A reader asks, “Sir, What return should I use while planning for retirement? I wish to retire by age 55. I am currently 35 years of age”.
Many people make two mistakes while planning their finances. The first common mistake is presuming that equity mutual funds provide a 12% (or more!) return and utilizing that figure to calculate the necessary investment amount. Regrettably, this approach entirely disregards asset allocation and the reality that investing 100% in equity is not feasible.
Even those considering asset allocation assume that the same weightage of equity and fixed income will persist until the need arises. We must appreciate that the asset allocation will not remain fixed in time. For example, the 30Y old can start investing 60% in equity and 40% in fixed income.
This ratio should not remain the same until he hits 55. That would be like leaving the fate of his hard-earned money in the hands of luck. In order to combat unknown market returns (aka sequence of returns risk), the equity allocation must be continuously tapered throughout the investment journey.
Also, return expectations vary with inflation. In the early 2000s, assuming a 15% equity return for “long term goals” seemed reasonable. Today 12% seems high! See: Ten-year Nifty SIP returns have reduced by almost 50%.
Considering taxation and lower inflation estimates in the long term, we suggest estimating 9-10% post-tax returns for equity investments. This recommendation often surprises individuals, leading them to question the rationale behind investing in equity if the returns are only 9-10%.
The answer is that fixed-income returns are also proportionately decreasing and will continue to fall over the long term, even though some spikes are due to inflation (and elections!).
So we recommend using not more than 7% from fixed income (even if tax-free!) and 5-6% if the product is taxed. The change in the debt fund tax rule from 1st April 2023 is a further blow, and we have proportionately lowered our expectations.
So for a 60% equity and 40% fixed income mix, the expected portfolio return (approximately) is (60% x 10%) + (40% x 6%) ~ 8.5% (approx). This is only the initial asset allocation and return expectation.
The freefincal robo advisory tool auto-generates the recommended asset allocation values at different stages of the investment journey. The user can change all assumptions (returns, inflation etc.). This is a freefincal robo advisory tool screenshot showing the suggested asset allocation (left image) and change in assumed portfolio return for a 35Y old wishing to retire at 55.
The equity allocation starts at 60% but starts decreasing gradually to 22% from the early 40s. This ensures the corpus is unaffected by a prolonged stretch of poor returns. This model has been extensively backtested to handle a wide variety of market fluctuations. See, for example: Why Understanding Sequence Risk is Crucial for Investing Success! And this video.
This also means that the returns from the entire portfolio change. This must be factored into the investment amount needed from day one (which the robo tool does).
A full retirement planning illustration with post-retirement inflation-protected income generation via a five-bucket strategy is available here: I am 30 and wish to retire by 50; how should I plan my investments?
In conclusion, an investor should never rely on a single return value for any asset class or the entire portfolio throughout the investment period. The asset allocation and its fluctuations will influence the variation in returns. Maintaining modest return expectations from equity and fixed-income investments is advisable. And these expectations must be revised from time to time as per changes in tax rules and economic conditions.
Do share this article with your friends using the buttons below.
🔥Enjoy massive discounts on our courses, robo-advisory tool and exclusive investor circle! 🔥& join our community of 5000+ users!
Use our Robo-advisory Tool for a start-to-finish financial plan! ⇐ More than 1000 investors and advisors use this!
New Tool! => Track your mutual funds and stocks investments with this Google Sheet!
Podcast: Let’s Get RICH With PATTU! Every single Indian CAN grow their wealth!
- Do you have a comment about the above article? Reach out to us on Twitter: @freefincal or @pattufreefincal
- Have a question? Subscribe to our newsletter with the form below.
- Hit ‘reply’ to any email from us! We do not offer personalized investment advice. We can write a detailed article without mentioning your name if you have a generic question.
Get free money management solutions delivered to your mailbox! Subscribe to get posts via email!
Explore the site! Search among our 2000+ articles for information and insight!
About The Author
Dr M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over ten years of experience publishing news analysis, research and financial product development. Connect with him via Twitter or Linkedin, or YouTube. Pattabiraman has co-authored three print books: (1) You can be rich too with goal-based investing (CNBC TV18) for DIY investors. (2) Gamechanger for young earners. (3) Chinchu Gets a Superpower! for kids. He has also written seven other free e-books on various money management topics. He is a patron and co-founder of “Fee-only India,” an organisation promoting unbiased, commission-free investment advice.
Our flagship course! Learn to manage your portfolio like a pro to achieve your goals regardless of market conditions! ⇐ More than 3000 investors and advisors are part of our exclusive community! Get clarity on how to plan for your goals and achieve the necessary corpus no matter what the market condition is!! Watch the first lecture for free! One-time payment! No recurring fees! Life-long access to videos! Reduce fear, uncertainty and doubt while investing! Learn how to plan for your goals before and after retirement with confidence.
Our new course! Increase your income by getting people to pay for your skills! ⇐ More than 700 salaried employees, entrepreneurs and financial advisors are part of our exclusive community! Learn how to get people to pay for your skills! Whether you are a professional or small business owner who wants more clients via online visibility or a salaried person wanting a side income or passive income, we will show you how to achieve this by showcasing your skills and building a community that trusts you and pays you! (watch 1st lecture for free). One-time payment! No recurring fees! Life-long access to videos!
Our new book for kids: “Chinchu gets a superpower!” is now available!
Most investor problems can be traced to a lack of informed decision-making. We have all made bad decisions and money mistakes when we started earning and spent years undoing these mistakes. Why should our children go through the same pain? What is this book about? As parents, what would it be if we had to groom one ability in our children that is key not only to money management and investing but to any aspect of life? My answer: Sound Decision Making. So in this book, we meet Chinchu, who is about to turn 10. What he wants for his birthday and how his parents plan for it and teach him several key ideas of decision-making and money management is the narrative. What readers say!
Must-read book even for adults! This is something that every parent should teach their kids right from their young age. The importance of money management and decision making based on their wants and needs. Very nicely written in simple terms. – Arun.
Buy the book: Chinchu gets a superpower for your child!
How to profit from content writing: Our new ebook is for those interested in getting side income via content writing. It is available at a 50% discount for Rs. 500 only!
Want to check if the market is overvalued or undervalued? Use our market valuation tool (it will work with any index!), or you buy the new Tactical Buy/Sell timing tool!
We publish monthly mutual fund screeners and momentum, low volatility stock screeners.
About freefincal & its content policy. Freefincal is a News Media Organization dedicated to providing original analysis, reports, reviews and insights on mutual funds, stocks, investing, retirement and personal finance developments. We do so without conflict of interest and bias. Follow us on Google News. Freefincal serves more than three million readers a year (5 million page views) with articles based only on factual information and detailed analysis by its authors. All statements made will be verified with credible and knowledgeable sources before publication. Freefincal does not publish any paid articles, promotions, PR, satire or opinions without data. All opinions presented will only be inferences backed by verifiable, reproducible evidence/data. Contact information: letters {at} freefincal {dot} com (sponsored posts or paid collaborations will not be entertained)
Connect with us on social media
Our publications
You Can Be Rich Too with Goal-Based Investing
Published by CNBC TV18, this book is meant to help you ask the right questions and seek the correct answers, and since it comes with nine online calculators, you can also create custom solutions for your lifestyle! Get it now.
Gamechanger: Forget Startups, Join Corporate & Still Live the Rich Life You Want
This book is meant for young earners to get their basics right from day one! It will also help you travel to exotic places at a low cost! Get it or gift it to a young earner.
Your Ultimate Guide to Travel
This is an in-depth dive analysis into vacation planning, finding cheap flights, budget accommodation, what to do when travelling, and how travelling slowly is better financially and psychologically, with links to the web pages and hand-holding at every step. Get the pdf for Rs 300 (instant download)
