How to approach Investment & Retirement Planning,
- It starts with your monthly expense. Even in the monthly expense there is a minimum and a maximum. A minimum amount with which you can survive and there is no maximum.
How much you need to save & invest ?
- Take your assets size as 100% of investments, Calculate how many years you can survive based on withdrawal rate %.
(Asset size) / (withdrawal rate) = (years)
100 / 10 = 10
100 / 8 = 12.5
100 / 6 = 16.667
100 / 4 = 25
100 / 3 = 33.333
Whats the end to investment ?
- We never know our expire date. Say 80 is the average life. If you plan retirement at 50. At 3% withdrawal rate you can survive till 83 without depending on your kids.
What’s inflation why that matters ?
- We all have a salary. And salary is the limit on what we can spend.
- Compare that to a government. Its salary is the tax being collected. And for a developing country like us. We always have to spend more than we collect. Bridges, Roads and Transport that we use cannot wait.
- Where is the extra cash that the government is spending come from ? Government can get money easily by selling a paper called Sovereign bonds Or Sell its stake in public companies.
- And since government does that. Your monthly expense grows by some percentage each year which is what is called as inflation.
- your expense grows at the same time if you keep in your bank account. It looses it value year on year.
How much returns one needs to tackle inflation ?
- Remember how I started with. 100% of what you saved and divided by your withdrawal rate. We dint take inflation into the account.
- Where is your return coming from ? Nominal India GDP grows at ~7% each year. If your returns is more than that, you investments are growing more than India average .
- I assume that where you invest, The returns should ultimately take care of the inflation.
- At worst case your investments returns should equal inflation.
- you will never run out of cash if your Returns % = Inflation % + Withdrawal rate %
Where to invest ?
- Government can get unlimited supply of cash by selling bonds and stakes. It cannot get unlimited gold or land.
- So Gold and Land alone sufficient ? We cannot eat gold or land. There are numerous things that we need vegetables from farmers, Gas to cook, Office to work, A government that takes care outside your home. All the process in this economy has a value. Each value chain has a value, margin associated. That is why we need equities.
- Equities in theory should be immune to inflation. Why ? Assume a biscuit company making biscuits. It always sells a fixed number of packets each year. To adjust the inflation it can increase the price of the biscuit packet. Only Drawback with choosing a company directly is, we need to choose a company which does not loose market share and has capability to shift the inflation to customers. This is difficult and that’s why we have diversified buckets such as active mutual funds and inactive index funds.
- For someone with a huge asset size. Even equities are optional. So it all depends on how much you have!
Why Emergency Funds in Liquid/ FD ?
- Equities does not give fixed returns like FD or liquid fund. Market Oscillates, equities returns are not constant. So to handle this volatility. People use to have 1Y to 5Y expense in debt funds. So that during those difficult time they are not forced to sell their equities.
Hope this helps someone starting out. Keep learning.
So the goal should be start with say for a 100% withdrawal rate. Work towards bringing the withdrawal rate to 3%. 3% is a good withdrawal rate. 3% with majority on diversified equities should be able immune you from inflation.
* Experts do correct if anything is wrong here.