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3 retirement planning pitfalls

By Larissa Fernand
February 06, 2015 09:18 IST
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A few missteps could put a chink in the armour, as far as your retirement plan goes.

Here we pinpoint three common pitfalls

1. Not having a plan

Would you scoff if you were told that individuals spend more time planning vacations than they do their retirement? It is probably true.

Assuming that everything is going to work out just fine is not a plan, it is a wish. Investing in the Public Provident Fund, or PPF, and Employees Provident Fund, or EPF, and thinking that you are sorted is also not a plan.

You need to map out how much you will need for retirement, and then (instead of panicking) determine how much you will need to save every month, and an appropriate asset allocation strategy to get there. If you cannot get your mind around it, or don't know where to begin, it would be wise to sit down with a financial adviser who can provide guidance and some valuable insights.

There are numerous online tools, but remember, they are only as good as the assumptions you make. For instance, you may underestimate your expenses during retirement, or overestimate the potential return on your investment. You would also need to budget for higher medical costs. Incorrect assumptions could end up decimating your entire plan.

2. Underestimating life expectancy

Seriously, no one is really good at this. Estimating how long you are going to live is one of the thorniest issues in retirement planning. A grave error is underestimating how long you are going to live, which brings with it the reality of outliving your money -- a fairly ghastly thought.

Think about it. You eat right, exercise regularly and conduct your regular health check-ups because you want to live longer and live healthy. While you should be commended for it, it could also be tricky if your planning does not take into account an adequate stream of income for these added years.

Statistics released by India's Union Ministry of Health and Family Welfare last year show that life expectancy in India has gone up by five years, from 62.3 years for males and 63.9 years for females in 2001-2005 to 67.3 years and 69.6 years respectively in 2011-2015. Before you start your calculations, take note of the term 'average'. There is a significant life expectancy gap between the affluent and deprived communities.

If you are in reasonably good health, have access to good medical facilities, and not suffering from chronic or acute diseases, you could live well into your eighth decade, way higher than the average.

According to certain studies, by 2050, the number of Indians above the age of 65 will cross 200 million from about 80 million currently, while the number of Indians above 80 years of age will be at 43 million, second only to China.

Look at your family history. How long did your parents live? Be rational. You also may need to re-evaluate any decision to leave the workforce completely.

Err on the side of caution. Plan for chances of survival for a decade or so post retirement.

3. Investing too little in stocks

When planning for your retirement, you could be taking too much investment risk, though not for the reason you might think.

Investors can fall short of their financial goals for many reasons -- key among them is under saving. But if you're saving for a long-term goal, holding too much in investments with little to no short-term volatility -- but commensurately low returns—will contribute to the shortfall risk.

If you are avoiding equity on the premise that it is more volatile and hence more risky, you are not seeing the whole board, to borrow an analogy from chess. We tackled this issue in Retirement Planning: Risk, not volatility, is your enemy. Don't shy away from maintaining an equity exposure in your portfolio. If you choose to do so, you could be jeopardising your entire financial plan.

No one is suggesting you go out and randomly invest in stocks. If you do not have the expertise to buy into equity, consider equity funds which are consistent and invest in them systematically. For instance, the 10-year annualised return of the large-cap category of mutual funds is almost 17 per cent. Not only is this much higher than what you would get in a fixed return instrument, it also has no tax implications in the sense of long-term capital gains being nil in equity mutual funds.

Neither are we suggesting that your entire portfolio be tilted towards equity -- there are various considerations that will go into such a decision, namely your age, the number of years you have left before you throw in the towel, various sources of income, and your risk capacity. Have a sensible asset allocation fine-tuned to your circumstances.

Illustration: Uttam Ghosh/Rediff.com

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Larissa Fernand