Prevention strategy

A retirement corpus is calculated from assumptions, and assumptions drift.

The prevention strategy is the workbook's first response to that. Do not wait to discover a shortfall. Go looking for it, early and repeatedly, while there is still time to do something about it.

It has two halves.

Review on a schedule. The thumb rules used in the early earning years — such as 70 percent of pre-retirement income — may not reflect what a person will actually need. So the assumptions behind the corpus have to be revisited periodically.

Rework after every life event. Any event that changes income or expenses in retirement changes the corpus required. A big raise that lifts the lifestyle. A medical condition. The death of a spouse.

The pay-off is time. Find the gap early and compounding helps you close it. Find it late and only bigger contributions can.

Why the first estimate cannot be trusted. Section 7.1 says it plainly: it is very difficult to estimate the expenses in retirement early on in the working years. The thumb rules used to size the corpus in the initial earning years may not truly reflect the actual needs. Needs, lifestyle expectations, the medical situation and other large expenses become clearer closer to retirement, and the corpus estimated at that stage is more accurate.

The two triggers for a review.

1. Periodic. Revisit the factors used in the corpus calculation at intervals, so adjustments can be made.
2. Event-driven. Rework the target every time there is a life event that has an impact on income or expenses in retirement. The workbook names three: an increase in income that will change lifestyle, a medical condition that means more health costs, and the death of a spouse.

The window the strategy exploits. The 5 to 10 years before retirement is the stage when other important goals have been met, incomes are likely to be high and expenses have stagnated. The workbook calls it the ideal time to ramp up retirement savings to bridge any expected shortfall, and suggests a budget to realise the higher savings that stage makes possible.

Why early beats late. Reworking the requirement periodically gives the individual a longer time period to make adjustments to the corpus. There is longer to accumulate and longer for the compounding benefits to add to it. If the need to change the target is realised only close to retirement, the advantage that time brings to bridging the shortfall is lost.

Where it sits among the alternatives. Section 7.1 lists four responses to a shortfall, and this is the first because it is the only one that costs the retiree nothing. The others are adjusting expectation (bringing retirement expenses down to fit the corpus), delaying retirement (which both lengthens the accumulation period and shortens the period to fund), and a second career.

Mrs Bhide, 42, had her retirement plan built at 32 on a thumb rule: 70 percent of her then-projected pre-retirement income. Two things have since changed.

Her income has risen faster than the plan assumed, and with it her standard of living. And she has been diagnosed with a condition that will need ongoing treatment for the rest of her life.

Both are life events of exactly the kind section 7.1 lists. She reworks the target.

She now has 18 years to find that Rs 90,00,000 of extra corpus. At the kind of return her portfolio is expected to earn, most of it can come from compounding rather than from her own pocket, and she raises her monthly contribution moderately to get there.

Now run the counterfactual the workbook is warning about. Suppose she had not reviewed anything and discovered the same gap at 56, with 4 years left. Compounding has almost no time to work, and by then the portfolio should be moving into lower-risk products as the pre-retirement stage requires. Nearly the whole Rs 90,00,000 would have to come out of four years of savings — or not at all, in which case she is left with adjusting expectation, delaying retirement or a second career.

Same gap, same person. The only variable is when she looked.

Chapter 7, section 7.1 (Bridging Shortfall in Retirement Corpus), opens with the Prevention Strategy and then gives the three alternatives in order. The section is short and structured, which makes it a reliable source of which strategy questions.

Expect: what is the prevention strategy (periodic review of the assumptions and a rework after every relevant life event), why is early detection better (longer time to accumulate and for compounding to contribute), and which stage is the ideal time to ramp up retirement savings (the 5 to 10 years before retirement). A case-study question may hand you a life event and ask what the adviser should do first — rework the corpus requirement, not change the investments.

• Prevention is about reviewing the target, not about investing more aggressively. Raising the equity allocation to close a gap is a different decision, and a risky one close to retirement.
• The 5 to 10 years before retirement is the ramp-up window, not the detection window. Detection is supposed to happen far earlier; that late stage is merely when the highest savings are possible.
• Death of a spouse is a listed trigger. Candidates remember income and medical events and forget this one, even though the workbook names it.
• The benefit of early review is time, not accuracy alone. The workbook's reason is that time allows both more contributions and more compounding.
• Prevention is one of four responses to a shortfall. The others — adjusting expectation, delaying retirement and a second career — are what is left once prevention has failed, so do not offer them as the first answer.
• A thumb rule is not wrong, it is provisional. The workbook uses the 70 percent rule itself in the early years; the error is never replacing it.