I made a mistake : Fixed returns can lead to Early Retirement

Several months ago, I had stated to my wife, quite brashly if I may add, that debt-like returns would not find any place in our retirement portfolio.  I have been in a tearing hurry to grow our retirement corpus and I thought that the slower growth rate of debt-like investments, when compared to equity based investments, was something I could not tolerate.  In fact I was so convinced about my logic, that I even posted a blog entry justifying my position.  I could not have been more WRONG!!  However, like all good things, ones financial strategy is also never 100% right, and there is always room for improvement.  I have now realized my mistake, and made room for some more fixed income into our retirement portfolio.  There is one key recent investment opportunity though that triggered my change of heart.  If you are a keen follower of personal finance, then you already know what I am talking about!  Yes, I am of course talking about ...

Stock Market Index in India (Part II)

We reviewed the origins of the Bombay Stock Exchange, in my previous post.  Established in 1986, the BSE SENSEX is the key barometer of the Indian Stock Markets and is widely quoted as a proxy for the overall Indian Equity markets.  When it was first established in 1986, the SENSEX comprised of stocks that were representative of the then pre-dominant companies and sectors.  Over the years the Indian economy has successfully completed its transition from a manufacturing basis, to a service oriented economy and now more recently biased towards a knowledge economy.  Several of the companies that were considered the bellwethers of the old economy are no longer part of the index, since the economy and concurrently their fortunes have changed in a large way.  A historical review of these changing times is critical to understand the fickle nature of individual stock investments, while learning to appreciate the stability offered by the index in itself.

Stock Market Index in India (Part I)

My early retirement plans are heavily reliant on a strategy that involves significant investments in equity linked products.  The bulk of my portfolio is invested in stocks and equity MFs, with the fundamental belief that in the long run, equity based investments will outpace all other forms of investment.  However, over the last few days I have realised that I have never really tried to understand the basics of the Indian stock markets.  I do not have an appreciation for the history of the stock exchanges, and some time spent researching on this front, will stand me in good stead while picking my future investment strategies.

PPF interest rate increase. Ponzi Alert! Like Social Security? (Part IV)

I started off this series of posts, in response to the change in rules governing the PPF scheme.  The interest rate for the next financial year has been raised to 8.6% from the current 8% for the PPF scheme.  I believe any defined benefit scheme that promises returns well in excess of market rates is no different from a Ponzi Scheme.  This is because no scheme can maintain a pre-defined level of returns which are not linked in any way to market returns.  Just because the scheme is backed by a government does not make it viable!  The government backing may ensure safety today, but in the long run the scheme cannot maintain itself.  We are already seeing this in the US with social security benefits.  The social security scheme in the US is also in some sense a defined benefits scheme, wherein you are guaranteed to get a certain payout when you retire that is linked to your prior years income and investment into the Social Security Scheme.  However, the payout from social security is not necessarily linked to market returns.  Hence, the scheme is under tremendous pressure to fulfil its obligations to payout to the millions of Americans from the baby boomer generation, as they retire. 

PPF interest rate increase. Ponzi Alert! Like Social Security? (Part III)

The Public Provident Fund Scheme, or PPF is arguably the most popular savings scheme currently available for small investors in India.  Literally millions of Indians, participate in this government backed scheme with the full confidence that their money is safe, and will grow over the years.  There are several detailed articles that you can find on the web, describing the benefits of the scheme, how to invest in it, and the rules and fine print for deposits and withdrawals.  You will also find every financial planner, first checking if you have a PPF account, and if not, encouraging you to open one, not just for yourself, but also for your spouse and minor children.  It is almost automatic today, for every earning adult (and in fact their minor children as well) to have a PPF account with money being stashed away dutifully every year, just like our parents did before us. 

PPF interest rate increase. Ponzi Alert! Like Social Security? (Part II)

Here is a picture of Charles Ponzi, carrying a gold handled cane and a diamond stickpin from August 1920 in New England, USA.  In my earlier post, I had shared with you the story of Mr. Charles Ponzi, who started as a small time con artist, and grew to become one of the most notorious, and certainly the earliest large scale swindler of all time. 

By the late 1920's, Charles was living the big life, with his business scheme seemingly unstoppable as more and more investors poured in their money to participate in his highly profitable business activities.  However, the banking authorities were beginning to get suspicious about this time, about the nature of his business, particularly since he seemed to spend very little time managing his business, and almost all of his energy talking about it and advertising it in the local newspapers. 

PPF interest rate increase. Ponzi Alert! Like Social Security? (Part I)

Charles Ponzi was born Carlo Pietro Giovanni Guglielmo Tebaldo Ponzi on the 3rd of March, 1882 in Lugo, Italy.  He grew up in Italy and came over to the US in 1903.  He started off by doing odd jobs, including working as a dishwasher in a restaurant and later waiting tables.  He then went to Montreal, Canada and worked in a bank for a while as a teller.  Here he got his first taste of handling other peoples money, until the bank failed and the bank promoter ran away to Mexico.  Penniless, Charles was soon driven to frustration, and he forged a cheque, was promptly arrested, and ended up spending a few years in prison.  It was here in prison, that he met his role model, Charles Morse, a wealthy wall street businessman with a penchant for swindling his clients. 

Wait a minute, you might ask!  What does this biography about Mr. Ponzi, have to do with the PPF rate increase in India?  And where does the Social Security angle come in to play?  Well read on my dear friend, and soon all will be clear. 

How much home loan can I get? (Part II)

In the Part I of this post, I had described a seemingly well set couple; Gaurav and Sneha, planning to buy their first home.  They had taken all the right steps in budgeting their home loan eligibility and are ready to take the plunge into home ownership.  Their financial planner approves of this step, and has given them the go ahead.  However from an early retirement aspirants perspective, they are making a huge mistake, that will potentially ruin any chances they might have of exiting the financial rat race early.  Where did they go wrong?  Isn't owning your own house a good financial milestone?

How much home loan can I get? (Part I)

Buying a home in India, or for that matter anywhere in the world, is a big decision for most people.  It is most likely the single biggest purchase you will ever make in your lifetime.  Gone are the days when one used to save for a lifetime, before finally being able to afford a small home towards the end of your career.  Today India is growing by leaps and bounds, and the average home buying age in India is dropping every year.  The Associated Chambers of Commerce and Industry of India (ASSOCHAM) estimates that the average age for home buyers in the 1980s was 55-58 years in India.  In stark contrast, since 2000, the average age for first time home buyers for personal use has dropped to 30-38.  Many first time buyers are either just married, or many times choose to buy a home even before marriage.

Inflation in India

Inflation is a much maligned but sometimes poorly understood phenomenon that has the most significant impact on any personal finance plan.  Particularly in a emerging country like India, inflation can be so rampant as to be the fundamental parameter that influences all investing decisions.  Inflation is usually defined as a rise in the general level of prices of goods and services in an economy over a period of time.  In the words of noted economist Sam Ewing, it is the reason why you pay $15 for the $10 haircut that you used to get for $5 when you had hair. 

Is 1 Crore enough to retire on in India?

If you had Rs 1Cr (approx USD $200,000) would you be able to retire right now in India? If you need to meet retirement expenses over 30 years, would Rs 1Cr suffice?  How much can you spend monthly, if you need the Rs 1 Cr corpus last over 20 years.  To understand these and several related questions, read on.

Compound Interest 101

Compound interest is the single most interesting and critical factor that impacts all projections of investment growth, retirement corpus accumulation, loan EMIs and payback tenures, etc.  For a concept that is so fundamental to financial theory, compounding can be exceedingly difficult for the average person to understand and fully appreciate.  This is fundamentally because with compound interest, the total corpus grows or declines in an exponential manner.  It is widely believed that the human mind has difficulty comprehending exponential behavior.  For example, Albert Bartlett a US scholar, once commented that "The greatest shortcoming of the human race is our inability to understand the exponential function".  In economics the exponential growth model is also known as the Malthusian growth model, after the Reverend Thomas Robert Malthus, who authored "An Essay on the Principle of Population", one of the earliest books on population growth rates.

Household Savings Rate

Earlier this month I had stated my intent of saving 85% of our family take home income.  I am still unsure if I can achieve this aggressive savings rate, but I am pretty sure that over the last few months, our savings rate should be around the 50%-60% levels.  This got me wondering as to what the average household savings rate is across India/World.  So I went searching for this data, and here is what I dug up from GFMAG.

I have reproduced the following table from the above site here for convenience. 

The shocking statistic for me was that across the world over 2decades of time the annual average household savings rate maxes out at 20%, with the most common savings rate being in the mid to high single digits.  Now of course the need to save could be different in different countries.  Typically countries that have a higher proportion of social security, should have lower savings rate since there is less of a drive to save for a household, as the government is expected to provide support post retirement. 

Though countries like India and China are not listed in this survey, I would assume we would naturally have a much higher savings rate since our government does not provide any kind of social security whatsoever. 

In any case, the fact that the average savings rate is much below my 85% target, gives me a lot of confidence.  On average, people do not retire early, and continue to work into their late 60s.  For me to be able to retire in my 40s, I need to be doing something that is not the average, and I hope my aggressive savings rate will make the difference when compared to the average joe.

Savings Rate or Investment Returns?

I see several articles and energy spent on figuring out how to maximize ones investment returns.  There are tons and tons of websites dedicated to guiding you on how to increase your stock market returns, or to find the best loan rates, or the highest FD rates.  Yes, I believe all of this is important, since you wouldn't want to be stuck with a less than optimal investment return, when better returns are available for the same product and risk profile.  However, the key realization you need to have is that, investment returns are not in your control.  You can try your best to increase your returns by a few percentage points, but for the most part you have no guarantee that this will happen.  Also, going for increased returns always goes hand in hand with a higher investment risk that you will have to take on. 

Instead I propose that you should spend your energy in figuring out how to increase your savings rate.  For starters this is completely in your control, so you can decide and implement any savings strategy, as long as you have the discipline for it.  Also most times I have found that a small increase in your savings rate, can easily offset any lower investment returns that you might see.

Here is a table that illustrates this principle.  I have calculated how many years it would take to save up 10 times your annual salary, if you make 0% to 20% returns (on the Y axis of the table), for different savings rates from 10% to 90% of your annual income (on the X axis of the table)

The first row is the simplest to understand, since it assumes 0% returns, or the equivalent of taking all your savings cash and keeping it in a bank locker.  Therefore, in this case, if you save 10% of your annual salary, it will take you 100 years to save up to 10times your annual income.  As you increase your savings rate, the number of years reduces proportionately.  If you are able to save 50% of your annual income, you can achieve your 10X target in 20years.  However, in real life, nobody keeps their money in a bank locker with 0% investment returns (unless it is black money!)

So lets take the example of 8% annual returns. In the current scenario of high interest rates, it is easy to achieve 8% investment returns by simply investing in low risk debt instruments (like FDs, MIPs, etc)  In this case, if you are able to save as little as 30% of your annual income, you can save up 10 times your annual salary in 16.9 years.  This may seem like a long time, but if you start at the age of 25, by the age of 42, you will have 10X your annual salary in your investment portfolio.  That is a very strong position to be in!  However, if you are not willing to wait that long, you can increase your savings rate to 50% (save half your annual income)  This will help you reach your goal in just 12.4 years.  Again starting at age 25, you would have met your goal at the young age of 33!  Clearly this illustrates the value of increasing your savings rate.

If you are willing to take on more risk, you can aggressively invest in equities, real estate, and these days even in gold.  Assuming an aggressive investment returns of 12%, you can see from the table that 30% savings will help you reach your target in 14.2 years, while an increased 50% savings rate will help you get there in just 10.8 years. 

This should clearly drive home my point that though investment returns are a good thing to chase after, an increased savings rate is a more powerful tool (and completely in your control) to help you reach your retirement corpus accumulation target.

Early Retirement Killer : Inflation

The single biggest obstacle I foresee to any plans for early retirement is inflation.  Yes, I believe this is a bigger challenge than even accumulating a large enough corpus in the first place to enable retiring early.  India continues to reel under the pressure of rampant inflation, ranging from 8% to 10% in recent times.  The inflation rate is not the same across the various components of my expenses.  In particular there are three areas that seem to have persistently high levels of inflation that show no signs of letting up.

Health care:  The cost of medical care, hospitalization, routine doctors visits, and medicines, continues to go up at what feels like an ever quickening pace.  Health care premiums also continue to shoot up at the same pace, as insurance companies have to raise rates to remain viable. 

Education:  Learning, which should ideally be accessible to every single person, also seems to be becoming more expensive everyday.  Tuition fees from nursery and day-care, to higher education professional degrees are becoming prohibitively expensive. 

Real Estate:  In India real estate has always been expensive, but in recent times, has seen a phenomenal increase in per sqft rates.  Everyone wants to own a piece of real estate, and the increased demand is resulting in continually increasing real estate prices. 

The key challenge I see going forward, is that I will definitely need access to health care and education (for my kids) and potentially also buy real estate (either for my self, or as an investment for rental returns)  But due to steep inflation rates in these areas, (and certainly my salary is not increasing at the same pace) I am getting priced out of the market.  In other words, as time goes by, I will be able to afford less and less, in the health-care, education and real estate space. 

Do you feel the same way? and do you have any suggestions on how to deal with this?

LBYM : Live Below Your Means

The key factor in building a retirement corpus, by far, is your ability to save (and invest) a portion of your income during your working years to fund your post-retirement expenses.  For those dreaming of an early retirement, it becomes imperative to save early and aggresively during your working days.  This concept has been discussed in great detail across the internet, and you can find many articles related to savings, frugality and a key retirement concept called Living Below Your Means (LBYM).  Simply described, LBYM refers to intentionally maintaining a lifestyle that is a little below what you can comfortably maintain.  The savings achieved by this approach can then be ploughed back into building your retirement corpus.  Now of course, this requires a lot of discipline to achieve, since in effect, you are giving up on your present comforts, to enable future well being.  Still, based on all the data I have seen so far, particularly from folks who have already achieved their early retirement goals, the key factor to enable this dream, is to save as much of your income as you can during your working years.  Thus, the earlier you want to retire, the larger percentage of your take home pay, you should be saving and investing for the future. 

This is something that should come particularly naturally for us folks in India.  Most of our family financial upbringing revolves around saving for a rainy day.  Interestingly I came across this lovely equation that describes the Indian philosophy beautifully.  The thought is that a persons happiness or contentment is a function of 2 factors; his/her needs or desires, and his/her belongings or assets.  This is represented as follows:

The western approach to enhancing happiness/contentment, is to aggresively increase ones assets and belongings.  The more one owns and possesses, the higher the numerator, and hence the higher the happiness levels.  The Indian (or eastern) approach is diametrically opposite to this philosophy.  The Indian approach suggests reducing ones needs/desires/wants.  This will reduce the denominator of the equation, thus leading to an increase in ones happiness quotient.  I found this simple concept a very intuitive way to understand and explain the LBYM concept, which fundamentally talks about the same thing in different words. 

Think about this.  In the meantime, my next post will focus on some number crunching to determine what would be the right percentage of take home pay to target for savings and investments to enable early retirement.