Hansi Mehrotra
September 16, 2016

While there are some people who never want to retire, and some who want to retire early, most of the population aims to retire around 60-65 years of age when they no longer have the energy for full time work. Yet the average life expectancy is going up; in India, men are expected to live to 67 and women to about 70 years while in developed markets like Japan, Singapore and Australia, the life expectancy is already 80 for men and 85-87 for women.

If these statistics don’t scare you, consider this: not only will you not have a regular salary income during retirement, but you are likely to have higher medical expenses. Add to that the fact that retirement is the only significant financial goal that you can’t take a loan for. You can take loans for buying a car, home, kids’ education, even holidays. But all of these rely on your ability to earn an income. Since you won’t have that, you won’t be able to borrow (other than perhaps a reverse mortgage).

At this point, most Indians I know say that their children will look after them. I wish them well, but the risk manager in me wants to ask ‘what if they can’t for some reason?’

So what’s the solution? Save now, lock it up and invest well!

Delay gratification and save when you can

When we earn well, it’s natural to want to live a good life. But you need to learn to delay gratification today to be able to live decently later. It’s like squirrels, who store nuts away for winter when they know it’s too cold for them to go out. Some of us are able to do this quite easily, whether by birth or early conditioning, while others struggle. But research shows that it’s a habit worth cultivating.

The Stanford marshmallow experiment was a series of studies on delayed gratification in the late 1960s and early 1970s led by psychologist Walter Mischel, then a professor at Stanford University. In these studies, a child was offered a choice between one small reward provided immediately or two small rewards (i.e., a larger later reward) if they waited for a short period, approximately 15 minutes, during which the tester left the room and then returned. In follow-up studies, the researchers found that children who were able to wait longer for the preferred rewards tended to have better life outcomes, as measured by SAT scores, educational attainment, body mass index, and other life measures.

The problem is that not all of us have the self-control or self-motivation – if we did, there wouldn’t be so many wasted gym memberships.

Lock it up for tax benefits…

In more developed markets, people didn’t have to think about retirement too much; they worked for large corporations and governments for decades and retired with a ‘defined benefit’ pension, linked to their last salary, for the rest of their lives. People who didn’t get a pension from their employer got one from the government as the age pension, a form of tax-funded social security. But in recent times, governments have realised that they got their math wrong – they have over-promised and can’t really deliver. So they are slowly encouraging people to take responsibility for their own retirement using tax incentives (carrot) and compulsory preserved savings (stick).

While India doesn’t really have a social security system for ordinary citizens, it does recognize the problem, one of many that can snowball into social unrest. So like many other countries, it is trying to develop ‘pension funds’ to help you save for your retirement. Watch the video for a summary of pension fund options in India

Link to video

In addition to those offered by the government, there are some offered by private firms in the insurance and mutual funds sector. They also offer tax deductions in return for locking your money up; the main difference is that these can invest in a wider range of investments, but the flip side is that their costs are much higher.

Having been involved in the launch implementation of the NPS, I can say the pension eco-system is still relatively nascent in India. The current debate around taxation and preservation is an example of this. Hence, it’s wise to diversify your retirement savings basket beyond these government pension funds, into other non-preserved financial instruments such as mutual funds, as well as real assets such as real estate.

…or higher returns

If you can’t get tax benefits to help, it’s worthwhile looking at other ways to boost the returns on your savings. These could be taking more risks by investing in riskier or leveraged investments, or by investing in longer-term investments.

Since your retirement can be decades away, you can invest in equities, which can be volatile in the short term but tend to provide higher returns than fixed income in the long term. This is because equities represent shares in real productive businesses. The benefits of higher returns over a long-term horizon are even greater due to the effect of compounding.

You can combine equity investing and tax incentives, both in a pension fund environment (such as the NPS) and outside (through equity-linked saving schemes, simple equity mutual funds or direct shares). Indeed, that’s what I have done with my pension fund.

Retirement savings is a tricky topic to cover in a short blog…I have tried to explain why you need to save and that you may need to hide these savings from yourself. You can do so by investing in pension funds where the government gives you tax incentives in exchange for locking the money up, or by investing in equity funds where you will experience volatility but do better in the long run.

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