There was a time when a salaried individual could leave his financial and retirement planning to their organisation’s finance department and forget about it. The government and the public sector were the biggest employers and these jobs came with either a post-retirement pension or a safety net in the form of employee provident fund (EPF).
The organisation would deduct a quarter of an employee’s basic salary and deposit it every month in EPF, which over the life-time, would create a large enough corpus for a salaried person to retire comfortably and gracefully. The EPF system was also followed by most companies in the private sector, reducing the need for a middle class Indian to plan for his or her retirement.
But those days are now behind us. Such jobs are fast disappearing from the Indian economy.
Employees also don’t complain initially as lower EPF contribution translates into higher in-hand salary.
The mood, however, begins to sour as one hits the age of 40 and youthfulness gives way to the worries and responsibilities of the middle age. Then suddenly many professionals realise that their EPF contribution may not be enough to provide financial security in old age and it may be inadequate to fund big ticket expenses such as weddings or child’s higher education.
This creates retirement anxiety among private sector professionals in their early to mid-40s.
The process of financial planning for retirement may seem overwhelming for many especially if you don’t know much about insurance, mutual funds or financial markets. But it’s a simple and straightforward process if you cut out the noise and stick to basics.
1. Start by savings 20-25 percent of your take-home salary or income in hand. If the amount is on the higher side then start with saving 10 percent of your income and then increase the ratio over the next 2-3 years by reducing or optimising your cash expenses. Put the savings in instruments that make it little tough but not impossible to spend the money on impromptu purchases.
You will be able to create a corpus only if you save religiously for at least 15-years or more.
2. Max out your income tax savings by investing in EPF, PPF and NPS. Employee and public Provident fund and New Pension Schemes (NPS) remains the best way to save income tax and also save for the long-term. You can save tax up to Rs 1.5 lakh per annum through EPF and PPF and additional Rs 50,000 through NPS. If your annual contribution is less than this amount, ask your organisation to raise your contribution to the Rs 1.5 lakh per annum and top it up by opening an NPS account.
Also Read: Tax planning: 6 ways to save tax this year
3. Protect your earnings through insurance. Once you have decided to set aside a fixed sum every month for savings, use a small part of it – not more than 10 percent – to buy life insurance. Start by buying a plain vanilla term insurance that gives maximum life cover for any premium.
Returns on these plans hardly exceed interest on long-term bank fixed deposits and they offer low life cover. You can invest in an endowment or whole-life annuity plan closer to the age of retirement when capital protection is more important than returns on investment.
4. Invest in a low-cost index equity mutual fund. There are basically two types of equity mutual funds – actively managed diversified equity funds and passive index funds. In actively managed funds, the fund manager invests the money in a basket of stocks that he or she believes will perform better than the market in the future. Most equity mutual funds in India are actively managed but stock selection is a laborious and expensive exercise. Active funds recover this cost by levying management fees (or expense ratio) that could be as high as 2.5 percent of the fund’s asset under management. The fee eats into the long-term returns of investors.
In contrast, passive index funds invest in a traded equity index such as BSE Sensex or NSE Nifty 50 and change the portfolio in line with the changes in the index composition.
For example, HDFC Index Fund –Sensex Plan has an expense ratio of just 0.3 percent.
In the last 5 years, the fund has given annualised returns of 15.4 percent – at par with top performing actively managed mutual funds. But due to lower expense ratio, investors will make more money in index funds compared to actively managed funds.
5. Invest in balanced or hybrid funds to gain from market cycles. Putting all your money in equity funds is risky; so diversify your portfolio by investing in balanced or hybrid funds that invest in both equity as well as the bond market. Some even invest in gold. In good times these funds give lower returns than pure equity funds but these funds outperform when markets turn choppy. But remember never to go for a single top performing fund.
Begin with these five-steps and the experience and the corpus will create new ideas and opportunities in future.
Happy savings & investment!
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist)