Early Retirement / Investment / Retirement Plan

Our Early Retirement Plan – Part 3

Slow and Steady

You can read an overview of our retirement plan here. Part 1 covered how we planed our retirement date and open questions around location, health and children expenses. Part 2 covered the thought process behind defining our ‘retirement number’ in this post. This is Part 3 of our early retirement plan. I will discuss how we plan to invest our savings to reach our retirement number.

When we had our retirement number, we had to figure out the approach that would suit us best. This might not be the approach that will generate the maximum returns. But the risk/return in the approach is something we will be comfortable with.

Asset Allocation

We plan to split our investment into 3 categories – Real Estate, Savings/Debt and Equity. While doing this we want to minimize tax – both on our income now and later when we start withdrawing money. We also want to diversify into different asset classes to minimize long-term risk. For now, since our portfolio excluding real estate is not big, I will not be monitoring asset allocation closely. Our focus will be on how we split our savings between equity and debt/related asset classes.

Real Estate

The real estate part is something I don’t want to consider as an investment, rather as a hedge against when we need to buy our retirement home. Most of our current savings will be used for buying real estate. Our thoughts now are to spread this across 2 different locations to diversify risk because we do not yet know where we want to retire. So the idea is to buy now and sell later just before retirement. This should give us enough money to build land & build or buy a ready to move in retirement home.

What should we buy: The next question is what should we buy. We can buy stand alone houses, ready to move in apartments, under construction buildings, residential land or commercial buildings. Rental returns for residential building are a measly 2% – and this is pre-tax! So not something that sets your blood racing. We decided to stick to residential land since we do not want the hassle of insurance, tax, maintenance and managing tenants. I also believe that land will have a better value appreciation compared to buildings.

Where should we buy: We are looking to buy in Tier 2 towns or rural areas as I believe we will retire in a similar area. So the price appreciation should be similar and I hope will be a better hedge. Residential land in bigger cities is terribly expensive and way outside our price range anyways.

Risks: The first risk is that our estimate of what our retirement home would be worth now might be wrong. The second risk is that the hedge might backfire with our chosen location not keeping up with the growth in other regions. I believe we are managing the first risk by taking a 20% higher value than what we will need now. We are managing the second risk by investing in 2 separate Tier 2/Rural locations. We do not want to split our investments more since that not give us enough to buy properties that we like.

Equity

This is a no brainer. When you want to grow wealth investing in equity is a must. The Indian economy is growing, India has a humongous middle class and the % of population < 40 is increasing. All of this points to a growth story that we should piggy-back on. Further the governance has improved over the last couple of years though there are concerns on job creation. But on the whole we believe in the Indian growth story and will invest heavily in equities. Excluding real estate, we will invest 80% of our savings in equity.

Mutual Funds: We have multiple options within Mutual Funds in India – Index vs Managed, Multi-cap vs specific and so on. I believe that index funds have still not reached the stage where they make more sense compared to managed funds. They still do not follow the index close enough and the fee is similar to managed funds that can be bought direct. The higher ROI in managed funds makes this decision easy for us. We are currently investing in 4 MFs and they are a mix of large cap, mid cap and balanced funds. This, we believe, helps us diversify while give us the benefit of growth across the spectrum.

From a tax perspective, MFs can be sold 1 year after without any tax implications and this is perfect for our retirement plan. Last, but not the least, we use monthly SIP to automate our investment. Mutual funds will take up at least 70% of our investments in equity.

Individual Stocks: A maximum of 30% of the funds that are marked for investment in equity will be used to buy individual stocks. This will be either via IPOs or via stocks that we research and pick ourselves. We are open to value wherever we find it – irrespective of sector and size. I am executing both monthly investments in some stocks while other are 1 time investments when there is good value.

Debt/Savings Account

We are looking to invest 20% of our savings in this class. There are multiple options here again and I will discuss the our the chosen few.

Employee Provident Fund (EPF): This is the star in this asset class. 12% of your basic pay is invested automatically in this. This is matched by your employer. The interest rates in previous year have been >8%. Both of us qualify for this and we are including this as part of our investment even though it is deducted before salary is paid out. The cherry on top is that it is EEE – this means the original principal invested is tax-deductible, the interest earned is not taxed and finally the withdrawals are tax-free too. Since this is government regulated investment, there are restrictions on the funds you can withdraw before the traditional retirement age of 60. This is ok for us, since we will have other sources we will have until we can use the funds from our PF account. We need to keep an eye on interest rates and whether interest is still paid for idle accounts (no deposits after we retire)

Public Provident Fun (PPF): This is our 2nd choice since this is also EEE. Even though this account has options for premature withdrawals, we intend to leave our deposits in for the full 15 years. From the 20% of savings, the amount remaining after our contribution to EPF will be invested in PPF.

NSC/Debt Mutual Funds: When & if our PPF limit of 1,50,000/year is exhausted, we will look at National Savings Certificate (NSC) or Debt Mutual funds as our next investment option. Between these,

  1. Investments in NSC are tax-deductible
  2. Interest earned from NSC is taxable. If you hold debt funds for a minimum of 3 years, capital gains will not be taxed.

So the decision here will be if we think debt funds can give us similar returns to NSC.

Emergency Fund

I believe in having an emergency fund to cover expenses for 6 months. These will be placed in fixed deposits (FD) that can be linked to our savings accounts for liquidity purposes. Both our banks allow us to break FDs when required – with an interest penalty of course.

Expected ROI

I am expecting we should get around 12-15% from the equity Mutual Funds and around 10-12% from the stocks we pick. I will monitor our performance vs the Mutual funds across a couple of years and check if our investment splits can be improved. The ROI from PF/PPF are fixed by the government and are dependent on prevailing interest rates. These are generally around 8.5% in the recent past. Inflation has been lower in the recent past and the central bank has been reducing reserve ratios and interest rates as a result. This will impact returns from PF & PPF too, but we will continue to invest 20% in these since they will always be higher than the rate of inflation. Considering these different ROIs, I will be happy with us achieving 10% ROI overall. This will allow us to invest without looking for lucky investments and without taking high risks.

Wrap Up

To wrap up, there are a load of open questions on location, expenses related to children and health care where we need to think about more. The positive is that the major item on our retirement home is in progress and we should have our investments covered within the next 12 months. The negative is that all the open questions will impact our retirement number and we have to be prepared to think about either moving our retirement date or improving our savings rate (currently around 60%).

We are in a good place now and are slowly walking towards our happy place.

What are the investment avenues that you are considering in your retirement plan? What changes/additions would you propose to your plan?

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