In conclusion, financial planning focuses on accumulating corpus while earning money. In retirement planning, you make the best use of the retirement fund. It is simple, but it is easier said than done, hence this deep dive. By design, financial planning determines savings and makes suitable investments when you work. On the other hand, you cater to non-earning years of life in retirement planning. Here the focus is to make your money work for you. We acknowledge that financial planning is a vast subject and incorporates retirement planning. However, it is still vital to understand the two separately to appreciate how retirement planning differs from financial planning.

Most importantly, the epicentre of each phase is different – people work in financial planning vs money work in retirement planning. The basic premise for financial planning is to earn, save and invest. On the other hand, the foundational thought in retirement planning is to ensure that savings and income (from those savings) are more than expenses and last until you live.

In other words, while we often interchange financial planning and retirement planning, there is a fundamental difference between the two. We will go through both concepts in detail and understand the differences through this note.

Financial planning – the concept

Financial planning is broader than retirement planning and is more present in nature. A financial plan is the immediate savings and investment plan based on the current incomes and expenditures. It is all about how much you earn, what you invest, and what you can afford to expense. In addition, the plan involves making certain strategic investment decisions to secure the financial future of you and your family.

A robust financial plan encapsulates all the aspects, such as:

1. Investment management – making the correct investments
2. Tax planning – optimizing taxes, not necessarily tax saving
3. Insurance (life and health) – subscribe to insurances and ensure timely payment of premium
4. Contingency planning – always keep an emergency fund
5. Debt profile – loan means interest costs; therefore, you must make the best use of debt and minimize costs
6. Cash flow management – to ensure you have money when you need it
7. Retirement planning – ensures your money lasts longer than you

As you can see, a well-rounded financial plan covers retirement planning as one of the focus areas. That is because retirement is the most crucial phase of life. Therefore, financial planning can never be successful unless you have made a solid retirement plan.

Investors must understand the nuances of a financial plan. It is essential. But, at the same time, it is also imperative for the investors to understand what could stop them from achieving the set objectives. Knowing the disruptors will allow investors to plan in advance and probably mitigate the same or reduce the impact.

What could derail a sound financial plan?

We often observe that investors miss addressing some of these potential roadblocks while making a financial plan. These may not affect you negatively, but there is no harm in knowing the bad boys:

1. Postponement of mandatory savings – start to save as soon as you earn
2. Unnecessary delay in implementing the investment strategy – immediately invest the savings
3. Not exercising self-restraint in expenditure – exercise control over outflows
4. Consider savings that are impossible to achieve – never grossly underestimate the expenses to make a financial plan look good on paper. Eventually, you will end up missing on the corpus, and it may be too late before you know it
5. Miss out on the long-term perspective – we are talking about 20-40 years from the time when planning happens, so work with a broad horizon

Split the goals for focused planning

You must split the objectives by time to sort the thoughts and ease the process. That is the foremost step in creating a robust financial plan.

First, determine the short-term goals. For instance, pay-off debt, create an emergency fund, make a monthly expense budget etc.

Secondly, determine the medium-term objectives. For instance, buy a life insurance policy, subscribe to health insurance, down-payment for a home loan, pay off a home loan, education fund, etc.

Thirdly, determine a long-term target, which is primarily about the retirement and estate planning

And finally, make a focused investment plan for every specific goal.

The importance of financial planning in the Indian context

Financial awareness is very limited in India for historical reasons. The earlier generations did not prefer to involve the younger generation in discussions related to money. Maybe, they were right, and the approach made sense then.

But the times are changing now, faster than ever. More nuclear families lead to decentralized decision making. A growing middle class, higher level of education, and the more need for resources increase the need for financial planning. Improving life expectancy due to better standards of life, technological advancements in medical sciences demands better insurance coverage, larger retirement corpus.

Employers are reducing the terminal benefits and shying away from defined benefit plans. That makes it critical for people to adopt sound financial planning, mainly because India does not offer good social security. There are systems and schemes available, but those are not enough.

No plan is a perfect plan, and no method is ideal. And, the idea is not to make a water-tight plan. Instead, start by determining the goals and begin to chase them.

Planning is about predicting the future, which is highly uncertain, so never feel bad if an unplanned event occurs.

Learn from the experience, make adjustments to the plan and move forward. Remember, there is no reward to forecast the obstacles, as no one can do it. But, there is undoubtedly a reward in the form of higher returns when you overcome pitfalls fast and continue the investment journey.

Do remember to read about how to make a financial plan by yourself. That detailed note will guide you and ensure the process is smooth. Forming a financial plan requires sound knowledge and understanding of investment management concepts. Do not feel shy to seek professional advice in this process if you need any.

What is retirement planning?

Retirement planning is to prepare for the phase of life that exists beyond the earning years. A retirement plan is about financial aspects, but it often includes non-financial facets such as lifestyle, place to settle, family status, insurance coverage etc. A well thought out retirement plan considers all possible financial and non-financial factors.

The amount of emphasis on retirement planning differs through different life phases. A general expectation would be to focus on retirement only closer to the years you are about to retire. However, there is merit in reconsidering the strategy and plan for retirement from an early age. Read on how to prepare for retirement at an early age and its advantages.

Why do retirement planning at all?

The most straightforward answer to this question is that you will stop earning one day. But you will need resources to lead a happy and healthy life. And since the resources are limited, you need to do retirement planning.

A good retirement plan will ensure that you live as you desire during that chapter of life. If this is not a sufficient reason, which we doubt, here are a few more to persuade you to consider planning for your retirement:

1. Better life expectancy demands more money (i.e. larger retirement corpus) for you to last longer. However, because you need more resources subsequently, you cannot increase inflows on your own – unless you have a magic wand! That said, it essentially means your need better investment planning for a larger corpus with the same inflows.
2. Saving money is possible only when you are earning
3. Life is not always straightforward, there will be emergencies, and you must be financially prepared
4. Retirement is the golden era of life, and you want the best out of those years. You have worked hard through the working years. Now you want to visit all the beautiful places you saved as your desktop screensavers. And you need money to fulfil that dream. That is one gift you want to give yourself and your family. Otherwise, what’s the whole point in working so hard all your life and making all the sacrifices?
5. Interest rates are sliding down, and relying on interest income is risky. Therefore you must diversify your investments and develop multiple sources of income
6. Living with children should be an option and not the only option – a financially secure retired life will provide you with the independence you deserve
7. To contribute to society and support the cause you believe in
8. Leave behind a legacy

How does retirement planning work? A step-by-step guide

The importance of retirement planning is a given. If you are not convinced yet, I urge you to re-think the above pointers. If yes, here is a step-by-step approach to guide you through the process of how to plan for retirement:

Evaluate the available time horizon

As a start point, determine the available active earning years. The process is simple for salaried folks, prescribed the retirement date. Self-employed people must boil down to age until they think they can work full steam. The next step is to gauge the years’ post-retirement, life expectancy. One can’t forecast life, so we should assume the average life. Of course, the life expectancy will be different based on your circumstances. Still, any reasonable assumption is acceptable as there is no right or wrong here.

Establish the risk tolerance level

It means you must know the amount of risk you can take while making the investments. Your financial and family background, i.e., the assets you own, liabilities you have, number of dependents etc., play a significant role. Further, the more years to plan for retirement, the higher the risk tolerance. And vice versa.

Determine living expenses

The next step is to find out the household expenses. The costs will change as you transition from the active life phase to the retirement phase. However, the quantum may not necessarily change significantly though. For instance, medical costs may replace transportation costs.

Focus on medical outflows

Generally speaking, such expenses form part of routine living expenses. However, it would help if you focus on planning for medical expenses. The idea is not to derive the exact number (as it’s impossible) but to keep a special fund for medical costs when you plan. In addition, life expectancy is increasing, given the technological advancements. Consequently, outlays on medical needs are on a constant rise. Therefore, medical costs can be significant in some cases and require proper attention. Also, ensure that you subscribe to medical insurance.

Calculate the corpus

Based on the living expenses, compute the target corpus required to meet those expenses. Give due consideration to the state of inflation, long-term expected rate of return (directionally, you will have a sense), tax rates, etc.

First, assume a life expectancy of approximately 80 years. Second, expect a 5-6% increase in the cost of living per year, including the cost of insurance and other premiums. Third, assume a maximum of 6-7% per annum (pre-tax) return on investment. Lastly, make the calculations based on the right retirement age.

As a thumb rule, retirement target corpus = 500-700 times the monthly household expenses

Make an investment plan

Identifying future living expenses is a crucial step. However, the immediate next step is even more critical. You have to save the right quantum and invest the money to accumulate the desired corpus. A well-crafted investment strategy and timely assessment of the progress is also necessary to meet the financial target.

Create an emergency corpus

One must expect the unexpected. Therefore, we recommend creating an emergency corpus equal to 12-18 months of living expenses to deal with contingencies. Keep this fund outside the scope and, over and above, the retirement planning exercise.

Key learning from 2020 is to maintain liquidity.

Liquidity refers to the ability of the seller to liquidate the assets. Generally, we assume that an efficient and fair marketplace exists, allowing assets to be bought and sold easily and quickly. The more organized the market is, the more liquid the assets are.

For instance, we consider financial assets like shares to be highly liquid. As a result, investors can easily trade in shares at the prevailing market rates with minimal transactions cost and convert money to cash almost instantly.

Unfortunately, many other assets do not have a similarly efficient marketplace. Therefore investors must assume sufficient time lag and higher costs to convert. For example, consider a real estate asset. Suppose the investor has an immediate cash requirement, like a medical emergency. In that case, the investor cannot immediately convert the house or piece of land to cash at a reasonable cost.

What differentiates retirement planning from financial planning

There are many similarities, and financial planning includes retirement planning. However, there is a difference between the two.

Income vs No-income

The phase of life where you do not have an active income is the retirement phase. Now, this may not be true for all as investors may have an alternate source of income, and inflows could continue. However, what we refer to here is the primary source of income.

Further, the financial plan assumes that you will have a continuous source of income until the age of retirement. The assumptions for income growth would depend on the work and a few other factors.

How to manage money at hand vs Will the money last?

In financial planning, you know the income and make assumptions using your knowledge. However, since the reference point is immediate, the data points are reasonably known. For instance:

1. How much should you invest
2. The retirement age
3. Know your goals like the child’s education cost, marriage expenses, holidays, etc.

In retirement planning, the time horizon starts after a relatively long period. Firstly, you can never be sure about factors outside your control like interest rate reduction, inflation, increase in medical costs, etc.

Secondly, you might have estimated a retirement corpus and may have saved that money. Still, you may be left with insufficient resources if some of the assumptions you made do not turn out to be true.

And finally, a retirement plan is based on a particular mortality assumption. Life is uncertain, and you may be left without money if you outlive the corpus.

Build vs preserve

Another critical difference between financial planning and retirement planning is in the purpose. In other words, the objective of the two is different.

When you have an active income (i.e. the financial planning stage), the emphasis is to grow investments and build assets. Further, you could have availed debt to aid the asset acquisition. In that case, the focus is to reduce the leverage and save the interest costs. In conclusion, you build the assets during the financial planning phase and repay any loans availed to create the asset base, if any.

On the other hand, the focus during the retirement planning phase is to preserve the assets and the investment portfolio. Even before that, the objective is to manage expenditure from the income from assets. And after that, the focus is to preserve the portfolio.

Possibility to course-correct reduces over time

Financial planning happens today, but the plan is for the long term. You will get a chance to course-correct the investment over the years. If you started the investment journey early, most likely, you would be able to catch up and still meet the corpus target, even if there were a few misses.

In the case of retirement planning, your money works for you. The corpus is already in place when you reach that stage. Therefore, there is a minimal possibility to make any big-time adjustments at this stage. For instance, you assumed a 7% annual return on the amount invested while deriving the corpus amount. Now, for reasons outside your control, the interest rate drops to 2.5%, severely impacting the inflows. In such a case, there is minimal opportunity to make any correction to increase the corpus size at that stage.

In conclusion

Retirement planning and financial planning share similar characteristics. A financial plan is a broader term and includes retirement planning. But that’s where the similarities end.

A financial plan is immediate, and the focus is to plan savings and investments to meet the long-term financial goals. For example, one goal could be to accumulate a large retirement corpus. On the other hand, the retirement plan focuses on preparing you for the retirement phase of life.

As we started, financial planning is when you work for money, while retirement planning is all about money working for you.

Happy financial planning!

About the author

The author is a senior finance professional with over fifteen years of work experience in corporate finance. He has an affinity for matters relating to personal finance and investment management. The author wants to share his knowledge and understanding of the subject through his writing.

Please leave your comment or share thoughts on this article via email at decodefinance.in@gmail.com. For more articles, please visit the website www.decodefinance.in.

Disclaimer

The author has used his knowledge, experience, and understanding of the subject and has exercised extreme caution to avoid possible mistakes. However, the author does not take responsibility for any error that exists.

 The article’s views, opinions, and thoughts belong solely to the author and not necessarily to the author’s employer (past or current), organization, committee, or other group or individual.

 Under any circumstances, the author shall not be liable for any views or analysis expressed in this note. Further, the opinions expressed are not binding on any authority or Court. We advise readers to consult their financial advisor for assistance in their specific case.