Retirement planning is one of the most crucial aspects of personal finance. Rising life expectancies, growing prevalence of nuclear families and lack of social security for the elderly have further increased the importance of retirement planning. However, retirement planning is often riddled with popular myths and avoidable mistakes, which can severely impact one’s post-retirement financial security. Here I will highlight some of the most common retirement planning mistakes and will offer some suggestions on how to avoid them.
Underestimating Your Post-Retirement Corpus Needs
One of the most common retirement planning mistakes that people make is underestimating the target size of their retirement corpus. Many investors wrongly assume a steep reduction in their living expenses post retirement. While some expenses like commuting and children’s education may be reduced, increased chances of catching diseases, sustaining injuries and other age-related health risks are likely to lead to a steady increase in their healthcare expenses.
Another critical factor often ignored is longevity risk the possibility of outliving your corpus. As medical advancements are likely to increase future life expectancy, individuals should factor in longer life expectancy, at least 80 years, while calculating their retirement corpus.
People also tend to ignore the impact of inflation on post-retirement costs while planning for their retirement. However, ignoring inflation can leave individuals with inadequate retirement corpus.
For example, assuming an average inflation of 6%, a 35-year-old individual spending Rs 50,000 every month will require Rs 2.15 lakh per month at the age of 60 for maintaining the same lifestyle.
Individuals can use online retirement calculators to calculate the monthly contributions required for creating their retirement corpuses. They should prefer calculators that consider key factors like current monthly expenses, expected inflation rates, rate of returns from investments (for pre- and post-retirement life stages), expected life expectancy among other things for calculating the retirement corpus. \
Not starting early
The most effective way to create an adequate retirement corpus without straining one’s finances is to start investing as early as possible. The more one delays his or her retirement investments, the higher would be the risk of ending up with an inadequate corpus and/or comprising other financial goals in their later life stages.
For example, assuming a 12% annualized return, a 30-year-old individual investing Rs 10,000 per month in equity mutual funds through SIPs would have a post-retirement corpus of Rs 3.5 crore within the next 30 years. Whereas a 45-year-old would require a monthly SIP investment of about Rs 70,000 in equity funds for building the same corpus in 15 years at the same rate of return.
Avoiding equities while building retirement corpus
The volatility in equities leads many investors to avoid equity exposure in their retirement corpus. However, equity as an asset class usually outperforms inflation rate and fixed-income instruments by a wide margin over the long term. This makes equities the most suitable asset class for achieving long-term financial goals like creating retirement corpus.
Individuals should also avoid shifting their entire retirement corpus into fixed deposits, debt funds or other fixed-income instruments upon their retirement. The long term growth potential of equities can help reduce longevity risk to their post-retirement corpus and thereby, increase the chances of their retirement corpus outlasting their lifespan. As individuals approach their retirement age, they should calculate the amount needed to cover essential living expenses and financial goals due within the next seven years. That portion of their post-retirement corpus should be allocated to fixed-income instruments like bank fixed deposits (with payout option) or short-term debt funds (with SWP activated) for regular income generation. The remaining corpus should be invested in equity mutual funds to ensure continued wealth creation.
Not reviewing your retirement portfolio at periodical intervals
Past performance of mutual funds does not guarantee future performance. Changes in market conditions and/or fund management styles/strategies can lead past outperformers to remain laggards for extended periods. Therefore, always review your retirement portfolio at least once every financial quarter. Compare the returns of your mutual fund schemes against their benchmark indices and peer funds. Exit mutual fund schemes that consistently underperform their benchmark indices and peer funds for over four consecutive quarters.
Not purchasing adequate health insurance cover
Employer-provided group health insurance policies cease to cover employees and their families after their retirement. As the risk of hospitalisation increases with age, relying solely on retirement corpus for these expenses can quickly deplete your retirement corpus. The best way to protect your post-retirement corpus from this risk is to purchase adequate health insurance cover for yourself and your dependents as early as possible. Then extend them to your post-retirement years as well. Purchasing health insurance covers at a younger age would benefit you with lower premiums and broader coverage of illnesses.
(An edited version of this article was printed in The Hindu)