Remember when Lijjat Papad was started with a seed capital of ₹80 in 1959? Now, you can only buy a packet of papad with this amount. The idea behind quoting this example is to underscore the depreciating effect of inflation on the value of money. The value of money is decreasing, which means that you must now pay more toward your living costs. The money you save for tomorrow may not be enough if you do not account for the impact of inflation.
Even if we were to keep all our money in bank deposits to earn, say 6 per cent on it, the ongoing inflation rate of roughly 8 per cent will result in a negative real rate of return.
Real Rate of Return
To understand how inflation raises the cost of our living while decreasing the value of our money, let us understand this with an example taken from our daily lives. Suppose you need ₹2,40,000 every year to meet your essential expenses. An inflation rate of 8% means
Current cost of living: ₹2,40,000
Inflation rate: 8%
Number of years: 30 years
Future cost of living: ₹24,15,038
This means that after 30 years, you will need ₹24,15,038 to meet your yearly expenses. This translates to an expenditure of ₹2,01,253 every month. Not accounting for inflation will ruin your planning for retirement too. This explains why you must worry about inflation while planning your retirement corpus.
Though a lot depends on how much you earn and spend on your daily living expenses, let us assume that you manage to invest ₹20,000 systematically every month in mutual funds. For the sake of posterity, let us assume mutual fund returns at 12 per cent. Assuming that you continue to invest non-stop for 30 years,
Invested amount: ₹72,00,000
Estimated rate of returns: 12%
Total value: ₹7,05,98,275
However, is this money enough to look after you and your family post-retirement? This is a pertinent question considering how many people lose access to regular income after they retire. Also, the fact that you had failed to account for inflation impedes your financial planning and ability to reach your goals.
Know that inflation affects every aspect of your life, which means that the money you spend on travel today would not be enough to meet your travel expenses tomorrow. Your health would suffer if you do not have adequate health coverage. Irrespective of the amount of health insurance coverage you may have sought, you will be required to shell out some amount as every insurance company refuses to pay in full.
Let us assume that you set aside ₹8,000 every month as a provision for travel and healthcare annual expenditures. The costs of travel and health expenditure would also be affected due to inflation, say 8%. The monthly cost of travel and healthcare at the time of retirement would be somewhere around ₹80,501. You may safely assume that the annual budget you must set aside for travel and healthcare would amount to ₹2,495,539. Historical data suggest inflation is a fact and a permanent factor that we dare not ignore.
Medical advancements mean that people now live longer. If you assume life expectancy post-retirement at 30 years, this means that you must save and invest enough to retain your current lifestyle till you turn 90 years old.
Considering all your current income, savings, inflation rate and daily expenses, you will require ₹305,318,885 corpus at the time of retirement. Accumulating such a huge amount may be difficult, though not entirely impossible. It is obvious that post-retirement you would want your savings to remain idle. Suppose you re-invest your accumulated corpus in fixed-income plans like bank deposits or target maturity mutual funds or liquid or overnight funds. Assuming that you earn 6% on your savings post-retirement, you will then need a corpus of ₹101,340,264.
Accumulating this corpus would not be difficult if you realize how stepping up your investments every year regularly can help you achieve your financial goals.
Instead of investing a fixed amount of ₹20,000 in mutual funds every year, consider stepping up your investments by 6% every year. This means
Monthly investment: ₹20,000
Annual step up: 6%
Expected return rate: 12%
Investment tenure: 30 years
Will result in
Invested amount: ₹1,89,73,965
Estimated returns: ₹9,00,26,884
Total value of the returns: ₹10,90,00849
This is the corpus amount that you will have at the time of your retirement.
We have already assumed in your previous calculations about the estimated annual expenses at ₹24,15,038. Assuming that you invest ₹1,00,00,000 in a fixed-income plan earning 6% every year out of the total corpus accumulated, you will earn ₹1,06,13,636 every year. This is more than the annual budget you had set aside to meet your expenses every year.
You can re-invest the remaining amount in long-term bonds, government-sponsored schemes and mutual funds depending on your risk appetite. Some mutual fund houses allow scope for systematic withdrawal plans (SWPs), which means that you continue to earn on your investments while withdrawing a fixed percentage of your investments every month or year depending on the frequency of withdrawals you opt for.