ATM :: Ensure your finances work as you ease into retirement years

By Uma Shashikant, | 21 Oct, 2013, 08.00AM IST | Economic Times


Many people, who belong to the happy generation that worked in the post-1991 era, are financially well-placed but unsure about financial planning.

Several have built wealth over time, and navigated the world of investing to the best of their abilities, leaning on friends and relatives to learn the ropes. What should they know about personal finance at this stage of their careers?

First, it is important to recognise the peaking of one’s income. A middle-aged professional should recognise that the return on the human asset is subject to risks, which can increase with age. Retirement is the most obvious risk, but economic cycles can create issues of job loss, retrenchment and lower increments.

Sportspersons, film stars, and media professionals may find that younger people encroach into their domains and render them less valuable. Poor assessment of future income has led many yesteryear filmstars to live in old-age penury.

While some professions may be based on reputation built over a lifetime, others may not be able to attract a consistent clientele with age. If you are 40, map your income realistically 50 years into the future, building in directorships and CEO positions you aspire for, with a good dose of realism. Not everyone finds an alternate profession easily.

Second, get real about the damage inflation can inflict over long periods of time. The key thing to remember is that the ‘safe’ bank deposit will provide a fixed and flat interest income, while expenses will compound over time at the rate of inflation.

If the calculations are too complex to comprehend, use a simple thumb rule: at an estimated inflation of 7-8%, your expenses will double every 9-10 years. This means your corpus should double every 10 years for you to stay above water. There are only two ways to deal with this problem.

First, save as much as you can in the years in which your income is higher than the expenses. Second, invest the savings in an investment that grows at least at the rate of inflation. At 50, when you already have a house and a car, and have reached the peak of your career, you should be saving 50% of your income. Put this to work for a later date when income falls and expenses move up.

Third, take a hard look at your assets and allocate them for future use. If you have a house that you live in, and a few deposits, shares and mutual funds, map these assets to your needs. The house will save you rental expense in the future.

The other assets should also have an identified use—your child’s higher education and marriage, your international travel plans, your need for investment income when your regular income falls, and your need to leave behind assets for your children. Every asset should have an identified purpose and a possible time at which it will be liquidated or given away. Don’t simply build assets and hope it will be fine.

If you leave your spouse with a large house and no income when you are gone, you may not have provided sensibly, even if that was your intention. Write down what you own and how you plan to use it. If the rent from your second house is supposed to fund your travels, put it down.

Fourth, divide your investments into three portions. The core portfolio is something you will need as long as you are alive, and its only purpose is to provide for your needs. You should lose sleep if this core is lost, erodes in value, or is inadequate.

After estimating your expenses, adjusted for inflation, as given in the above-mentioned second step, ensure that the funds that generate this core expense are put in this bucket. Your house, gold, the PPF, PF, bank deposits, saving certificates, SCSS and every other safe asset that will generate an income should be here. If you need an income that grows with inflation, this component should double every 10 years.

Since it is safe and generates income, it won’t appreciate in value. You have to invest in it and augment this core component as long as you live.

This is why you need the next bucket—wealth portfolio. This represents your risky portfolio. Invest this in assets that will grow in value over time, but may be volatile in the short term. Equity shares, mutual funds and second property come in here. Without this portfolio, your core portfolio will struggle to fight inflation.

If your PPF earns 8% and your equity earns 15% over a 15-year period, the equity component helps your money last longer and enables you to save lesser than that needed were you to depend only on the PPF.

The third bucket is your fancy portfolio. This holds exotic things you want to indulge in. Equity, derivative and commodity trading, buying and selling assets tactically, or indulging in private equity and art, should be done here. Needless to add, the amount you invest here depends on how well you have provided for the other two components.

Fifth, have a plan for every 10 years of your life. At 40, consider the above four points and review what you have. Map your income till you turn 50. Find out what you are saving, and save more. Reduce or eliminate your borrowings.

Build assets that will cover at least your current expenses until you are 50. Whatever is excessive, invest in the wealth portfolio. If you are doing well at 40, you will find that your core assets protect you from job loss, and your wealth assets have enough time to grow in value. When you turn 50, enhance the wealth portfolio further.

From 60 onwards, keep transferring from wealth to core portfolio to maintain your lifestyle. If there is more, indulge yourself. By the time you are 70, evaluate the wealth portfolio and begin to give away what you don’t need.

By 80, your core expenses may have fallen, and you may be able to live well, transferring all your wealth to the core portfolio. When you work with your financial adviser, don’t ask whether a specific fund is risky or a bond is safe. Fit them into your map of income, expense and needs well into the future. Investing will then become easy.

The author is Managing Director, Centre for Investment Education and Learning.

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