How to use mutual funds for retirement planning?

How to use mutual funds for retirement planning?

Retirement planning is one of the most ignored topics among the working population in India. Once they get near the retirement date, many people realise that they have not saved enough for their retirement and fear losing their financial independence. Retirement is the culmination of the decades of hard work you put into your career. This should be the golden period of your life, and you should be free from financial worries.

Why is retirement planning important?

  • Inflation: Inflation reduces the purchasing power of money over time. If inflation is 5%, Rs 100 can buy only Rs 95 worth of goods after one year. After ten years, it can buy only Rs 60 worth of goods, and after 20 years, only Rs 37 worth of goods. Your needs will remain the same, but your money will be worth less and less. To fight inflation, it is essential that your money also grows over time. You need to plan for inflation.
  • Rising medical costs: With advancing age, senior citizens' health-related problems are a concern. However, the cost of quality private-sector healthcare is increasing at a very fast rate in India. Some studies show that inflation in the price of medical expenses is around 15% per annum. A severe illness can consume much of your retirement savings and put you under considerable stress.
  • No pension: India is primarily an un-pensioned society. Unlike western nations like the United States or the United Kingdom, private sector employees in India do not have a safety net in the form of a national pension program. They must create their own post-retirement income stream by saving and investing systematically during their working lives. As such, retirement planning should be one of your most important financial goals during your working life.

How much do you need for retirement?

We have many responsibilities in our working lives, like taking care of children’s education, caring for aged parents, paying home loan EMIs etc. Many erroneously assume that most expenses will disappear when they retire, but they are mistaken. Financial planners suggest that 70% – 80% of expenses remain even after retirement. Suppose your monthly expenses are Rs 1 lakh, and you are ten years away from retirement. Ten years later, your expenses will be Rs 1.6 lakhs assuming a 5% inflation rate. If your post-retirement expense is 70% of your pre-retirement expenses, then your monthly expense post-retirement will be Rs 1.1 lakhs.

You will need a corpus of Rs 1.7 crores to generate a monthly income of Rs 1.1 lakhs if you get an 8% return on investment. We ignore inflation and taxes when estimating the corpus. Assuming that your retirement life is 25 to 30 years long and inflation is 5%, you will need a retirement corpus of Rs 2.5 – 2.7 Crores to maintain financial independence throughout your retirement. In addition, you should also have some emergency funds set aside for medical or other necessities. If you want to leave behind an estate (inheritance) for your loved ones, you must have an even larger corpus.

Mutual funds for retirement planning

Return on investment is one of the most important attributes of wealth creation. Mutual funds help you get exposure to different asset classes and subclasses, which may enable you to get superior returns. Historical data shows that equity is the best-performing asset class in the long term and can create wealth for investors over a long investment horizon.

In the last ten years, Nifty 50 TRI, the total returns index of India's 50 largest stocks by market capitalisation, gave 10.3% CAGR returns (Source: NSE India). Suppose you were saving for retirement by investing in Nifty 50 TRI through a monthly Systematic Investment Plan (SIP) for the last 10 years. In that case, you could have accumulated a corpus of Rs 2.7 crores with a monthly investment of Rs 1.2 lakhs. If you started five years earlier, you could have accumulated Rs 2.7 crores by investing just Rs 55,000 per month through SIP.