The basics numbers of saving, investment and life expectancy have changed and we all need to save more for old age
If you want your savings to be worth more, then you should invest more. It sounds like a joke, but it isn’t. Over the last few months, while analysing savers’ long-term projections and answering their questions, it’s become increasingly clear that most people do not save enough. This is not unique to India–financial advisors around the world have started talking about it. In the developed world, this is driven by the realisation that interest rates and the resulting income from fixed-income products could possibly stay at negligible levels for many more years, perhaps a decade or more.
In India, there are a range of reasons why savers need to save more, and interest rates are only one of them. Nominally, in terms of the number that your bank has written on your fixed deposit certificate, interest rates in India are quite high. However, anyone who understands even a little bit about savings and investments knows that this is an illusion and real interest rates over and above inflation are a fairly small one to two per cent. But even that’s an illusion. People’s personal inflation rates, especially as they retire and get older, are generally much higher than the official one.
What’s more, interest rates will likely head down. Raghuram Rajan is the rare RBI boss who was explicitly committed to maintaining a certain real rate of return. In the future, under a governor who is more accommodating to the low-interest cheerleaders, savers will probably have a harder time earning anything at all after adjusting for inflation.
What makes this worse is taxation on interest income. Even if you are in the 10% tax bracket, post-tax real returns from interest on deposits is barely neutral. In the higher tax brackets, it’s clearly negative. That’s the reality of interest income that few realise. None of this is going to change anytime soon and some of it is going to actually get worse. If, like most Indians, you are a believer in deposits, then you’ll just have to put in that much more to get out the same value.
However, that’s not the end of the story. What’s making this worse is longer life spans. In India, life expectancy at the age of 60 is now 17.8 years. As recently as 1990, this was 14.8 years. That large a change in the average means that some people–specially those with access to better nutrition and healthcare are living a lot longer. We can see this around us. It’s very likely that this trend will continue. The flipside is that your retirement kitty may have to last 25 or 30 years. To do this, your savings will have to earn better returns–which, as we’ve seen–is likely to be a challenge. Even if they can–perhaps for investors who have a reasonable equity allocation–there is no alternative to saving more.
Most people just save whatever they can, or they save some arbitrary number driven by tax saving needs. Instead, we’ll have to start projecting future needs and projecting backwards from there to see how much we need to save. The best thing to do is to be pessimistic in these calculations–assume that needs will be higher and returns lower.
This is for those who manage their own savings. For the millions who depend on statutory schemes like PF, the government should tweak the system to lead to higher savings and returns. In the last budget, there was an attempt to reform EPF that had to be rolled back in the teeth of protests. However, an increase in the EPF contribution or some other fundamental tweak is needed to ensure that those dependent upon it can cope with the changes that are taking place.
Longer lifespans and lower returns are a lethal combination for being comfortably off. All of us will have to recognize the threat and act sooner rather than later to manage it.