Rs.1 Crore… A Life-Changing Sum or An Illusion of Abundance…?

For the average Indian, Rs.1 Crore somehow comes across as the Elixir to all his financial worries. This perception gets further fuelled by the fact that many investment / insurance plans tend to use this figure of 1 Crore as the magic number that can take care of all our needs and aspirations. So with the help of a simple reality check, let’s try and understand if there is any merit to this thinking.

How Long Will My Money Last…?

This is a question that most retirees would ask when it comes to determining the adequacy of their retirement corpus…

Let us understand this with the help of an illustration:

A person aged 60 retires today with a corpus of Rs.1Crore. He has no financial liabilities or obligations to be met. His current monthly household expenses are about Rs.50,000/- and he intends to maintain the same lifestyle going forward. He is confident that this corpus would easily serve him for at least the next 25 years and more so he believes he will be able to afford a far more affluent lifestyle than what he is living today. Is this a fair expectation to have?

We will begin with a basic set of assumptions from a Retirement Planning Perspective:

Duration of Retired Life: 25 years (approximately) …assuming a life span of 85 years.

Accounting for Inflation for this period (Living Expenses + Lifestyle Inflation): 5% p.a.

The corpus would be invested in Fixed Income Generating Instruments yielding 7% p.a.(Post Tax) (Considering safety aspects coupled with the need for generating regular income)

This would mean that the corpus would grow at a real rate of approximately 1.9% p.a.

Analysis:

Upon applying the fundamentals of Time Value of Money (TVM) to this situation, one would realize that the corpus would fall short of serving the Retiree (Family) for the targeted number of years by about 5 years i.e. there is a distinct possibility of the family outliving the corpus in about 20 years.

For the given corpus to last for about 25 years, the Family will have to curtail their monthly expenses from Rs.50,000/- to Rs.41,778/- (i.e. Monthly Expenses will have to be cut by about 16%).

Thus, contrary to the original thought of the corpus being able to sustain a far more affluent lifestyle for targeted number of years, a simple TVM (Time Value of Money) Check tells us that the retiree/family will in fact have to further compromise on their existing lifestyle to make the corpus last for the expected time duration.

The same logic applies to Insurance Planning too when determining the adequacy of the Sum Assured.

Thus the adequacy of Corpus (whether used for managing Post Retirement Expenses or as an Insurance Sum Assured for managing family expenses after death of the Insured) depends on the following factors:

1. Inflation – Rising cost of living (including lifestyle inflation) needs to be accounted for in our estimates

2. Investment Yield – Investment yield will depend on the choice of instrument which is further dependent on our safety expectations and regular income generation needs.

3. Real Rate of Return – This is the effective returns one would end up earning over and above inflation.

4. Present Monthly/Annual Expenses – This will be adjusted periodically to factor in inflation.

5. Total Time Duration: Number of years for which one needs to make provisions for meeting household expenses. This depends on the expected life span of the younger spouse/member to be covered.

These are crucial considerations when it comes to planning one’s retirement corpus or even when determining the Ideal Sum Assured for insurance, and hence any laxity in accounting for them in your computations would possibly lead to underestimation of the required corpus thereby forcing one to settle for a compromised lifestyle.

Conclusion:

So it is amply clear that there is nothing divine or magical about Rs.1 Crore… Although the figure may appear to be psychologically comforting, it can at times be misleading and give us a false sense of security about the future. Hence to ascertain the adequacy of any corpus under a given set of circumstances, one has to weigh it against the stated financial parameters.

Note: The case discussed in this blog is one of managing the corpus for a person retiring today. The situation becomes even more challenging and requires deft handling of resources, when one plans for a Retirement that is not immediate, but say a couple of decades away from now. In such cases one may have to formulate appropriate strategies for two key phases: Phase –I: The Accumulation Phase (Pre-Retirement)… and Phase-II: The Distribution Phase - Managing the Corpus (Post Retirement)… (We will be explaining the complete Retirement Planning Process in detail in one of our upcoming blogs… Stay Connected…)

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