The document provides guidance on financial planning for retirement. It discusses estimating longevity and inflation, investing for retirement, asset allocation strategies, withdrawal rates, and taxation considerations. The key points are: estimating longevity is essential for planning; a balanced portfolio with 40-65% in equities can maximize returns while minimizing risk; withdrawal rates of 5-7% of the initial portfolio value are typically sustainable; and diversifying investments across asset classes and rebalancing periodically reduces risk.

1. BY RANJAN VARMA HTTP://RANJANVARMA.COM Financial Planning for Retirement

2. Why the necessity ? Management of retirement funds is one of the most difficult/complex jobs today Correct estimation of longevity required Correct estimation of inflation required Correct estimation of future expenses Provision for mediclaim/life insurance correct estimation of future taxes Spending too much on retirement Correct retirement plan & strategy

3. Contd. Estimating longevity is an essential part of planning for retirement. An underestimation will cause people to save too little, retire too early and spend too much. If you don’t have a realistic estimate of personal longevity, how can you know whether you have the right retirement plan ? Contrary to your working years, when you work for money to sustain your lifestyle, during retirement, money must work for you. For retirees, the principal, needs to be an income producing cash cow.

4. Contd. Some people think that they need to ride the fastest horse in the race in order to win, and often they wind up losing at a time when they can least afford it. The best strategy is to maximize your greatest possibility of winning, right from the start. That approach is not the same as trying to win the most. Poor investors seek the highest possible returns, while the great investors seek the highest probability of good returns.

5. Contd. If you want to leave a portion to your children or to charity, and be sure you do not outlive your income, then you need to have a reasonable money-management strategy in place. Our goals should be shaped not only by our wants (which must take second place to our needs), but also by an honest assessment of the marketplace. For most retirees, at least 40 % in equities for growth is essential, some say even more is needed. Buying equities does not mean speculative trading in stocks. That is gambling and not ownership. The stock ownership portion should be placed into a well-balanced , professionally managed portfolio.

6. Longevity Mortality Table Male Life Expectancy 50 percent IAM LIC will live past 55 24.8 yrs 25.2 79.8 yrs 60 20.6 yrs 21.2 80.6 yrs Female 55 30.2 yrs - 85.2 yrs 60 25.7 yrs - 85.7 yrs Source:1983 Individual Annuitant Mortality Table; Mortality Rates of Annuitants in LIC A (96 – 98) Ultimate

7. Inflation Decade Avg. Decadal Growth 1950s 2.1 % 1960s 6.0 % 1970s 7.5 % 1980s 9.1 % 1990s 9.5 % 2000s 4.0 % 2005 5.5 % 2006 7.0 % 2007 6.5 %

8. Rate of Interest Year Bank Rate(%) 1996 13.00 1997 11.50 1998 11.00 1999 10.50 2000 10.00 2001 9.50 2002 6.50 2003 6.00 2004 6.00 2005 6.00 2006 8.00 2007 8.75

9. Growth in CPI Year CAGR (%) Overall 2/86 – 2/91 7.55 7.55 2/91 – 2/96 10.09 8.70 2/96 – 2/01 7.03 8.18 2/01 – 2/06 4.20 7.21 2/06 – 2/07 6.78 2/07 – 2/08 5.52 7.12

10. Future Expenses ? Let us assume that total monthly expenses today are : 15,000, i.e. 1,80,000 p.a. Further, let us assume that the annual rate of inflation is 7 %. Then, after 25 years, the annual expenses are likely to be 9.8 lacs, i.e 81,000 p.m. The total expenses of 25 years will be an astonishing 1.24 Crores. The problem is , how to provide for this, now.

11. List of Probable Expenses FOOD MEDICINES CLOTHING MAINTAINANCE TAXES MEDICLAIM INSURANCE SERVICES COMMUTING TRAVEL CHARITY/GIFTS ENTERTAINMENT HOBBIES CONTINGENCIES TOTAL MONTHLY EXPENSES TOTAL ANNUAL EXPENSES

12. Why this list ? Golden Rules If you don’t know how much you need to live on, the money you make is never enough. If you think good health is everything, then health insurance is next to every thing. The day when you need insurance is the day it is too late to buy it. Most retirees must have both a spending discipline and an investment discipline. Retirees generally need between 70 – 80 % of their last drawn “net salary” as monthly expenses. Wealth is not defined by the number of things you have but by the largest number of things you can do without.

13. Mediclaim Premium Company Premium/ 3 lacs Name Age 60 yrs Chola Genl. Ins 8045/- Royal Sundaram No Cover New India Assurance 7862/-

14. How much to spend ? This is a tricky question because we must know the following : What is the rate of inflation (w) ? what is the rate of return on the principal (x) ? What is the rate of taxes to be paid (y) ? What is the amount (%) that can be safely withdrawn so that the principal never goes down (z) ? Hence, under any circumstances, z < (x – y – w)

15. Contd. For example, let Rate of inflation = 7.0 % Rate of Taxes = 0 Rate of withdrawal = 5.0 % Then, rate of return, has to be equal to or more than, 7.0 + 0 + 5.0 = 12.0 % This means that you have to find an avenue that gives you a minimum return of 12.0 %.

16. Contd. Pension = 10000 x 12 = 1,20,000 Interest on 20lacs FD ( @ 9.50 % for Sr.Cz) = 1,90,000 Less - Income Tax = 8,755 Reserve for inflation @7.0% = 1,40,000 Total = 1,61,245 Average/month = 13,437 This is the amount within which you have to manage all your expenses.

17. The Other Option Pension 10000 x 12 = 1,20,000 Withdrawal of 5 % Principal 20 lacs (Equity/Mutual Fds) = 1,00,000 Income Tax (After Sec 80D) = NIL Balance Fund Available = 2,20,000 Average/month = 18,333 In this way you can increase your monthly Income by Rs.4896/-per month.

18. A Return of 12 % Possible ? Annual returns will most likely be, on an average, what the returns have been for the last 50 years – about 13 % for the S & P 500 – even then we cannot count on the ambiguity of returns when managing retirement money. Some think, a better bet may be the combination of large stocks and bonds, but that combination also did about 13 %. Regulating how much you draw can be accomplished by setting some minimum withdrawal rate to meet your needs. You can withdraw further amounts every couple of years, after seeing what the market delivers. Such an approach will make your retirement account a good servant and not your poor master .

19. 1999 2000 2001 2002 2004 2005 2006 Sensex 63.6 -26.1 -17.5 3.9 72.2 10.98 46.7 Debt Fund 12.97 10.19 15.8 14.72 7.54 0.9 5.28 Gold 0.9 -3.33 1.36 23.25 21.93 5.49 35

20. Will your Portfolio Survive ? Using actual historical data from 1926 to 1992 it was found that an appropriate asset allocation for a retiree’s portfolio must include no less than 50 %(and up to 75 %) in stocks. A Harvard University study concludes that if one took a payout of 5 % of the account each year, there would be a 95 % chance of having the principal grow to outpace inflation.

21. Contd. Trinity University conducted a study examining and comparing the outcomes of different withdrawal rates from hypothetical portfolios made up of stocks and bonds, in which the percent invested in stocks and bonds changed, but the percentages added together always equaled 100 %. The study found that at a 6 % withdrawal rate an investment mix of stocks and bonds outperformed both an all-stock and an all-bond portfolio. And at a 7 % withdrawal rate , a 50/50 mix of stocks and bonds outlasted portfolios with higher stock allocations for 20 and 30 year payout periods.

22. Creating a Financial Planning Review The first step, before making investments, would be to enter into a process that includes a comprehensive financial plan or review : Organize a personal balance sheet that shows what you have done to this point List your investments that support (or do not support ) your investment goals Examine your tax liabilities and suggest ways of controlling or reducing them Review your cash flow (sources of income and cash needs) and how they change Make calculations regarding the surviving spouse’s income goals Review your risk exposure, especially your medical and long term care coverage

23. Target Asset Mix Asset Class Minimum Weight Target Weight Maximum Weight Equities 45 % 50 % 65 % Fixed Income 30 % 45 % 60 % Cash and Equivalents 0 % 5 % 15 %

24. Probable Portfolio One’s goal to maintain the following overall portfolio balance may be : 35 % large cap funds included in the S & P CNX Nifty/BSE Sensex 10 % mid - cap funds measured by the CNX Nifty/BSE mid – cap index 5 % small – cap funds through the top mutual fund houses 25 % in purely debt mutual funds 10 % in real estate mutual fund 10 % in gold ETF 5 % money market mutual funds

25. HOW TO CUT YOUR RISKS There are a few steps which must be scrupulously followed to cut down risks while investing in the capital market – 1.Invest through the mutual fund route 2.Opt for the long term 3.Diversify through different asset classes 4.Use the Systematic Investment Plan

26. Taxation Issues Under Section 2(42A), a unit of a mutual fund is treated as short – term capital asset if the same is held for less than 12 months. The units held for more than twelve months are treated as long term capital gains. Thus, long – term capital gains on equity oriented funds [>65 % in equity (AY 06/07)] is exempt from tax from AY 05-06. Short – term capital gains on equity – oriented funds is taxed @ 10 % + cess Long – term capital gains on debt – oriented funds are taxed @ 10 % flat or 20 % with indexation benefit, whichever is less. Short – term capital gains on debt – oriented funds are taxed at the tax bracket applicable.

27. contd Dividends declared by debt or equity oriented mutual funds are tax free in the hands of the investor, as dividend distribution tax of 12.5 % including surcharge is paid by the mutual fund. Interest income on fixed deposits and bonds is taxable under the head “income from other sources”. The entire income received is taxable from FY 05-06.

28. Break up of Portfolio Type of Fund No. 1)Diversified 3-4 large caps Equity Fund 5 - 7 2-3 mid caps 2) Tax Saving Fund 1- 2 1 large cap 1 mid cap 3) Debt Fund 2

29. NFO’S OR OLD FUNDS ? New Fund Offers are invariably at Rs.10/- whereas old funds are invariably priced many times higher. So the dilemma is whether to buy the NFO or the old fund? If the fund manager and house are same, it makes absolutely no difference!! If the fund manager or house are different, then always go for the old fund, as there is a track record to guide you.

30. DO NOT UNDERESTIMATE THE POWER OF COMPOUNDING 10 lacs invested for 20 yrs 10 yrs 7yrs @ 12% @ 36% @60% 96,46,293 2,16,46,570 2,68,43,546

31. Questions? Contact Ranjan Varma @ http://ranjanvarma.com