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Meeting the gap between Requirement and Reality

The distance between a child and his need - a childs perspective

s a young child, if you have been lucky to have a small yard or a garden or even an orchard in the town, then you will be able to relate to the next story narrated. There was a small guava tree where I was growing up. This tree had grown to approximately the height of a one storey building and small guavas were there for us to feast on them. Me and my friends, saw that it was too high for us to reach. So what did we do? Did we give up? Our Game Plan Ofcourse not, the guavas were too enticing to be given up without a try. My neighbour, Ashish, suggested that he will climb the branches and throw the fruits down. We saw that the branches were too small and narrow and may not be able to hold his weight, but nonetheless, try we did. Afterall, if Ashish got a few scratches it wouldnt matter! The second suggestion came from my friend, Aarti. She suggested that we throw stones and try the old method. This method could hurt somebody badly. Also the neighbourhood passersby, always chided us saying that throwing stones was bad manners and it should not be done. The third way, that we could approach the problem was to ask the friendly gardener to help us in our efforts and partake in our fruits. Recommendation This is the most relevant childhood memory that brings out the analogy between the requirements/goals and how did we get past the glitches/bottlenecks to get to the goal. What Ashish did would be similar to a systematic process of wealth generation using a ladder and a conservative approach, what Aarti did was an ad-hoc manner, indisciplined manner to achieve our goals, and there was no guarantee that we would get anywhere. If we asked the gardener for help, it would be the best method to be used, since he would be like an financial planner. He knew exactly how many guavaswe needed to share, which fruits were ready and ripe enough to be plucked and how best to access the easiest ones and leave out the ones at the top. We must be able to correctly prioritize our goals, assess the gaps and then know how best to bridge the gaps correctly and efficiently. The need gap analysis has to be assessed correctly In this chapter, we will discuss ways to bridge the gap between our financial goals and mutual requirements Taking stock There has to be a complete format in which the various items are listed out. A common way of doing this is to have a format where assets from different areas are listed and records maintained of the same. Some of the areas here would be: Equity investments Bonds and debentures Mutual fund units

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Insurance polices, both traditional and ULIPs PPF account Provident fund account Other small savings Bank fixed deposits Gold Other investment assets not falling into any of the above categories The requirements of the individual are initially known and after that, the current holdings and the investments are arrived at. Taking the mixture of these two items and making the necessary calculations will give the difference in terms of the resources that have to be raised. This can also be depicted in a simple equation: Requirements Available Resources = Additional Requirements Now this is where the entire thing gets a bit complicated. The important thing is that there is no surety of the amounts under consideration. Consider each of the three items to understand this point. The Requirement refers to the requirement at the time of retirement. This means that the figure here is one that will be witnessed several years, and in some cases, decades, down the line. There are quite a few factors that can change the situation in the interim period and hence there is nothing sure about this figure. The Available Resources are as of the current date with the individual. However, while using this figure, for the purpose of the equation, this will also have to be projected years down the line. This has to be done because the available resources will also grow from the current level over the years to come to a certain figure. This once again means that there is an element of expectation and calculation built in to the figure. The final figure of Additional Requirements will then change depending upon the change and the movements in these two figures. This is also quite volatile and there is nothing sure about this. This means that there might have to be several changes in this over the years and will require the individual to ensure that there is a change in the way it is met. There are various changes that are taking place constantly. Any figure or calculation that has been made will be impacted by the current market situation. This can completely change the picture that one might have expected at the starting time point. Some of the reasons, which can give rise to various changes, are: The debt market might see a turn of events. This could mean a sharp fall in rates as was witnessed in 2001 onwards in India. It could also mean an upward turn in the cycle and a sharp shooting up of rates. Inflation could take a big jump and this would affect all the retirement planning figures. Equity markets might see a sustained bull rally, as is the case with India, that might result in a complete change of fortunes. The markets could also slump dramatically leading to a severe erosion of capital and once again, a change in the situation for the planning. A new range of sectors could boom resulting in increased opportunities there. The economy could completely turnaround as far as its characteristics are concerned and this can lead to a complete reevaluation of the various options present. The investment world could witness the introduction of a lot of new products that can change the situation as far as putting money is concerned. Competition in various areas can see a change in the options chosen by an individual.

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Real estate could change its nature due to new developments leading to a change in this area. Commodities are very volatile and a surge in some assets might see a part of the planning targets being met here. A sharp drop in commodity prices could also lead to a complete evaluation for the various requirements. This also means that there has to be a review of the various calculations at some point of time. Review is an essential part of the planning process and would have to be built in with the other activities. Reducing the Retirement Income gap When you determine how much income youll need in retirement, you may base your projection on the type of lifestyle you plan to have and when you want to retire. However, as you grow closer to retirement, you may discover that your income wont be enough to meet your needs. If you find yourself in this situation, you will need to adopt a plan to bridge this projected income gap. Unanticipated problems Things can go wrong when you invest for retirement or manage retirement funds. For instance, a medical emergency can whittle down your cash stash. This can lead to a shortfall later. So, you must change course and get the funds back up to level. Strategy of asset alloction is to be used here too.The answer lies in investing a part of the corpus in equity-related options so that the jam of retirement funds lasts till the end of the sandwich of your life. The answer to how much you should invest depends on your regular income needs and risk-taking ability. Examples Delhi-based B. Subba Rao, 80, a retired media professional, and Mumbai-based Farrouk Irani, 58, an exbanker who took a voluntary retirement in 2001, are two people who have got their retirement funds back on track this way. They had another friend,Satish Narale,65. Subba Rao, 80, a retired media professional Throughout his work life, Subba Rao swore by and invested in bank FDs and post office savings schemes such as Public Provident Fund and National Savings Certificates. The faith remained till, a few years back, he realised that inflation and declining interest rates on his investments were eroding his corpus. To rebuild it, he started investing in balanced, as well as equity MFs. Today, the last two make up 10 per cent of his portfolio. Farroukh Irani, 58, retired bank official He thought that his VRS payment invested in FDs would be enough to last a lifetime, till low interest rates and inflation hit him. Today, he has invested 50 per cent of his money in different mutual fund schemes. This is the only way I can make my corpus grow. Iranis story runs similar to Subba Raos, except that he had a much longer retired life ahead when he saw the erosion. His shift has been sharper. Now, 50 per cent of his funds are in MFs. This is the only way I can make my corpus grow, he says. To make this mid-course correction you need to keep reinvesting the surplus cash that you are left with at the end of every month in equity-related products. Satish Narale, 65. While in case of Satish Narale, he had inherited an old house from his ancestors. It was fairly spacious and he had extra space which he did not want. He let out 800sft of his house on rent, which earned him

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a fair bit of money. Since he was fit and wanted to be active, he insisted on taking up some extra assignments. They served a dual purpose of engaging him and bringing him the extra bit of money. So his strategy benefited him and his family in all respects. Some suggestions Hold on to the money you save Keep in mind that the money you save should be earmarked for your retirement. It should not be frittered away on minor expenditures and impulse purchases. The point of reducing your spending is to overcome projected income shortfalls, not to indulge yourself at end-of-season clearance sales. The money you save should be put away immediately. Continue saving during your Retirement Dont think of your retirement date as your deadline for saving. Instead, continue to save money throughout your retirement years. Saving may become more difficult after retirement as a result of reduced income and potentially increased medical expenses. But you can work part-time during retirement and take other steps to keep saving. Putting away just a little each month can make a significant difference in how long your money will last. Consider greater Investment Risk If you are facing a projected income shortfall, you may want to revisit your investment choices, particularly if youre still at least 10-15 years from retirement. If youre willing to accept more risk, you may be able to increase your potential return. However, there are no guarantees; as you take on more risk, your potential for loss grows as well. Re-evaluate your Standard of Living in Retirement If your projected income shortfall is severe enough or if time is too tight, you may realize that no matter what measures you take, you will not be able to afford the lifestyle you want during your retirement years. You may simply have to accept the fact that your retirement will not be the jet-setting, luxurious, permanent vacation you had envisioned. In other words, you will have to lower your expectations and accept a more realistic standard of living. Recognize the difference between the things you want and the things you need and youll have an easier time deciding where you can make adjustments. Here are a few suggestions: Reduce your Housing expectations Perhaps youve always planned to live in a luxury area in Mumbai or Bangalore when you retire. Realize that this goal may not be realistic. If you are facing a severe income shortfall, you might have to shop around for a more affordable housing option in a less exclusive location. Cut down on Travel plans Maybe youd always planned an extended tour of Europe or a cruise around the world to celebrate your retirement. You may have to downgrade these plans to a driving trip to visit relatives or a train trip to Kerala. Simple trips can be just as much fun as extravagant vacations, and they dont put as big a dent in your retirement funds. Lower Household expenses There are numerous ways to decrease your everyday expenses. You might find that simply cutting back on your spending will help stretch your retirement money. For instance, you could eat out less often or use public transportation instead of your car.

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Exercise
Rahul is planning for his retirement. He has a current expense level of Rs. 40,000 per month. He expects that by the time he retires 10 years down the line this will grow by the rate of inflation of 5% per annum. On the other hand, the current sum available with him is Rs. 25,00,000. The rate of return is on an average of around 7% and this is expected to dip to around 6% in the next ten years. What is the requirement for Rahul in terms of additional resources? Hint The current expense figure is present which can be used to get the future expense. Corpus figure is available and this can be assumed to accumulate earnings or even pay out the earnings. The future earnings will be known from the estimates. Given the earning level, the mismatch in the corpus and the amount required can be found out.

Chapter Review

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