Microsoft founder Bill Gates, famously said, “If you are born poor, it is not your fault. However, it is entirely your fault if you die poor.”
Gates’ comment was not out of whack. If you do your retirement planning well in advance and systematically, you could end up being self-sufficient and financially independent in your retirement years. The earlier you start retirement planning, the better it is.
Understanding the 555 Rule for Retirement
Every person wants to retire rich, or have enough to last a lifetime. Today, having a sound retirement corpus is not about hitting the proverbial pot of gold or inheriting a fortune. You can actually invest money on a regular basis to achieve the goal of a comfortable life after retirement. All that’s required are discipline to start early and the persistence to stick to the plan.
What the 555 rule says is that if you start investing a small sum of Rs 5,000 a month at the age of 25, then after 30 years, at age 55, you can end up with a corpus of Rs 2.64 crore. We are not assuming some supernormal or outlandish return here. Just a humble 12 percent compounded return (per year). Your first reaction would be to immediately use an online SIP (systematic investment plan) calculator and verify this claim.
Incidentally, this SIP will end up with just Rs 1.76 crore and not Rs 2.64 crore as promised in the example above. That brings us to the third 5 in the formula, which is the 5 percent extra annual accretion in your SIP, or what you can call the 5 percent annual step-up. In simple words, increase your annual SIP contribution by 5 percent.
With this, the plan called Retirement 555 formula falls into place.
Also read: Retiring in a few years? Don’t skip de-risking your retirement corpus for sequence-of-return risk
It actually works
Let us get back to the illustration of an SIP of Rs 5,000 at the age of 25, for 30 years up to the age of 55. We add a caveat that this will be a step-up SIP with 5 percent annual SIP accretion. Your income is going to increase over time, and you need to save out of such increases.
When you input the 5 percent step-up, the target is actually achieved. At a 12 percent compound annual growth rate (CAGR) return, if you start saving Rs 5,000 per month in an equity or index SIP and increase your contribution by 5 percent each year, your corpus when you turn 55 would be Rs 2,63,67,030 or nearly Rs 2.64 crore. That is an amazing learning, as to how such a small contribution each month with small increases each year can result in such a large sum. In this case, the total investment over 30 years is Rs 39.83 lakh, while the balance Rs 2.23 crore is the investment return generated over 30 years.
Can I retire earlier using Retirement 555 formula?
Let's say you want to retire at 50, instead of 55. Is it still possible to create a corpus of Rs 2.64 crore? There are three ways it can.
1. Enhance the monthly SIP, or
2. Enhance the annual accretion, or
3. Increase the returns through higher risk.
Let us keep the 5 percent annual increase constant and change the other two. Here are two scenarios.
In Scenario 1, if you assume a higher CAGR return on the SIP, how much higher do you need to go for the same corpus at the age of 50? If you want to achieve Rs 2.64 crore at age 50, you just have 25 years, going by the starting age in the example. Now, you must grow the money at 15.95 percent CAGR to reach Rs 2.64 crore by 50. That almost sounds impractical.
Also read: In your 30s to 40s now? Here’s how to reach Rs 10 crore by 60
The other, easier, option would be to increase the starting SIP amount and then increase it by 5 percent each year up to the age of 50. How much should the starting SIP be, if we keep returns at 12 percent CAGR? You must now start with an SIP of Rs 9,700 per month and increase it by 5 percent each year. That means you need to double your starting SIP.
If you want to retire early, enhancing the return is not feasible and higher escalation may not be practical over the long term. However, you may then have to start off with a much higher starting SIP or mix a higher SIP contribution with a slightly higher return assumption!
Also see: MC30: The best mutual funds to invest in
Do not delay your retirement planning
The most important factor determining your retirement corpus is time—the more the better. It is best not to compromise on time. Let us look at it practically.
If you start at the age of 25 with a starting SIP of Rs 10,000 and increase it by 5 percent each year, even at 12 percent CAGR returns, you end up with Rs 5.27 crore at the age of 55. Interestingly, this corpus doubled in the last five years, so that is the story you miss by cutting your investment time. The rule is to start retirement planning early and sustain it for around 30 years. That is when Retirement 555 really comes to fruition!
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