HOW AVERAGES CAN RUIN THE MATH

Calculating a retirement corpus on the basis of average returns can have disastrous consequences as different sequence of returns can lead to different outcomes

- RAVI SARAOGI

It's 1996, and after a long and fulfilling career, Shalini is looking forward to her retirement in a couple of weeks. After having worked hard and accumulating a good retirement corpus, she is keen on spending the next many years in leisure.

Shalini is grateful that her retirement has come after the tumultuous years of 1990-1991 when the Indian economy went through a crisis. Much to her relief, the economic liberalisation that followed stabilised the economy. She was hopeful for better days.

A disciplined saver, she has accumulated a retirement corpus of ₹1 crore. This consists of a mix of Employees' Provident Fund (EPF), Public Provident Fund (PPF), fixed deposits, mutual funds and shares.

Before her official retirement date, she rang up her trusted adviser, Maya, to undertake a retirement planning exercise and Maya prepared the following analysis.

Shalini was about to turn 60. Based on family history, Maya assumes her life expectancy as 90 years. Both Shalini and Maya are aware that having a large allocation to debt investments would not be optimal as the post-tax return on these can be dismal, but some amount is needed for safety. Finally, Maya settles for an allocation of 70:30 in equity and debt.

For equity returns, she assumes an average return of 11 per cent each year, a conservative estimate, as the equity markets delivered close to double that return over the previous 15 years. Maya would always remind Shalini, "The reality should outperform the plan, and not the other way around."

For debt investments, she assumes an average return of 7 per cent each year, assuming a 1 per cent real rate of return over the projected inflation of 6 per cent. The blended portfolio return was expected to be 9.8 per cent each year.