Archive / Investment Adviser (Level 2) / Miscellaneous Aspects of Retirement Planning

nism-series-xb-required-portfolio-return-fund-shortfall[ INVESTMENT ADVISER (LEVEL 2) ]

In Case 4, Mr. Smart has a retirement corpus of Rs. 40,00,000. Since the present value of his retirement shortfalls at a 5% discount rate is Rs. 80,18,710 (exceeding his Rs. 40 Lakhs corpus), what approximate annual portfolio return must his Rs. 40 Lakhs corpus earn to fully meet all shortfalls over the 27-year retirement period?

[ A ]6.00% p.a.

[ B ]7.50% p.a.

[ C ]14.50% p.a.

[ D ]9.90% p.a.[ CORRECT ]

Takeaway

To fully fund the 27-year shortfall stream from a starting Rs. 40 Lakh corpus, the required internal rate of return is approximately 9.90% p.a., so option D is correct.

Derivation

Since the present value of shortfalls at 5% (Rs. 80,18,710) far exceeds the available Rs. 40,00,000 corpus, a plain 5% return is insufficient; the corpus must instead earn a materially higher rate to keep pace with the escalating shortfall stream over 27 years. Solving via Excel's Goal Seek or IRR function on the corpus against the projected shortfall cashflows returns approximately 9.90% p.a. This question tests the practical skill of backward-solving for a required rate of return once a funding gap is identified, and probes whether candidates recognise that closing a large PV gap over a long horizon needs a return well above the discount rate, not just marginally above it.

Why the others fail

A — 6.00% p.a.

At 6.00% p.a. the corpus falls substantially short of matching the escalating shortfall stream and would be depleted well before the end of the 27-year horizon.

B — 7.50% p.a.

7.50% p.a. is still insufficient to bridge the compounding gap created by 6% inflation on living expenses outpacing the corpus's growth at that rate.

C — 14.50% p.a.

14.50% p.a. is an unnecessarily aggressive, high-equity-style return assumption that is not actually required to meet the goal, overstating the needed return.