Retiring early is a dream of many, but it needs hard work. You should have enough to meet future needs
A simple financial planning perspective to early retirement is: the number of years you intend to live off your wealth moves up. In retirement planning, we consider the accumulated wealth and estimate its adequacy to cover the needs of the remaining years. Outliving one’s wealth is the biggest fear. When you stop working early , you increase your dependence on accumulated savings even more.More years into retirement means a lot more variables and assumptions. There may still be financial goals to achieve and loans to repay . Inflation will be a killer as it compounds over the long years. As a thumb rule, unless you have enough wealth that you will not need more than 2% of it to manage all your needs each year, early retirement is likely to be a risky venture.
Whether we have enough money to retire early is a tough question to answer.First, whatever money we have seems like a large sum compared to our current expenses and income. The human mind is not capable of imagining the compounded effect of inflation. Second, the temptation to use a large lump sum to indulge in big-ticket expenses is high.Due to the simple mental comparison of the amounts involved, many retirees are prone to be bold spenders in the initial years. Third, we do not have the means to correctly estimate the future returns.We therefore end up over-estimating returns on investments, while underplaying risks.
Let me use an example to illustrate these limitations. A relative of mine will retire with a corpus of `30 lakh next year.His current take home salary is `1 lakh.In his mind, he foresees a comfortable retirement. He told me that `30,000 a month is all he plans to spend since he lives in his own house and his wife is also earning. He thinks his need is just 1100th of his corpus and thus quite small. His long-standing wish is to buy his wife a pair of diamond earrings. He also wants to pay off a pending `4 lakh housing loan on his second home. These are small amounts compared to his retirement benefit. He thinks that if he puts his money in a good mix of investments that gives him 10% return, he should be fine.
I had to flip his arguments over and hold the mirror to his face. In retirement planning, it does not matter how much the constant the corpus is, and how much income it generates. There are only two rates to work with–the rate at which the corpus is growing and the rate at which it is being drawn upon. For example, if my relative draws `30,000 a month, that is `3.6 lakh of drawdown from a corpus of `30 lakh. A 12% draw-down is an alarming no-no. The logic is simple. Even if you placed the money in the bank and got an interest of 10%, your corpus will grow at that rate, if you did not draw the interest. So the math to work out is, if the growth rate is 10% and the drawdown is 12% per year, it is easy to see that the corpus will be eroded.
Why should the draw-down rate be small? A retired investor’s biggest enemy is inflation. Therefore, allowing the money to grow with time is the only defence.The mental separation of principal and interest is simplistic since a principal that remains unchanged is no protection from inflation. It being “safe“ actually means nothing, when the income it earns have all been consumed. It is important to see investment returns as accumulations to the corpus, and to draw at a rate that is much smaller than the rate of return, so that the money lasts longer. The 2% draw-down rule applied to my relative yields a measly `6,000 a month, a number he is very shocked and unhappy about.
Now let’s move to the temptation to spend. `5 lakh drawn out of `30 lakh means 17% of the corpus has been spent early and is not available to grow over time. Small amounts of money can grow into large sums, even at conservative rates, if they are given time. To consume the corpus is to scuttle its ability to grow larger with time, and it amounts to losing protection when most needed. Much as one may be tempted to indulge, it is important to see how such withdrawals can short-change the future.
The last argument of my relative was about the rate of return. He asked me if 10% was a conservative number. I told him that it seemed very aggressive. If India moves on the macro-economic path that is being set up by its policy makers, we are likely to see low inflation (which is nice) and low rates of investment return (sigh!). It is already evident that banks are unlikely to offer double-digit returns on deposits. A high 10% return requires exposure to equity . That would mean volatility in invested value, lower draw-downs in initial years, and longer waiting period before the money can be accessed.
My advice to my relative was this: why retire at all? If work was boring and tiring, find something else that makes you happy . 55 years is not the age to simply stop working. You will soon feel the need to be productively engaged, to have your social network, and to get up in the morning and have an agenda for the day .Do not mistake the need for slowing down, taking in more of life around you, and the need for breaks as the clue to completely stop working. Review and restart and find something new to do.When you love what you do, it no longer seems like work. On that philosophical note, I left my relative both worried and optimistic.