Retirement via mutual fund investments - FIRE
Tuesday, May 14, 2024
Retiring early means attaining financial freedom early, so it doesn’t happen at the traditional retirement age of 65, but even before that, which is 30 or 40. You reach a stage where you no longer have to think about earning that chunk of money but rather spend quality time wherever you like.
You can retire knowing that you are backed by the money you need to live post-retirement. But the question is, how do you get that early retirement? So to achieve that, there must be some planning today.
What is FIRE after all?
It simply stands for financial independence. retire early!
By emphasizing three things:
- Have a frugal lifestyle
- Save as much as 50% of your income while you are active until you turn 40.
- Invest those savings wisely in a low-cost index fund.
If planning a retirement is that easy, then do you know the corpus you need to retire? Quite not. Nobody has a definite answer to this and that’s why people go by some calculations and some method to arrive at it. This is a rough estimate!
Only if it were easy to predict what the inflation rate is going to be, how long you will live, and what your post-tax returns would be. Perhaps nobody knows what these numbers are going to be!
But to implement FIRE, you need that corpus number. Let’s get into practically thinking about arriving at a number.
It can depend on things like:
- What will the inflation rate be?
In India, you can see the historical inflation rate and take the average of it as a consideration for retirement and it changes for every goal you have. Keep a buffer of 2 to 4% of the expected return so that you don’t fall short.
- What will be the rate of return?
You might have a fair idea of the corpus amount, now it’s about the rate of return you must get to achieve that. That will also give you an idea of the amount you have to keep aside to invest every month.
Based on the investment type, you can decide on the amount for the monthly investment. You can consider investing in mutual funds such as debt mutual funds, flexi cap mutual funds, and sectoral mutual funds for better returns.
Debt mutual funds give an average return of 6 to 7%. Flexi-cap mutual funds give anywhere between 16 to 23%. For sectoral mutual funds, depending on the sector, an average return of 15 to 21%.
Always expect a lower-than-expected return on these so that you are sorted for even the lowest average potential.
- What will be the life expectancy that you have?
The life expectancy in India is about 65 years. But there is no harm if you consider a higher life expectancy of about 85 years. It’s about a little more money to save for living life without regretting having missed a little.
- What will be the growth in your income?
That’s the solid basis on which you can save, invest, and plan your life. It’s also obvious that with time, it will grow, and you need one average number to consider this in your retirement plan. That makes a solid, realistic, rough estimation for your future.
To arrive at a number, consider the annual increments and the hike you received on changing jobs, or an average of 10% growth every year. Whichever gets realistic!
We arrived at how these valuations happen; though it is an assumption, it can give some realistic retirement corpus numbers to live a retired life without any challenges!
Where is the corpus number, though?
Well, we are just getting there! The summary is that you need to have data for the following and a calculator can help you get there!
- What’s your present age?
- When do you look forward to attire?
- How long do you wish your life to be?
- What are your savings up to now?
- How much are you saving monthly?
- How much do you wish to increase your savings annually?
- What is the rate of return you expect on the pre-retirement investments? (Pre-Tax)
- What will be the capital gain tax?
- What is the return on investment post-retirement? (pre-tax)
- What are your current monthly expenses?
- What is the inflation rate you want to consider?
- What would be the monthly expenses post-retirement?
So go ahead and calculate the retirement corpus here! (Add a link to any good retirement corpus calculator.)
The other ways to find out retirement corpus
There are popular ways out there that you might have heard of, like the rule of 25 and 4%! What’s with that?
They don’t get into the intricacies of all the factors above but they give you the solid corpus that you are looking for.
The rule of 25
Here’s what goes into it! You save 25 times the annual money you decide to spend in your retirement beforehand. This approach goes into thinking more about how much to save before leaving the workforce, assuming you have 30 years to retire and have invested all the saved corpus in an investment that allows you to safely take 4% out of it every year after retirement.
If you have another source of income coming into play, this isn’t taken into consideration for the calculation, so you might have to deduct that buffer. Also, if you have extensive spending goals after retirement, this is not the most accurate one to rely on!
To do the calculation, you might need to know the amount of money you want to spend post-retirement annually. Suppose it’s 12 lakh a year and to this, you have to subtract the other source of income, such as a provident fund or part-time income. Assuming it is Rs. 4 lakh a year.
It gives you an amount of 12,00,000 - 4,00,000 = 8,00,000. 8 lakh is the amount you are planning to spend post-retirement every year.
To do this, multiply it by 25! 8,00,000 x 25 = 2,00,00,000
It accounts for you to have 2 crores of money in hand before leaving the company. You are not expected to make 2 crore just by saving but by having a solid investment plan that makes you earn not just returns but compound returns.
The oversimplified method, though it gives you a simple number, doesn’t take into account important factors like inflation, life expectancy, and other expenses.
4% Rule
It’s a flip of Rule 25 that emphasizes how much to withdraw during retirement. It begins from a point where you have 2 crores in hand and tells you how much you should withdraw to sustain the amount for 30 years.
William P. Bengan, when handling multiple clients’ retirement portfolios, had to often deal with calculating the amount their clients needed to retire. The portfolio had investments in 50% equity and 50% debt that had given an average return of 10.3% in equity and 5.2% in debt. Assuming they would withdraw it at the end of every year.
On running simulations on multiple withdrawal rates, he found that 4% was the rate that lasted for at least 30 years and a few up to 50 years.
4% of 2,00,00,000 is 8,00,000, which means a retiree would get 8 lakh to spend every year post-retirement. Which would come for 25 + years from the extra amount from other sources of income that was deducted initially in this example above.
However, it has a few drawbacks concerning the assumption of 30 years for retirement, which only takes care until 70 for a person retiring at 40, where a buffer of 15 is disregarded.
The role of mutual fund investment in FIRE
While you have figured out your retirement corpus, it is also time to invest in good opportunities that meet your rate of return requirement. Know what role a mutual fund can play in your retirement planning.
Vast funds to go about
Mutual funds are not limited to one thing, such as equity, but rather you can invest in debt mutual funds, sectoral mutual funds, flexi cap mutual funds, and more. Usually, it is recommended to begin with equity initially and later move towards debts, either way giving you loads of choices.
A lot of flexibility
Suppose you get an increment or a hike and want to increase your investment money as well. You can do that with a mutual fund. Let’s say you plan to withdraw; you can do that anytime too.
If the fund you picked isn’t performing well, you get to switch! If you are a person who can track markets, then get along on the direct plans without giving anything to the commission.
Money in different eggs
You don’t need to worry about losing money in one place, you can spread money across various sectors to take advantage of good opportunities and reduce the risk.
Diversification happens in mutual funds!
Mutual fund returns post-tax are higher compared to other instruments! With debt mutual fund returns taxed at 20% + indexation benefits for LTCG and equity mutual fund returns taxed at 10% above 1 lakh for LTCG.
Your retirement portfolio via mutual funds
Retirement planning is a long-term goal that requires greater consistency and SIP is the best way to go about it with discipline! As the name suggests, a systematic investment plan, where, on a specific date, a fixed amount gets debited from your account towards an investment in the best mutual funds.
SIP is a mode, not to be confused with an instrument.
Let’s understand how SIP works. As you understand the retirement corpus that you would need depending upon your retirement goal, considering the expected rate of return and the time to retire, let's find out the SIP amount that you must invest to achieve that corpus before you retire.
Assuming you are at the age of 25 and want to retire at 50 with a retirement corpus of Rs 2 crores while receiving a 10% return on investment for 25 years. The SIP amount required in this case is Rs 15,000 every month. If you have 5 more years to retire, the SIP amount required monthly will come down to 8,780 Rs.
Therefore, to calculate the amount, you need the rate of return and the number of years left to make the returns. The greater the time left, the smaller the amount of SIP. If you start early, you can not only retire early but also make more money from the compounding effect on the investment.
SIP is a way to beat the volatility. By buying more units when the market is lower, fewer when the market is higher, and more units, it’ll average the buying cost to make more returns and lower the risk, allowing you to start small and grow more wealth over time via compounding.
You are thinking of retirement and so is everyone else about living their unknown future. Having a plan in place always feels like a sense of relief and FIRE was just a way to look forward to retirement as achievable and indeed it is as long as you plan. Also, make the right investment choices where mutual fund returns have turned out to be promising to most investors.
While increasing your savings all the while when you are young to reduce the stress towards retirement is a systematic process, it may or may not work as stringently as thinking of that exact round figure number.
Sometimes you can go a little flexible in tweaking it to suit your situation, such as either reducing the post-retirement spending as there are a lot of expenses that cut down during that time, or you can earn more in the initial days when you have more energy and slowly move towards a less demanding job when you are closer to retirement time and quit working around 60 easily, or you can never quit a job, meaning do a serious high paying job until 40 and switch to a part-time job post that and never quit as long as you love your part-time work. Use the active money for some expenses and some amounts from partial withdrawals of the invested corpus.
There is always some way, but ensure you are always secure and have a plan for a good retirement!
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