People work all their lives to accumulate enough so that they can have a comfortable life once they decide to stop working. The largest risk an individual faces is running out of money.
One commonly faced problem with retirement investments is that we are unaware of how much money will be required.
By Chanda Lokendra Kundnaney
Published: Sun 27 Sep 2015, 12:00 AM
Last updated: Mon 28 Sep 2015, 10:09 AM
Retirement planning is a concept with many facets. Retirement calls for money to maintain one's lifestyle, needs, medical benefits, healthcare, travel budgeting and tax planning in some countries as well.
One commonly faced problem with retirement investments is that we are unaware of how much money will be required. How much and when we will need and the factors affecting the "how" and the "when" of retirement are hard to forecast.
The largest risk an individual faces is running out of money when you need it the most and in the right amount to ensure a desired lifestyle. People work all their lives to accumulate enough so that they can have a comfortable life once they decide to stop working. But generally, they find that they have saved a little less than what they should have.
Retirement planning needs you to answer some basic key questions: 1) How long does your investment portfolio need to provide for you? 2) How much will you need and what is the impact of inflation on your portfolio? 3) What are the maintenance requirements of your portfolio? 4) How to do all the above?
Once you answer these questions, you will probably have a clear picture of what you need to save for your retirement.
Life expectancy
Let's discuss point number one - how long will your portfolio need to provide for you? This will depend on your life expectancy.
Average expectancy may not necessarily be applicable to all. But average expectancy forms the basis of calculation most of the time. For life expectancy, we must also consider factors such as current health status, family's medical background and the geographical area you live in.
Based on the average life expectancy chart, if your current age is 59, your life expectancy is 83. So, you have 24 years before you die. If you wish to retire by 60, you have 23 years left to enjoy your retirement benefits.
In general, people should target to save at least for 20 years of retirement.
The second factor is your lifestyle during retirement. Mostly, your current lifestyle will form the basis of calculating the amount you will need for a similar lifestyle in future. Current monthly expenses minus current liabilities (assuming you will finish paying all dues by the time you retire) will be your basic retirement requirement.
Let's look at a simple calculation: A's monthly expenses are Dh20,000 (this includes rent, food, maid, petrol, utilities and all regular monthly expenses). A's monthly personal loan EMI is Dh8,000; car loan EMI is Dh3,500; and monthly school fees are Dh7,000. So, A requires Dh20,000 per month to maintain his lifestyle today. But this amount will not be sufficient after retirement owing to the impact of inflation.
Impact of inflation
Let us look at the impact of inflation on your portfolio. This is critical for realistic expectations. We are fast approaching the five per cent per year inflation mark in the UAE.
Let us consider on average three per cent inflation per year at the global level. If the average inflation rate continues to be the same in future, X who requires Dh240,000 per year to cover his living expenses now would need approximately Dh361,220 (1.806 times) in 20 years to maintain the same lifestyle.
Similarly, if you keep Dh1 million in a bank today, in 20 years, the money would be worth around Dh555,000 approximately. Inflation takes a toll on the retirement money you put aside.
If the idea is to live off your money during retirement and not to leave behind any legacy, we need to know how much money you will be able to safely withdraw each year from the amount, so that you have enough for the term of retirement.
A common but incorrect assumption is that equities have historically delivered roughly 10 per cent. The market may have given an annualised average return of 10 per cent over the long term. But the returns are different every year. Withdrawals during market downturns can substantially decrease the probability of maintaining your principal amount.
For example, if your portfolio is down 20 per cent and you take a 10 per cent withdrawal, you will need a 39 per cent gain just to get back to the initial value. This will require maintenance, recalculation and extra allocation of funds to reach your goal.
The last step is the most crucial one in retirement planning. How to achieve all the above? The simple answer is to start planning.
The author is an entrepreneur and financial planning consultant. Views expressed are her own and do not reflect the newspaper's policy.
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