Case Study – SIP is not the only way to save towards Retirement

sip - systematic investment plan

I am not sure if I can achieve my retirement goals. I need at least Rs 40 thousand per month during my retirement years and its been around 10 years of me working and I have not yet started with any SIP. Mukesh approached me with this confusion.

But how can you say the SIP will be able to help you achieve your goals? What do you know about Systematic Investment Plan? I asked Mukesh, to have the clarity on what exactly is the issue.

Well, this is what I have been hearing on different channels. Mukesh Replied.

Channels as in? I enquired.

TV, My friends, Bankers, Newspapers etc. Everywhere it is coming that SIP is the best way to save and only SIP be able to beat the inflation, and I believe you also are going to advise me the same.

Well Mukesh, that I am not sure. My advice will totally be based on what is actually required and what could be the best way to achieve your goals. SIP in mutual funds is one of the ways you can do investments, but whether you should go with it or not that needs to be seen.

Since equity is a volatile asset class so we need to see if that risk is required to be added in your profile or not.

Does that mean SIPs are not a good way of saving? He looked at me with doubt.

I did not say that. I just said that we need to see, if that suits you or not. Since you come up with a single goal of Retirement, so we first look at the mathematics of your Retirement and then will see, how and if at all we need to Fit in Systematic Investment Plan somewhere or not.

Ok. Let’s do it.

Mukesh shared his basic financials with me, as below

Details Amount Annual Increase*
Current Age 40
Retirement Age 60
Life Expectancy* 85
Net Income 1244000 p.a. 10%
Expenses 459000 p.a. 7%
Retirement Goal 40000 p.m.
Current Savings:
EPF 1800000 (Saving 150000 per year) Savings by 10%; EPF rate-8%
PPF 1000000 (Saving Rs 150000 per year) PPF Rate- 8%
Gratuity*(On Retirement) 2000000

*Expected/Assumed

Mukesh, after seeing your financials I must say you are doing well in all segments. You have a good income, fewer expenses, good savings current and regular.

All do not have such structure at the place and many are struggling with the cash flows only, leave aside making Investments and with this struggle, they tend to make many mistakes under the lure of making high returns in short span of time.

With all the above data, the Retirement Corpus that you (Mukesh) need to accumulate in the next 20 years, to manage your future retirement expenses would be around Rs 4.13 crores. All this is assuming that your investments keep earning 8% Post-tax return every year even after retirement and inflation remains @7%

Calculating the Future values of EPF and PPF, considering all the assumption of growth rates and expected increase in salary the total savings would be Rs 3.59 Cr. Some Portion will be taken care of by the gratuity, And the balance of Rs 33 lakh can be accumulated if you start saving Rs 7300 p.m. in a product which generates 6% post-tax return. Now, this can be easily saved looking at the cash flow surplus you generate.

Does this mean I do not need to start with any SIP? Correct? Mukesh jumped out of his seat in excitement.

Wait Mukesh, let me Finish.

All the calculations that you have seen above, are based on some assumptions like your income stability with growth at a fixed rate, EPF and PPF growth rates, expected gratuity provided you keep working till that time etc. But in Reality, you cannot predict the future and these growth rates may vary in coming years.

See, you are targeting Retirement goal @ Rs 40000, considering your current expenses minus your children expenses.

Now in my view this is not correct as you have not accounted for the vacations/family outings, your future medical costs, Your Insurance outgo, the other expenses in the form of gifts on ceremonies etc. for all this you need to keep abreast with your expenses, so you may get close to your actual requirement.

So, what’s the point? Mukesh asked curiously.

For now, you are exposed to only one asset class in terms of your savings i.e. Debt, or a fixed income segment. And the best part is that you are seemingly achieving your Retirement goal in the arrangement.

But as I said the future rates are nothing but assumptions, so it would not be wise to stay dependent on the said arrangement and you should also start investing in Equity through Mutual funds and SIP which you were looking for is no doubt the best way to invest in the same.

This way you would make the best use of the surplus you generate and I believe this will fill up the gap of your wrong calculation of Expected retirement income.

Hmm…but does SIP guarantees the return? And how much shall we expect from it? Mukesh went bit defensive here.

Well, SIP does not guarantee anything. Moreover, SIP or as known as Systematic Investment Plan is not a product in itself. It is just a way to Invest in Mutual funds which further have diversified portfolio in different sectors. And since this would be an investment into Equity which you may also call as into various businesses that are being traded in the stock market, so Volatility is the basic feature of it.

Considering all this what I can say is that You should not expect any return in the short term (If you get, consider it as Bonus) and also be prepared to see your portfolio into losses (Notional Losses), but in long term you will in all probability see your portfolio giving better return than your traditional investments like PPF or EPF.

In the nutshell, what I can say is that SIP is not the only thing that will achieve your goal, but this should not be ignored too. Equity has given brilliant returns in the past but with volatility. So, you need to balance it out. Debt you already have, now let’s go for equity.

And one thing more. Since you are looking at your finances from one goal perspective, and I am sure you must be having other goals too, which could be Children future, some asset purchase, vacation, and many others.

If you want to have a detailed understanding on your financial structure and know if you should or not go with a SIP and how much would be ideal amount to save, then, you have to look at your finances holistically and not in bits and pieces. (Read: Financial planning doesn’t work in bits and pieces)

Get your Comprehensive Financial Planning done.

Conclusion:

SIP in mutual funds is a wonderful product. It helps in averaging out the market volatility and provide you with decent long-term returns. But if you are not doing SIP that does not mean you will not be able to achieve your goals.

It’s just when you expect equity returns to be around 12%, and in traditional instruments around 8%, to achieve goals you need to save more towards your goal.

If you want to go conservative on investments, you should also be conservative in your spending too. Aggressive in Spending, and conservative on investments may not be a good combination.

It worked well with Mukesh only because he was conservative with the expenses too. But he was also not looking at his goals holistically, so many more areas in his life and goals are not yet explored which may result into some different picture.

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