Pages

Tuesday, 14 July 2015

My 50+ Year Retirement Map : Do I Even Stand a Chance?


The single biggest challenge of an early financial independence and retirement journey can be quite a revelation.  Most people would think that the toughest part would be, how to collect and grow your corpus at a rapid pace to meet the requirements of early retirement.  

Though partially true, the real challenge (once you have of course reached your required corpus size) is to figure out how to structure your hard earned savings in a manner that will last through the entire period while you cool your heels and chill out!

The twist thrown in by the EARLY retirement, is that you have to spend a much longer period retired, which creates all kinds of crazy challenges and surprises for you to deal with.  I need to figure out a way to carefully nurture my hard earned corpus, which I would have built through the accumulation phase of my financial career, and make it last through all the turbulence I expect to encounter during the distribution phase in my golden retirement years.

I had discussed in my post yesterday called A4 Portfolio, that asset allocation plays the key role in the success of the accumulation phase of your financial journey.  (I must clarify based on some feedback that I received from readers, that the aggressive asset allocation I have described in that post is only during the accumulation phase)

In the same way, asset allocation is also the determining factor to ensure your hard earned corpus lasts through your entire retirement phase. The critical factors during the retirement or distribution phase, are very different from those during the accumulation phase, so you will expect that the asset allocation strategy will also need to be tuned to the changed circumstances. I have put together a visual representation of how my retirement portfolio will be structured on the day I call it quits from the corporate rat race.  Here is what the picture looks like


The first thing you will notice is the absurdly long duration for the retirement plan.  But hey, I had warned you earlier, this is what you get if you plan to retire early. I need to make sure our retirement portfolio lasts right through my and my wife's lifetime comfortably.  Which means, I have to plan for a MUCH LONGER retirement period, than is normal.  Nowadays with improving health care, and growing life expectancy, it is not uncommon to see a normal retirement plan (with retirement age at 60) being drawn out for 30-35 years. My plan is all about EARLY retirement, so voila, I need to plan for 50+ YEARS.

The next thing you will notice is that I have divided my overall corpus into 5 buckets to help with the different goals and needs during my retirement. I will describe the 5 buckets in some detail here today, and explain some of my thought process over a few more posts.

A. RETIREMENT CORPUS: is the bulk of my retirement savings ear-marked for living expenses through the long retirement period. This constitutes about 66% of my overall corpus allocation. I have discussed before, how I calculate my total corpus needs as a function of my annual expenses. You can read about it in the post How Much Should I Save Before I Retire.  I have bumped up the requirements a little bit, based on feedback from a couple of readers of my blog.  I am shooting for a target of 40X my annual expenses, and expect it to last about 50-55 years through retirement, assuming that I can beat inflation consistently over this period by about 2%. The critical piece in this computation is to make sure all potential recurring expenses (either yearly, or maybe with a longer recurrence pattern like once every 5 years) are accounted for in the annual expense.

B, C for KIDS: I plan to keep aside about 8% each of my total corpus for each of my kids higher education and marriage. This amount is NOT for any schooling or training expenses till 12th grade, which is already accounted for in my annual expenses.  This is money set aside purely for under-graduate education, and for their marriage expenses. Any amount not spent, would be their inheritance.

D. LONG TERM MEDICAL CARE: I have a new component I created recently for long term health care. All of us are very careful about allocating funds in our annual expenses for yearly medical health insurance cover. This will provide for all health related expenses that may come up during normal times.  However, I continually worry about a prolonged health issue, that might crop up, and have decided to keep aside 8% of my corpus specifically for this purpose. I hope never to have to use it.

E. SAFETY: Finally given the absurdly long range plan that I need to put together, I need to build in additional margin of safety.  For this, I have allocated my only real estate holding, which amounts to the last 8% of my corpus. I will keep this as a safety net, in case I need something to fall back upon. (This is separate from the house that I live in, which will be paid off by the time I actually hit financial independence.  In accordance with generally accepted principles, I do not include the house I live in as part of my networth)

This is my high level plan.  I will describe my thought process a little more in subsequent posts.  In the meantime, please share your inputs on the viability of a plan like this. My biggest concern of course, is the long duration of the retirement, which makes it extremely challenging to plan for. Have I adequately thought of all potential scenarios? Are there any surprises in store for me? Is there a way to stress test this plan? Do you see any chinks that need to be addressed? I am open to all suggestions. In particular from folks who have already achieved the holy grail of financial independence, and can share real learning's based on experiences and surprises (both good and bad) that life tends to throw our way!

3 comments:

  1. - What is the difference between Mutual Funds and Mutual Fund Folios in your list? They should ideally be the same thing.

    - If you are planning to beat inflation by 2%, and want your portfolio to last 55 years, you don't need 40x. 32x will suffice if you assume 8% inflation and 10% rate of return. The Excel calculation for this is below:

    Annual Expense Multiplier = Excel PV((1+i)/(1+g)-1,N,-E) / (1+g)

    Where:
    g = Annual Inflation Rate
    i = Portfolio Rate of Return
    N = Number of years
    E = Expenses = 1 (to get the expense multiplier)


    - Unless you are a very experienced investor and have some definite reason and plan, there is no gain from investing in equity shares directly if you are investing in Equity Mutual Funds.

    HDFC Prudence has given a 13.5% return over the last 5 years, whereas a 100% mid cap equity portfolio would have given you approximately 21% over the same period. When you compound this, it is a significant difference.

    - Moral of the story is that in a long horizon portfolio (target horizon 7+ years), there is no point in having a debt component. I know that asset allocation models have various ratios (80/20, 70/30 etc between equity and debt), but these are generic models and can be detrimental if you do not use them properly.
    The entire reason one invests in equity, which is a volatile asset, is that over a long term, equity out performs any other asset class. Which means that over the long term, the risk that equity will not deliver the expected return is very low. So if you accept this fact, then there is no reason to clutter a long horizon portfolio with debt.

    Generally your allocation between debt and equity depends on your investment horizon (when you want to use the investment).
    - Immediate horizon (<1 year): 100% Debt
    - Long term horizon (>7 years): 100% Equity
    Intermediate horizons are any mix, depending on your risk appetite and knowledge (or ignorance!)

    ReplyDelete
  2. I liked your overall portfolio structure. I myself have not bought any health insurance, but I plan to create separate corpus through SIP route of around 8-10 lakhs in today's time to handle medical emergencies.
    In city like Mumbai, property prices being so high that one hardly gets good flat in budget of 75-80 lakhs so this is something I will have to postpone.
    Post retirement, I would split my retirement corpus in ratio of 90:10 in equity and debt.
    40 % of my equity component to be invested in dividend option of UTI Mastershare which has consistently paid dividends even during 2008 crisis. The remaining 20 % maybe in some good large cap fund like SBI Magnum Equity/Blue Chip and the remaining portfolio to be continued in midcap funds.

    Even in my current portfolio, I have rental income from family inherited asset, so that should continue to provide me the safety net as and when required.

    ReplyDelete
  3. Very good & informative post. The comment given above are also like a post. Thank you

    ReplyDelete