Investing VRS funds -- A tricky balancing act

Suresh Krishnamurthy

Half of all current workers have never tried to figure out what they will need when they retire.

Half of those who try to make those calculations do not succeed in coming up with a figure. -- Mathew Greenwald, Mathew Greenwald and Associates, quoted in the report on National Summit on Retirement Savings, US.

THE spotlight is now brighter than ever on saving/investing for retirement, with the slew of voluntary retirement schemes launched by a number of public sector banks. Saving or investing for the post-retirement period is probably one of the most complicated exercises in investment planning. While the value of many kinds of investment planning can easily be demonstrated quantitatively, the value of retirement planning cannot be that easily measured.

The latter part of the quote at the beginning of the article aptly sums up the tricky issues involved in retirement planning. Even if investors try to plan ahead, they are unlikely to come up with satisfactory numbers. For one, the period for which an investment is made is not known, as life expectancy cannot be ascertained accurately. Similarly, other relevant factors, such as taxes and inflation, also come loaded with uncertainties.

Overall, this makes planning for retirement considerably complicated. So much so that the original plan may prove quite useless if not changed periodically in tune with altered circumstances. However, the perils of not planning for retirement, being caught off-guard by an illness, for instance, are equally frightening.

VRS: Equally complicated

Investing the proceeds from a voluntary retirement scheme as part of retirement planning is equally complicated. Persons who receive VRS proceeds can be divided into two sets of investors. One would include those still in a position to work and earn a regular income. Such people might seek to deploy their VRS proceeds now for eventual retirement later. The other set would include persons who have actually retired with the VRS, and are seeking to invest in assets to hold their retirement wealth.

The investment objective for the latter is more amenable to a precision in planning than the former. This is because of the relatively lower degree of uncertainties. This set of investors, whose age-group is likely to beyond 55, is likely to have fulfilled some of life's objectives, such as education of children, their marriages, building a house, and so on. In their case, investing VRS funds is essentially a subset of retirement planning.

Earning and investing

For the other set of investors, still in their mid-forties, many of life's objectives may remain unfulfilled, requiring substantial changes in the plan. For them, investing the VRS funds may be a subset of not only planning for retirement but also planning for other major events in their lives. In other words, only a portion of the VRS funds would be available for retirement planning.

Retirement planning

Overall, both class of investors have to take account of the following factors that are important in planning for retirement.

They are:

*income at present and expected future income

*existing assets

*taxes and inflation

*expenditure at present and that expected *estimated life expectancy

The present income and expected income are important factors. Most people receive only a proportion of their present incomes post-retirement even if they are in a job that provides pension post-retirement. Thereafter, along with existing assets and expected return on them, the level of future incomes can be ascertained. The incidence of taxation could then be considered to find out the income available to an investor and if it would cover his expenses.

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Focus on expected income

These incomes need to be measured against the expected expenditure of investors. Once again, post-retirement expenditure is normally only a proportion of pre-retirement expenses. Again, care must be exercised before arriving at a figure that is relevant and reasonable. This estimate needs to be adjusted for inflation.

For example, suppose the monthly expenditure is likely to be Rs 10,000 at today's costs, retirement is 15 years hence, when the rate of inflation may be 5 per cent on an average. At that time, expenditure post-retirement is likely to be of the order of around Rs 20,000, 15 years hence.

An investor has to measure his expected income against such expected expenditure. Thus, the investment plan for the VRS funds would have to be drawn up so as to bridge any shortfall. Here is where the estimated life expectancy of the investor assumes importance. Indeed, life expectancy varies from person to person and cannot be foretold accurately. However, this factor does determine the nature of suitable investments.

A person expecting to live for more than 20 years after retirement has to be more careful in creating his portfolio than a person whose life expectancy is about 10 years. Achieving clarity in the case of estimating life expectancy is difficult, but has to be attempted. The investment plan has to be drawn up such that it will not only meet the shortfall in expected income but also generate a surplus that will account for inflation, post-retirement.

Risk preference

Both expected shortfall and life expectancy dictate an investor's risk-preference. If there is no shortfall, investors can take relatively higher risks. If the shortfall is rather large, they cannot afford to be adventurous in their investing. Similarly, higher life expectancy post-retirement requires investors to be extra careful about preserving capital.

Not all of those facing retirement may be fortunate enough to have their expected income match that from invested VRS proceeds. The objective of planning is to discover if there would be such a shortfall during retirement. And if the plan indeed suggests such a shortfall, investors have to explore other options.

Generally, for all investors -- whether earning now or not -- it would help to curtail consumption now to generate surplus that would help them meet post-retirement expenditure. If they are in their mid-40s and still planning to be employed, it directly translates into saving objectives from their incomes earned in the pre-retirement phase. For others, incomes earned from assets need to be conserved now.

(The concluding part of this article will be published on February 11, 2000).