Prepare for a Comfortable Retirement with SIP in Mutual Funds
The importance of retirement preparation cannot be overstated enough - it is vital to begin planning as early as possible! However, what exactly constitutes "early" when it comes to retirement planning? Is it ten years before retiring or an even longer timespan of twenty or thirty?
The biggest hurdle in your wealth-building process is inflation. The average inflation over the past 25 years stands at 5.55% (Source: RBI, 2023). The detrimental impacts of inflation are manifold because it lowers your purchasing power and reduces the value of your hard-earned money. To put this into perspective, if you are 35 and your monthly expenses stand at ₹35,000, then at the time of retirement (assumed at 60) would be ₹1.3 Lakh.
Moreover, with the significant advancements in medicine leading to increased life expectancy, the rising costs of medical expenses further emphasise the need for a substantial retirement fund. Over the past 25 years, an upward trend has been observed in life expectancy, growing by 14.56% from 61.47 in 1998 to 70.42 in 2023 (Source: Macrotrends, 2023). Additionally, changing cultural norms have shifted from large joint families to nuclear ones, making it impractical for parents to rely solely on their children for financial support during retirement. In such circumstances, proactively preparing for retirement allows individuals to attain financial independence while upholding their self-respect.
Considering these factors, it can be concluded that a huge retirement fund is needed, which cannot be built in a short time span. When one starts building the retirement fund early, they give enough time to the power of compounding to work its magic. It is for this reason that experts recommend starting early when it comes to building a retirement fund.
Traditional Tools for Retirement Planning
When it comes to building a retirement fund, traditional investment avenues have long been relied upon in India. Among these, the public provident fund (PPF) is one of the most widely used tools to build a retirement corpus. However, the rate of return on PPF stands at a mere 8.51% (Source:National Savings Institute, 25-year average, 2023). Moreover, the size of the retirement fund cannot be tailored effectively due to the limit of Rs 1.5 lakh for maximum investment.
Another common choice among investors is fixed deposits, yet the returns generated by this option are even lower than those of PPF, amounting to just 7.28% (Source: RBI, 25-year average, 2023). When considering the impact of inflation, the real rate of return for these instruments is merely 2.80% and 1.64%, respectively. Additionally, taking into account the effect of taxes, the returns may only marginally surpass inflation.
Historically, equity mutual funds have demonstrated the potential to deliver attractive returns, with some even achieving double-digit real returns.
Source - PPF and FD returns are 25-year average shared by National savings institute & RBI, respectively. Mutual funds returns are 25-year average returns for available select MF equity funds based on internal study as on 31 March 2023.
Exploring SIP for Retirement Planning
A Systematic Investment Plan (SIP) in equity mutual funds has emerged as one of the most effective strategies for saving for retirement. Through SIP, one can invest a fixed amount at regular intervals, typically monthly, into a mutual fund. This approach aims to make mutual fund investments more accessible and manageable for individuals by breaking down the investment into smaller, consistent contributions. By investing through SIP, investors can enjoy the flexibility and leverage the power of compounding, which enhances returns and provides better risk-adjusted performance.
Considering the impact of inflation, declining interest rates in traditional investment options, and the aspirations for higher post-tax real returns, building wealth rather than merely protecting it becomes crucial. In this context, equities, as an asset class, and mutual fund SIPs appear to align perfectly with the needs of our time. They offer the potential for substantial returns over the long term.
To determine the required size of a retirement corpus and the corresponding SIP contributions needed to accumulate it, further analysis and estimation are necessary.
Let us get some estimates as to the size of the retirement kitty required and how much SIP will be needed to accumulate the retirement kitty.
| Case 1 | Case 2 | Case 3 | |
| Current age | 30 | 40 | 50 |
| Years to Retirement | 30 | 20 | 10 |
| Retirement Kitty Need | ₹6.87 crore | ₹3.85 crore | Rs 2.15 crore |
| Monthly SIP Amount Required to Accumulate Retirement Kitty | |||
| Returns @ 12% | ₹ 22,400 | ₹ 41,850 | ₹ 95,900 |
| Returns @ 10% | ₹ 33,150 | ₹ 53,150 | ₹ 1,06,650 |
| Returns @ 8% | ₹ 48,600 | ₹ 67,200 | ₹ 1,06,650 |
Assuming retirement age is 60 years, life expectancy is 85 years, the monthly expense is ₹50,000, inflation is 6% and returns on retirement kitty are 8%.
Considerable insights can be drawn from these estimations. Firstly, it becomes evident that the required monthly SIP amount increases significantly as one delays their investments and approaches closer to retirement age. Therefore, initiating investments early on is preferable. Additionally, the choice of asset class plays a crucial role. It is notable that if the expected returns are lower, a considerably higher savings amount is needed. This disparity becomes more prevalent when the investment horizon is long. For instance, for an asset class delivering 12% returns (such as equities), the required savings amount is less than half of what would be needed for an asset class offering 8% returns (such as debt). Commencing investments early allows individuals to harness the power of compounding over the long term.
This gives rise to the question of what if one is unable to save the required SIP amount starting today? In such cases, a Top-up SIP can come to the rescue. With Top-up SIP, individuals can commit to increasing their SIP amount at a predetermined frequency, typically on an annual basis. Taking our example, assuming a return of 12%, a 40-year-old individual would only need to start with a SIP of ₹29,800, along with an annual top-up of ₹2,000. Similarly, a 50-year-old individual would require a SIP of ₹78,000 with a yearly top-up of ₹5,000. However, it is worth noting that with SIP top-up, one can achieve much more, as its impact can be substantial over the long term. This strategy can be intelligently employed to accomplish other financial needs and build even greater wealth.
To conclude, SIP and particularly SIP with Top-Up, present an excellent approach for building retirement funds. The consistency and discipline of SIP enable investors to save and invest regularly over an extended period in a growth-oriented asset class like equities while minimizing risks. The benefit of rupee cost averaging with SIP helps mitigate the impact of market fluctuations and volatility, offering a more stable investment option. Moreover, the convenience, flexibility, liquidity, and tax benefits associated with mutual funds enhance the attractiveness of building a retirement fund through equity mutual fund SIPs.
Investors can also seek guidance from a mutual fund distributor, who can help quantify the fund required during retirement. By doing this, they can provide tailored recommendations on the most suitable mutual fund schemes based on the risk profile of the investor and the horizon to build the fund. Through the guidance of mutual fund distributors in starting an SIP, investors can build a sustainable and sufficient retirement corpus.