Finance and Accounting

The Retirement Conundrum: preparing for the grey days

The date was 16 November 2013, when Sachin Tendulkar, one of the greatest cricketing icons of our times wielded the willow for the last time on international stage. Retirement, nevertheless, is a fact of life for all athletes, as much as for each one of us.

Do we have enough retirement contingency fund to sustain a certain lifestyle? Are we equipped enough to meet all our social, medical, and family costs? These questions and more haunt all of us alike. In the first of a series of articles intended to answer these pressing questions, we attempt to unwrap the complexities of planning for retirement.

Let’s first understand how governments think for us when it comes to deciding when to retire.

The national retirement age is usually designed basis multiple factors, including demography, fiscal cost of ageing, health, life expectancy, supply of labour force, among others. The age of retirement is also dependent on the profession of an individual. The average retirement age for athletes, for instance, is around 33 years. Sachin Tendulkar was 39 years old when he announced his retirement. For professionals or salaried people, the retirement age is usually at a later stage.

As more economies are in flux and with higher life expectancies, the average age of retirement is getting longer, as many continue to work even after the planned retirement age to dole up sufficient funds. The effective retirement age in the countries part of the Organization for Economic Co-operation and Development (OECD) declined substantially since 1970, but has started to rise in the last few years. Apart from Japan and Korea, with the average age of retirement at 70 years, the effective world average stands between 58-65 years.

Retirement systems across the world

The Melbourne Mercer Global Pension Index conducts an annual ranking of retirement systems across the world and the index is built using three sub-indices – adequacy, sustainability, and integrity – to measure each retirement income system, against more than 40 indicators. Most Scandinavian economies such as Denmark, Norway, Sweden, and Finland, along with the Netherlands rank very high on the index due to provisioning of adequate state benefits and transparency, while large Asian economies like China, India, and Japan are at the lower end of the scale.

In the UK, workers can continue to work post State Pension age and are eligible to receive extra pension funds as lump sum payment, provided they defer the claim to a later date. In Singapore, the statutory minimum retirement age is currently set at 62 years, but the government maintains a re-employment program, which is intended to provide senior citizens with employment opportunities. It implements a comprehensive social security savings plan called The Central Provident Fund (CFP), which includes savings for specific expenditures such as investment, education, home purchase; investments in retirement-related financial products; hospitalization costs and approved medical insurance and a Retirement Account created when an employee turns 55 years old.

In Australia, the social security program is called Age Pension, which entitles anyone residing in the country for over 10 years and above the age of 66 years, to state benefits. It has a mandatory retirement saving system for its citizens, which requires them to put away 9.5% of their salaries every year into a private/public 401(k) called a superannuation account and this is expected to go up to 12% between 2021 and 2025.

In India, the two most popular retirement savings programs are the National pension Scheme (NPS) and the Employee Provident Fund (EPF). The NPS went into effect from January 2004 for Central/State government services. It has now been extended as a voluntary contribution scheme to all citizens. Under the EPF scheme, employees contribute 12% of basic wages plus dearness allowance from salary, and the employer matches the contribution. A part of the contribution is also diverted to the Employees' Pension Scheme (EPS) account.

Retirement experts in the US generally opine that one’s retirement income should be about 80% of an individual’s final pre-retirement salary. In the same vein, the US urges working professionals to invest in retirement plans – aka Defined Contribution 401(k) plans, which is the primary source of retirement funds.

Where can I invest?

The government-led schemes in each of the countries elaborated above are designed to encourage people to save a part of the earned wealth for the grey days. Unfortunately, that is not the case for most people, as lack of savings, bad investments, often lead individuals to be dependent on government benefits. After all, social security is only supplemental to the investments done during one’s prime working years, to sustain a comfortable retired life.

This is why prudent investing is of prime importance and it is equally important to know the right financial instruments to invest in. Investment options are broadly categorized into four main asset classes – equities, debt instruments, cash, and alternative instruments.

Building investments and thus a satisfactory contingency fund for retirement is a strategic and a gradual process. The lure of high returns on low risk is a non-existent concept in all practicality. Investments in cash, for instance, can help in rent or mortgage payments, food, clothes, and maybe some funds for splurging on vacations or other excursions to enjoy the retirement. But money market instruments generally have low yields. Similarly, debt instruments are safe but again have low yields on maturity. On the other hand, investments in equities are a lot riskier, but have been known to give high returns.

Although, a low-risk option also exists in equities. Investing in blue chip stocks across industries, for instance, will have a slow and steady growth rate that offers consistent dividends. For a dynamic approach, one may heed the advice of the experts, who opine that the percentage of stocks in an investment portfolio should equal to 100 minus your age. Even so, the decision rests on personal circumstances and risk appetite of the one investing. One must plan ahead for retirement by several years with a strategy that suits them the best.

For instance, there are a few alternative instruments to invest in that have longer gestation period before they bear benefits. These asset instruments include private equity or venture capital, hedge funds, managed futures, real estate, art and antiques, commodities, and derivatives contracts. These financial assets do not fall into any of the conventional equity/income/cash categories, and are usually the playground of uber wealthy. If the rate of wealth generation of an individual is not at par with the targeted net worth individuals of these instruments, the investment might just fall flat or even incur losses. These investments are generally illiquid, complex, come with some risk and are not as regulated as other investment classes. They usually come with high initial minimums and upfront investment fees. Though these asset classes are a good tool for portfolio diversification due to its low correlation with market movements, extensive due diligence needs to be done before investing in them.

We will understand more about these complexities of preparing for the retirement in the next few articles of the Retirement Conundrum series. Till then, we all must bear in mind that the nest egg we put away today through careful and prudent financial planning, will directly determine the quality of our retired life. Starting early is the key to reap the benefits of compounding investments. Try it, you will be pleasantly surprised.

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