Working in the capacity as an investment advisor, I have
been asked multiple times by many clients and prospective clients on how they
can manage their financials to make their retirement as stress-free as
possible, not to depend on their children and live a comfortable life in the
end. Well today I would just like to bring to your attention on why retirement
planning is important and how can an individual save for his/her retirement.
I was attending a seminar here in Lahore (Pakistan) on
pension schemes being offered by various asset management companies and a
dialog from the speaker really moved me which was and I quote “If you are
failing to plan, you are planning to FAIL!” If one really pays attention to this quote, you will soon realize that
your future should be important to you and planning for it should be on your
agenda. No matter how old you are, it is important to pay attention towards
your retirement funds. When you are young, you may not even think of retiring
or getting older and may not realize the importance of this aspect of financial
planning. This is where a young person like myself should start thinking about
investing in a pension scheme. Your pension may be your sole income when
you get older and therefore should be a priority in your younger years. If the
company you work for does not have a pension plan, then you should start
investing on your own so that you do have an income to fall back on. It is important to have a pension so
that when you reach the age of retirement you will have enough money coming in
each month to cover the cost of your bills and allow you to live comfortably.
You want to spend time with your family and have money enough to travel if you
wish.
In the US, there are pension plans in the form of 401K plan
and in the UK there is a national pension program by the name of The State Pension, but sadly in Pakistan
up till 2007 there were no pension plans being offered to the general public. Living
in Pakistan has its downfalls in the shape of negligible pension fund schemes
offered by private institutions and government sector pension not being
sufficient to cover basic expenses. An individual like myself should consider
other options on how to save for retirement. There are two ways in which you can set up a pension scheme account for
yourself. The first method is fairly straight forward, in which you save for
example 10% of your monthly salary and put it aside in an interest bearing account
which should accumulate a fair amount at retirement. The other way is the one I
would advise all my clients and prospective clients to take which is a defined
contribution plan. A defined contribution plan is a plan whereby the employee
himself directs the employer where he would like the firm to contribute towards
his pension plans. In case the investor is not a salaried individual or an
entrepreneur, s/he can set up a private pension scheme. One of the advantages in living in Pakistan
now is that, major asset management companies are offering personalized private
pension plans where an individual would select his or her asset allocation
amongst three board categories i.e. equity, debt/income and money market.
Equity being the most riskiest offering highest returns and money market being
the least riskiest offering nominal return in line with the inflation rate. The
overall target of these schemes is have a good inflation adjusted return so
that once a person retires, he may live comfortably. These private pension
schemes are helping individuals in our state to create a better retirement for
themselves.
I would like to take
this opportunity and explain to you the power of compounding and why you must
start saving for your retirement at an early age. Let’s take an example to
understand this phenomena better.
Mr. X is currently 25 years old
Mr. X wishes to retire at the age of 60.
Mr. X has 35 years to retire
If Mr. X were to save Rs. 5,000 a month for
the next 35 years, given that his retirement fund grows at the rate of 13%, Mr.
X will have Rs. 42,159,195
Whereas if Mr. X were 45 years old, he would
had to save Rs. 76,691 in order to reach the same amount keeping other
variables constant.
There are some key
facts you will need to consider before setting up your retirement fund which
are as follows:
1)
Your
current age
2)
Expected
retirement age
3)
Life
expectancy
4)
Years
after retirement
5)
Current
earnings
6)
Expected
annual growth (in %) in income
7)
Rate of
return on retirement fund
8)
Inflation
rate
9)
Inflation
adjusted rate of return (Real rate of Return)
After calculating
the above factors, you will need to find out the amount required to save in the
retirement fund. The components involved in deriving this figure are:
1)
Number
of years to retirement
2)
Rate of
return during accumulation phase
3)
Any
existing pool of money set aside for the retirement fund
The motive behind
listing these components is to explain that it is not merely accumulating
millions of Rupees for retirement rather the right retirement fund is one which
helps you maintain your standard of living even after retirement.
A word of caution to
all investors seeking to invest in their retirement is that, contribute each
month / quarterly or annually. You may think that skipping a period of
contribution will not make a difference, you might be wrong. Systematic
investing instills discipline and this is the key to accumulating a good
retirement fund. Planning and saving for your retirement is an ongoing process and
it does require discipline, self-study and time. The earlier you start the
better it is as you can gain from the power of compounding as well as aim for a
high return. Once you start contributing to a personal pension fund, you don’t
have to worry about losing your money. All the funds are held in a trust for
you until you reach your retirement age. You can choose to receive your pension
as a monthly income or you can choose to receive a lump sum payment. Please
note that once you decide that you want to save for your retirement, you do
need to seek the advice of a professional financial planner who can help you
make the right choices and help you decide how much money you should invest in
your pension by any frequency which best suits you.
