much larger size. Long-term goals such as retirement are ideally funded by equity, whose short-term volatility can be borne for the long-term benefit. If an 8% return leads to the doubling of value in nine years, a 12% return can do that in six years. Over a 36-year savings period of accumulation, it can make all the difference.

Secured retirement is about saving and investing sensibly. As long as each earning year is evaluated for adequacy of income, savings and investments, retirement is most likely to be secure.