My greatest joy as a financial planner comes from working with senior citizens. Planning their finances is challenging and gratifying at the same time. Challenging, because it often takes months to change their outlook about the way they have managed their money thus far. Gratifying, because when they see the difference it makes to their fortunes, their appreciation and delight is heartfelt.
When X and his wife came to meet me last year, they were resigned to being financially dependent for the rest of their lives. Apart from the house that they lived in, they owned no other significant assets. Their children provided them a monthly allowance to meet their routine expenses. Neither the children nor the parents liked this dependency, but saw no other way out of the current predicament.
After meeting Mrs and Mr X, we determined that the only way they could be financially independent was if they sold their property. It took us several weeks to convince them that this move would place them in a better situation than where they were today. Selling their property was a big first step, since any planning for the future would require liquidating this large, illiquid asset.
Once the money was in the bank, we had the flexibility to plan their retirement in a way that not only allowed them to meet their basic needs, it also opened the prospect of a whole new lifestyle that they never imagined possible.
Subsequently, we embarked on their financial plan, where we determined their risk profile, asset allocation, time-frame for income generation, and expense patterns. Meeting essentials like rent, food, utilities, domestic help, medical expenses (including medical insurance premiums), and clothing were a breeze. In fact, not only would the couple meet their basic expenses, they would also leave behind a sizeable asset for their children if they continued with their current, frugal existence.
We then examined an alternate expense set, an extravagant dream budget, which they thought would be impossible to fund. This budget would enable the couple to splurge on non-essentials like vacations, gifts, hobbies and entertainment. A luxury for Mrs X was a monthly visit to a beauty parlour and a cab or auto for her local travels. She despised having to commute by public transport at her age. She hoped that we could enable these indulgences through a carefully structured plan.
I remember Mrs X's jaw drop when I told her that not only were these expenses doable, she could also spend up to Rs3 lakh a year on holidays and yet remain financially independent.
Even after assigning aggressive inflation numbers and conservative portfolio returns, the elderly couple would be financially independent, albeit with lesser assets to bequeath to their children. The couple chose this option—to spend more and leave a smaller inheritance for their children—a mindset that is common in the West, but still not widely embraced in India.
We structured their portfolio into three silos. The first consisted of liquid or money market funds that would meet immediate expenses over the next year-and-a-half. The second set consisted of high-quality debt funds that would bring stability to the portfolio, and render returns that would beat fixed deposits on post-tax basis. The third, smaller set consisted of balanced funds to enable the portfolio to stretch for a longer period and beat inflation comfortably. By organizing the portfolio in this manner, we were able generate a regular monthly income that was mostly tax-free.
A systematic withdrawal plan (SWP) was set up from a liquid fund to meet immediate expenses and to create an emergency fund. An SWP is the reverse of a systematic investment plan (SIP). While an SIP takes away a fixed amount of money from your bank to invest in a certain fund, an SWP redeems a fixed amount of money from your investments and deposits it into your bank account. While SIPs can be used to create wealth over time, SWPs are used to distribute accumulated wealth across a length of time.
After the liquid fund gets exhausted, we planned to generate an income either from the debt or the balanced fund portfolio, bearing in mind the existing market conditions and the required asset allocation at that time. We assumed that the assets will grow at a certain rate over a period that will not only generate a steady income, but will also sustain inflation. The income drawdowns will also be a certain percentage of the assets, so that the rate of drawdown is lower than the rate of growth of assets. Clearly, the SWP strategy is best executed if the portfolio is carefully monitored so the assumptions made on portfolio return, inflation and income generation hold true.
Through the SWP, we fixed a predetermined level of income in the beginning of the year and revisited expenses frequently to check if the income funded those expenses comfortably. When expenses for the same basket of goods rose with inflation, we opened the tap a bit more, and increased the income flow. The income was tax efficient too, since the total drawdown could be staggered across years to manage tax liability effectively. Also, all income drawn from balanced funds could be generated tax-free after a year of investment. All income from debt could be indexed to inflation and taxed at 20%, if drawn after 3 years.
We structured the entire retirement portfolio for Mrs and Mr X with mutual funds. I haven't yet found a more elegant or optimal method of income generation and wealth creation than through mutual funds. Generating an income through an SWP is tax efficient, flexible, factors inflation, and compounds the portfolio better than traditional investments like fixed deposits and annuities.
With the average lifespan increasing by 1 year every 3 years, and retirement ages dropping to the early 50s, we need to open our minds to alternate investments that help our portfolio stretch till the end of our lifetimes. Else, forget about leaving money at the end of our lives, we may end up with too much life at the end of our money.
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