The most important number when it comes to retirement
TLDR: What is the most important figure when it comes to retirement - it is not SWR
There are way too many factors that influence your retirement. Instead of assuming a single figure in your head, think of retirement or other financials goals as different milestones instead of a $ amount.
Create that goal list and then try and estimate the numbers to arrive at a realistic figure.
So what are the factors that can influence your retirement
Starting age of investment
Duration of retirement
Portfolio return
Product expenses
Safe Withdrawal rate
Saving rate
So these are some of the numbers that come to mind. Let us dive deeper into each of these to understand more.
Starting age of investment
The eight wonder of the world - compounding is truly amazing.
Its influence is huge when it comes to determining the size of our portfolio.
You know what this means, scenario time
Scenario 1
Let us imagine 3 people who are looking a build a retirement corpus starting at 3 different ages - 25,30 and 35.
Monthly investment = 25,000
Annual increase = 10%
Investment period = 240 (20 years)
Portfolio maturity at age 55 (30 years for the 25 year old, 25 years for the 20 year old and 20 years for the 35 year old)
Assumed returns = 10% compounding annually
See the huge difference in the interest income generated between the different age groups. The power of compounding in action for you.
Scenario 2
Imagine that all of them are looking at getting the magic figure of 1 crore, then how much do each has to invest, with all of the other assumptions being the same from the above scenario.
Monthly investment needed
at age 25 = 25,000
at age 30 = 40,250
at age 35 = 64,850
Huge difference in figures, all in the because of a delay in starting investment by 5 or 10 years.
Duration of retirement
How long the money needs to last is another big question. I have written about this in my SWR post earlier. The difference between somebody retiring at 65 and someone retiring at 40 is huge. As the retirement corpus needs to last a long time and you will still have other expenses that need to be managed as well like kids education, weddings etc. unlike a regular retiree.
You can read up about the impact of retirement period in my two posts here and here.
Portfolio Return
How aggressive or conservative you are also makes a big material impact on your retirement corpus. If you are super conservative, never venturing beyond FD and debt mutual funds, then your portfolio will barely keep up with inflation, which means your real return would be close to 1% to 2% after inflation which is quite poor.
Long term return of FD = 6 to 8%
Long term return of Debt mutual funds = 6 to 8.5%
Long term return of Hybrid mutual funds = 8 to 10%
Long term return of equity / index funds = 10 to 12%
Scenario 3
With the same assumptions as scenario 1, this is how the return looks like.
Product expenses
There is a lot of focus on expense ratios when it comes to our portfolio returns. I have floated the idea several times in the blog and the potential compounding effect of expenses on the portfolio value.
It is an important aspect that needs to be optimised to get the maximum out of your investments but when it comes to the net impact on portfolio it is not the most impactful.
The delta between a regular mutual fund vs. a direct fund or index fund is between 1 and 1.5%.
Safe Withdrawal Rate (SWR)
I have covered this topic in detail here, here and here. The impact on SWR on the utilisation of the portfolio.
Savings Rate
This number is probably the one financial number that has the biggest impact on your retirement. If you are not saving enough, you will never reach retirement.
The general rule of thumb to save 10% every month and assuming a return of 10%, you will need 33.12 years before you can retire. This is assuming the 4% SWR, but if you are even more conservative you need to do better than that which means longer duration to save.
If you are able to save close to 35% every month at 10% return, you are good to retire in 18.16 years.
Conclusion
The objective of this post is not for you to focus on one particular item, but rather focus on the big ticket items first before the other smaller factors after that. If I have to order them by importance
Savings rate
Starting age
Duration of retirement
Portfolio return
SWR and
Product expenses
I would use this as the order of importance to prioritise.
Happy Investing.