Negative impact of inflation. Understand and be prepared in your retirement

Sourced with thanks from economictimes.indiatimes.com

You may be retired or close to retirement and planning for it. Here is a very important lesson for you. About how inflation “decompounds” your savings and impacts the money available in the long years of retirement. Understand this better and be better prepared for the future. Here is what a well-respected and popular investment expert (Dhirendra Kumar  of Value Research) has to say about this matter. Team RetyrSmart

Negative impact of inflation. Understand and be prepared in your retirement

A couple of days ago, in a webinar I was invited to, I came across a question that really bothered me. In fact, it is still bothering me. Someone wanted advice on post-retirement income. That is, on generating income from savings after retirement. Except for the lucky few who have an adequate inflation-linked pension, this is a problem that everyone of us has to solve at some point.

To find Retirement friendly inputs in your Inbox

Subscribe to our Newsletter

This person had just retired and had savings of about Rs 50 lakh. He said that his lifestyle was modest and all he wanted was a steady Rs 40,000 a month. He just needed some guidance as to what was the best way to generate that income. His query was almost the same as that of a relative of mine who had asked me about generating an income of Rs 1 lakh a month from savings of about Rs 80 lakh.

Neither of these people had any anxiety about their question and that’s something that has caused me a lot of anxiety. They took it as a matter of course that they needed to find out how to generate their required income and then just settle down to a long and happy retirement. Can you see the problem here? It’s blindingly obvious to anyone who has a good awareness about inflation and returns.

These are the middle-class people who have earned a modest salary all their lives. Now they are retiring and they have at their disposal an amount which to them feels like a lot of money. Sure, in many contexts, these are large sums. However, they are not even remotely adequate to generate the kind of income that these retirees are expecting. Given the expected life spans nowadays, that income will have to be sustained for some 20-30 years.

Why are they under this delusion? The reason is something I try to hammer home every time I write about retirement. They understand returns but do not understand inflation. They understand how income compounds but do not understand how inflation ‘decompounds’ it. Nominally, Rs 40,000 a month requires a return of 9.6% from Rs 50 lakh. Rs 1 lakh a month requires a return of 12% from Rs 80 lakh. On the face of it, it’s doable. The latter is a stretch but not by much.

If there was no inflation in the world, then the two would look forward to a long and happy stretch of golden years. But no, that will not happen. Prices will rise and the money will not be enough. They’ll start digging into their capital. They may not even realise it for a few years because while the nominal value of the savings will be maintained or even grow a bit, the real inflation-adjusted value (purchasing power) will keep declining. In a decade or so, they will be looking at the biggest tragedy of retirement—old age poverty. This is not a mere theory. Look around yourself, you will see any number of older people who are already facing this tragedy.

So how much will these two retirees be able to safely generate from their savings? At Value Research, we have done a lot of study on this problem and think that a withdrawal rate of roughly 4% is quite safe. If you do well with your investments then in the long run, a high rate of 6% may be possible but in the early years one needs to keep it as low as possible.

For my two examples, that gives us Rs 16,000-18,000 a month out of Rs 50 lakh, or maybe Rs 30,000 for the second case. Like I said, it’s a tragedy in the making, one that to me is the most bothersome part of the Indian savings scenario. For those who still have some time to go for retirement, please pay heed to these numbers and ensure that you are never faced with this problem. On Value Research Online, we have a lot of good information and tools to help you plan your savings, and the earlier you take the opportunity, the happier you will be in your old age.

To read the original article in full Click Here

To find Retirement friendly inputs in your Inbox
Subscribe to our Newsletter

Subscribe
Notify of
guest
0 Comments
Inline Feedbacks
View all comments