Early retirement: exercise the power of choice by Priya Sunder

A big challenge for financial planners is to deal with instances of people dying too young. A bigger challenge is when people live too long. However, the biggest challenge is when they retire too young and live too long.

Let me explain. Earlier, it was normal for people to work till 60 and live till about 75. They had to plan for only 15 years of retirement. Today, many of my clients ask me if they can retire at 45. However, the average lifespan of men and women has increased. They say that the person who will live till age 150 is already born. So how does one plan to have a working lifespan of 20-25 years and a retirement lifespan of 50 years?

People who have ‘successfully’ retired have set themselves a clear path towards this goal, which involved meticulous planning. These people have chosen to be free from worries about whether they are in or out of favour with their bosses, whether they will get that big salary hike, or whether they can retain their jobs next year. It’s not that these people don’t earn any income after they quit early. Many start their own ventures or pursue consulting roles. The difference is that this income would only be a bonus and not a necessity for them to be financially independent.

One of my clients who retired recently while in his late 40s, said that the last 7 years building up to his early retirement were the most fulfilling. “Just the process of inching closer to my goal every passing month was my biggest motivator. Even the lifestyle cutbacks didn’t seem like a pain.”

For many, planning for a goal as ambitious as early retirement can mean compromises on several levels. It also contributes to stress because you are always watching expenses. In one such stressed family, my client’s wife took up home tuitions to supplement the family income just so the children wouldn’t be deprived of an occasional fancy dinner, holiday or extracurricular activities. However, cutting down on smaller expenses will not move the needle. It is the big-budget items like expensive holidays, cars, gadgets, or large-scale house refurbishments that one needs to be wary of.

If you are serious about early retirement, here are the steps to take in this direction:

1. Work with a financial planner to take stock of your current assets and assign the right asset allocation based on your goals and your risk appetite. Align your portfolio to the required balance a few times a year, preferably every quarter. The wrong asset mix could put you in a place you never wanted to be. Your composite portfolio must deliver returns that beat inflation comfortably, not just today but during your lifetime.

2. Review expenses regularly, focus on what you need to invest each year till retirement, and realign expenses accordingly. Certain items in your expense basket may grow at a higher inflation rate than others—such as travel, medical expenses or education costs. Recalibrate these expenses frequently so that your plan can accommodate those changes. Expenses may not drop after retirement—as many of the activities that we wish to pursue such as frequent travel or other hobbies may not have been possible during our working years, but will form a large part of the expense basket in retirement years.

3. Review the portfolio frequently. You must clean your portfolio of laggards at regular intervals. If there are changes in your circumstances such as unexpected big-ticket expenses or windfalls, you must realign your portfolio and put your plan back on track.

4. Your retirement portfolio must be flexible, tax efficient and liquid. Monetary assets will see you through your retirement comfortably, not illiquid assets such as real estate. You cannot count on rental yields or real estate returns to fund retirement expenses. Rental yields are on average about 3% in India and the return on real estate is anyone’s guess. Hence, most of your physical assets must be monetized before you retire.

5. You must be free of all liabilities before you retire. It’s hard enough to sustain large EMIs when you are generating a regular income. It becomes harder when there is no steady paycheck. Bonuses or any other one-time inflows should be used towards paying down loans.

6. Large unexpected expenses relating to illness, and loss or repair of physical assets can be a huge setback to your early retirement dreams. These are high-impact, low-probability incidents, but when they occur they can delay your retirement plan even by a few years. Healthcare costs increase at a rate faster than inflation. Ensure you have private medical insurance and critical illness covers that are adequate for future medical expenses, and not just today’s costs. Similarly, ensure your physical assets are insured. Fire, floods and natural perils can destroy assets, the replacement costs for which can be high.

7. Determine if there are gaps in life cover between your current assets and what you need to build towards retirement. Cover the gaps adequately with pure term insurance. Factor in the cost of all insurances in your overall annual expenses.

8. If you start a new venture after you retire, do not dip into your retirement fund. If you do so, you may be left with a corpus that struggles to beat inflation. Your monthly draw down may increase at a faster rate than the rate of growth of assets. If the assets are not large enough to meet your expenses, you may outlive your assets and become financially dependent.

For early retirement, you must lay the groundwork for an activity that fills some part of your day. It will enliven your social life and keep you gainfully engaged. One client who retired early grows his own organic vegetables, fruits and flowers and retails the proceeds in local grocery stores. He’s financially independent, enjoys what he does, and I am not worried even if he lives till a ripe old age. If you ask me, I’d say his life is a bed of roses.

Priya Sunder is director and co-founder of PeakAlpha Investments.