A common grievance we hear from our elder relatives, neighbors and associates from the retired bracket, is how day-to-day expenses are so high vis-à-vis their pension and regular income that is not sufficient to compensate for the same. The cost of food, medical expenses and transport is perpetually on the rise considering the fact that we live in a higher inflationary economy.
Is it the fault of the rise in expenses, that their incomes were lower than what it was meant to be in their earning stage, or is it the faulty retirement planning which has hit them in the war against inflation? Let’s try to take a more systematic and detailed look at the same.
In phase one, an average person in his or her mid-twenties who just finished his or her education and begins a job. Gradually, he or she gets married and begins a family. Initially, during formative years, the latest trend suggests that people tend to spend more of their earnings on consumption related facets such as purchase of latest gadgets, real estate for family, new vehicles, travelling, etc. They might even use Credit Cards for No Credit as their income can be low and of course, they’re still young so haven’t really generated any credit for themselves. While there is no harm in enjoying life, the above lifestyle weighs heavy on the savings ratio and also tends to create long term pressures on their goals as they are saddled with heavy EMIs and debt which is unfavorable on personal balance sheets. Due to heavy lifestyle expenditures and the EMI burden, the savings ratio is skewed right at the bottom of the pyramid in the ratio of earnings.
In phase two, people in their mid-life gradually begin to deleverage their home loans and auto title loans while rising lifestyle expenses are present but are set off with rising salary incomes. The riding is smooth so far. The first major hurdle is hit when the realisation is that now a major part of whatever is saved has to be given to children in the form of education, corpus and marriage expenses. Whatever savings are done, are in the form of various asset classes that have to be given to the child. Since there is a rise in salary, the level of savings gradually increases. In some cases, people prefer to invest by taking more leverage (for example, investing in real estate by taking further loans) and hope to settle the same in due course of time.
In the last innings of life, after all responsibilities are set, people now decide that it is time to plan for their retirement. It’s also during this stage that people tend to take life insurance policies more seriously as a way of providing for family members in case of a crisis. With only a few years of their earning cycle left, and with inflation gradually compounding the cost of goods and medical service requires the family to invest huge sums to weed out the inflation problem on a gradual basis. If the same is not met, it results in families either having to dispose off assets to create liquidity or to be dependent on their children for the shortfall of income.
The above is an average case scenario but we have not taken some more contingencies into account such as a medical event in formative years, death of an earning member, loss of the job due to a certain event, etc.
Let’s take a common analysis of what mistakes were done:
- Heavy EMI burden at a young age propelling them to reduce the savings ratio. Some EMI is even dedicated to depreciating assets such as auto mobiles.
- Not investing at an early stage with a skewed asset allocation
- Liquidity constraints of savings
- No hedge was formed for investment
- Wrong asset allocation
- Starting too late for long term goals
Let’s take an alternative look which might help in a much more holistic planning approach –
In phase one, the same person can see what goals are in store for him in the future. Some common goals which all people have for a long term is retirement planning, corpus for children, purchase of house, etc.
He can understand the corpus required for him and understand how much he needs to save for the same in his desired time frame and accordingly adjust his investment portfolio. In the long term of goals and beating inflation, he can plan a mutual fund SIP to help fund the goals in tax efficient manner. It’s very important to understand that a person must save what he requires first and then learn to spend with whatever is left. If the same is done at the inception, the amount to be allocated to the goals is smaller as long term compounding helps you reach the goal. Equity over a longer term can help give inflation beating returns and help to ride out the volatility in a tax efficient manner. In the past, equities have consistently given 13-15 per cent CAGR tax-free returns. Since invested at younger age, it gives you more time to stay invested in the market as you are in the formative years and the risk taking capacity is higher, which helps to ride out the volatility. It should be assumed as an EMI for your future. An ideal asset allocation is (105 – Current Age) should be allocated to equity of your savings and the same must be revised every five years. Your savings in equity keeps compounding as you near your retirement and you will be required to gradually transfer the gains into debt instruments which will give you a regular pension like an income, helping you to meet daily expenses. This is an important aspect to think about when speaking to an estate planning Orange County service, or indeed one more local.
As far as real estate purchases are concerned, people must realise that the same property purchased can be offered at two per cent rental yield to the cost of property while the loan interest are much higher. The family can wait for some time to improve the saving ratio and purchase the property with a lower leverage on their books, helping in achieving both goals.
Another very important thing is that people must understand to hedge their long term investment planning. If an investment is allocated for a goal to be fulfilled for 10 to20 years but has to be broken before for some contingency unplanned for, then the whole purpose is void. So, it is very important to hedge your investment. Most common risks which can be thought of can be avoided if a person has insured himself properly. Some insurance facilities which people must have are:
- Term plan – Earning member of the house must be insured for 10 to15 times of the annual income. In case of death of an earning member during a younger age, it can create a situation of burden of debt (real estate, personal loan, etc.) and other expenses of family members and also shortfall in investment corpus left behind for the family.
- Health Insurance – The entire family including parents must have a good comprehensive health insurance cover. With medical expenses rising and in case of costly treatments, savings are diverted for the same as it affects the structure of the savings. One must realise that the cost of an insurance premium is much lower than the cost of the treatment itself. If taken at a younger age, the cost of the premium is much lower.
- Personal Accident cover – This will help cover a situation where an earning member becomes disabled due to an accident which results in affecting his earning capability.
- Critical illness cover – Cancer, cardiovascular diseases, etc. These diseases have no age and can affect everyone. This can cause a premature death and a huge burden on medical expenses affecting our savings. A comprehensive critical illness cover can help in hedging risk of breaking investments for funding the treatment, but we can transfer the risk to insurance company by paying a premium.
A combination of early savings with the right asset class allocation matrix with regular balancing along with appropriate hedges in place, an average middle class family can not only achieve all his goals but also do it in a smooth and a less staggered, less volatile environment.
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