Retirement is the art of getting your expenses met by your passive income. To explain that process in detail, we may have to start with the definition of the following keywords: Income, Expenses, Assets, Liabilities.
Income: It is the process by which you get money into your account. This could be either a salary, commissions, dividends, or capital gains. When you spend your time and effort to generate income, it is called Active Income. Whereas income generated without your physical effort or time is called Passive Income. For example, income from Salaries and commissions is active, while income from dividends and capital gains is passive.
Expenses: It is the process by which money flows out from your account. When you spend on food, travel, shelter, clothing, vacation, leisure, etc, it is an expense. These expenditures are required to maintain our lives and lifestyles.
Assets: These are items that generate income continuously. For example, a property that generates rental income, or a mutual fund that pays out a dividend.
Liabilities: They are activities that continuously shell out money. For example, the loan repayments (EMIs) for an automobile or a home.
Retirement happens when you no longer have to work, yet your expenses are fully covered by income from your assets. This means you no longer have to pursue a job or profession, and the income from your rentals and dividends is enough to cover daily and monthly expenses.
To make this happen, you need to have some money left after expenses that you could spend on buying assets. Once these assets mature, they start yielding income in the form of rentals, dividends, or capital gains.
Let us assume your current monthly expenses are Rs 50,000. Using an online systematic withdrawal plan (SWP) calculator, we can see that if you have an initial capital of Rs 50 lakh in a mutual fund yielding 12 per cent annual returns, you can withdraw Rs 50,000 every month for 20 years and still have some surplus left.
Here, the initial capital of Rs 50 lakh is the asset that continues to generate passive income in the later years. To raise the same via mutual funds, you might have to invest Rs 22,000 every month for 10 years, assuming the annual returns to be 12 per cent.
Retirement planning is not that difficult, but it requires years of hard work to build the assets. In this specific case, it requires at least 10 years of monthly contributions of Rs 22,000 to build a corpus of Rs 50 lakh.
Interestingly, most people may not be able to stick to this plan, as their expenses spiral out of control, leaving them without the capital to invest.
When you take on debts such as car or home loans, they add to your monthly expenses, and pretty soon, you may not have a surplus to invest.
This is where the asset-building cycle gets interrupted. Next time, when a mouthwatering “spending idea” comes up that is funded by “debt”, exercise caution, as it could postpone your retirement by many years or indefinitely.
The author is a research scholar in applied economics, CUSAT and NISM-certified research analyst and investment advisor.
DISCLAIMER: Calculators are for illustrations only and do not represent actual returns. Mutual Fund investments are subject to market risks; read all scheme-related documents carefully.
The opinions expressed in this article are those of the author and do not purport to reflect the opinions or views of THE WEEK.
