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Inflation Linked Investments

Are retirement websites (and retirement calculators like mine) overdoing it? A 35 year old, with an expense of 8 lakhs a year today, will need to build up a corpus of Rs. 4.84 crores just in order to get the same quality of life, assuming retirement is at age 60 and a person is expected to live till he’s 80. This makes sense – because at 6% inflation, the 800,000 you spend today will go up to 51 lakhs (5.1 million) per year in 25 years.

The next part is tricky. Assuming a 12% long term return, you then need to invest 25,000 per month to get there, is what most calculators tell you. But is that really true?

No. Not in real life.

With inflation, your income is likely to go up as well, and therefore the ability to save increases at least at the same level as inflation. That means if I can save 25,000 per month today, I can save 26,500 per month in 2011, and 28,000 in 2012 and so on.

If I put those savings in, a quick excel table tells me I will generate a corpus of more than 7.35 crores in 25 years. That’s way more than I need.

Saving 25,000 a month for 25 years: 7.35 crores 

Inflation linked savings

To generate the 4.84 crores I need at age 60, with a saving increasing with the same 6% inflation, I need just Rs. 16,500 a month. That’s a whopping 34% lesser!

Saving 16,500 a month for 25 years: 4.85 crores 

Consider Different Retirement Costs

Consider also that costs are lower when you’re retired. You probably don’t have a home loan (or rent) to pay. Your kids are out of home and won’t need your support. You can’t digest heavy food or too much alcohol, so your restaurant bills will be lighter. On the flip side, you’ll travel more, your medical bills will be higher, and you’ll want to splurge on your grandchildren. And, you might even have an income at retirement – royalty from something you’ve written or patented, dividends from companies you’ve bought, rental income from a second house or even consulting income.

You don’t need that much

Chances are you don’t need to save all that much today – remember, I haven’t even considered the possibility of your getting promoted and getting a salary hike higher than inflation. The chances of that, in a growing economy like ours, is almost 100%. So if you get really conservative and save a lot today it may be utterly useless – saving too much is just as stupid as saving too little, because you give up today’s pleasures to enjoy life when you’re 60; what’s the point of lending to the future unnecessarily?

So go on, spend that money

I just saved you 34% off your retirement plan. Go on, spend it and buy that Nintendo Wii or Beach Holiday you’ve been putting off till retirement.

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  • Anonymous says:

    >Great Post.I am 59. Having worked and saved (like a fool) and invested, I am in the situation described by you. I have a big flat bought in 1979 with my Employer's Loan at 4% pa (got great tax rebate). Once you have roof over your head in a city like Mumbai, rest of the expenses are easily managable. I don't know what to do with my Money now. I also enjoyed my foreign travels and postings (paid for by employer). So even here I have no agenda. So finally it dawned on me that best way to move forward is to take early retirement at 56. I am now enjoying the same. My peer group are still working (may be they did not read your blog/post).

    MK

  • Anonymous says:

    >thank you.

  • Anonymous says:

    >Good Post. I too had a feeling that we are saving much more than we need and your post brings that out very well. Keep up the good work

  • Ankur says:

    >Deepak sir,

    I think main reason why planners do not take into account higher salary in future is to be conservative.

    To me, this very assumption of 6% inflation rate to eternity is basic flaw in the process. We have been experiencing double digit CPI level inflation. Hence, inflation to be taken into account should be in double digit.

    Other problem is upgrade of life style with increasing income which makes extrapolation of current cost of living irrelevent beyond a few years.

    As for salary increases, it is not necessary to keep pace ith inflation especially if one considers double digit inflation.

    Most important, in my opinion, high savings in early years give longer time to compound and allo room for something going wrong unexpectedly.

    We would like to knoww your views.

  • Lincoln says:

    >We should also take into consideration that at the time of death the balance should be zero. Difficult to time both of them correctly but some factoring should be done for the same 🙂

  • Deepak Shenoy says:

    >MK: Thanks – I admire you, for realizing earlier and taking the time off! Awesome.

    Ankur: CPI level inflation doesn't touch you and me, most likely. Our expenses could shoot up 10% when CPI is benign, and right now, could be growing only 5% as CPI is at peaks. Eventually we'll control this inflation and might go down to the 3-4% range as we grow, but taking 6% long term today, for the web-enabled, is perhaps fair.

    Cost of living wise – you're right, that can change, but then I expect people will come and change their retirement calculations alongside. But I've noticed that most people don't go berserk with lifestyles when they get richer – a few do, they come on page 3 etc.

    It's not useful to save more money than necessary. remember, we all benefit from our SPENDING, not our saving – the GDP growth, the fun, the joy of living, the whatever, comes from the present, not the future. I know there are extremes – people use credit cards to enjoy themselves today and then repent at leisure; but there are just as many at the other extreme, who would perhaps enjoy life better if they could lighten up on the saving.

  • rajsmusings says:

    >Thanks Deepak. Was eagerly waiting for this one after you had mentioned about this some time back in one of your earlier posts.

    Is it possible to prepare a calculator for this and put it on your site for users to play with ?

    Regards
    Raja

  • Sandeep says:

    >Deepak,

    Great post. I believe people should spend according to their income and not their desire. At the same time early years of income should save more compared to later. As lifestyle inflation does happen naturally for most of the people. Moreover the % rate of growth now a days is not at all something can be predicted, as many people are inclined towards equity linked investments.

    Your point is very valid and one should spend in present than saving too much for future which is not known.

    I love all your posts as they give lot of practical outlook.

    thanks
    Sandeep

  • Anonymous says:

    >Like the post.I have a similar query. Is it better to commute your 50% pension (18000) for 15 years and take it now OR draw this amount every year for the next 15 years( if one survives)keeping the inflation in mind.
    Thanks
    HPS

  • sjdate says:

    >Great article and very valid points, which are not considered by financial planners who raise the bogey off starting early to save for retirement; almost suggesting compromising todays pleasures for tomorrows gains.

    You have suggested salary increase at inflation rate. I say that, that is the rate at which the house maids salary increases. She only uses the skills of her hands to wash clothes, clean utensils, and swipe the floors. A educated person should certainly aspire for say 10% increase, a graduate/ post graduate / manager should aspire for more than 15% ? A software person …?

    The taxes do go up as they are linked to the income but then every 4 or 5 years the minimum slabs are also increased and taxes are reduced ? The EMIs are at a flat rate and do stop after 15 to 20 years. The luxury items may have a 10% rate of inflation but technological advancements do reduce the prices and they are in the reach of the common individuals. So the potential to save increases in % terms year after year.

    If all these are considered, yes we need not compromise today for retirement.