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Inflation is the biggest risk in retirement planning

Warning: Many people fail to account for inflation, when estimating their retirement corpus.

Suppose, Rs.50,000 per month as living expenses is their target, post retirement. To earn a safe and regular income, they plan to invest their corpus in a bank fixed deposit. Based on the historical trend, one can expect to get around 8% p.a. as interest income.

Thus, to earn Rs.6 lakhs per annum, they work out that a corpus of Rs.75 lakhs would be sufficient for their retirement.

Beware!

Let’s say the retirement is still 15 years away.

It is but natural that after so many years, the cost of living would have shot up. As such, Rs.50,000 p.m. assumed, based on the current standard of living, would most definitely fall short. Even if we consider a moderate annual inflation of 6.5%, the monthly requirement would be almost Rs.1.3 lakhs i.e. about Rs.15.60 lakhs per year.

As you can see, within less than 5 years, the entire corpus would be gone. There would be no money left thereafter.

Of course, some people are intelligent enough to understand this simple truth. So they do account for this increase in cost of living.

To earn Rs.15.60 lakhs p.a., they correctly estimate a sum of Rs.2 crores (and not Rs.75 lakhs) as their retirement target. 

Wait:

This is not the happy ending of this story.

Inflation is a moving target. 

The above calculation of Rs.15.60 lakhs as monthly requirement (and Rs.2 crores to meet the same), is applicable for the 16th year only.

The prices will keep increasing year after year. So, after few years into retirement, even this Rs.15.60 lakhs as annual interest income will not be sufficient to meet the monthly budgets. 

When we work the numbers, we discover that the entire corpus of Rs.2 crores will be over within about 12 years. After that… zilch income!

If we have to ensure that the money lasts for at least 20 years post retirement, the correct number would be nearly Rs.3 crores. This will protect us against inflation till (probably) the very end.

Worried?

The amount  of Rs.3 crores may seem as huge money today. And the threat of inflation too appears really scary.

Don’t worry:

We have an antidote… compounding:

If you invest your monthly savings, 
a) across a well balanced and diversified portfolio (of debt, equity, property, gold), and
b) in a patient and disciplined manner for 15 years  
it is definitely possible to achieve a large enough corpus for the retirement.

(Note: For simplicity purposes, I have ignored income tax in the above calculations. However, you must incorporate that too, to realistically estimate your retirement corpus.) 

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