Do such schemes really work? Invest ₹10 Lakhs a year for 10 years and then get an income of ₹20 Lakhs per year thereafter!

A scheme like this sounds very attractive, where a certain amount is to be invested for a few years and then you get double the amount every year for perpetuity. First point to note is that if these are market-linked schemes, then no such guarantee of returns can be given in accordance with market regulations. In this article, we delve into whether such schemes are viable at all, from a purely theoretical perspective, for educational purposes only.

From finance theory, we have the formulae for time value of money calculations for fixed-term annuity as well as for a deferred perpetuity. Now, we are interested in knowing: what is the required annual rate of return to make such a scheme possible in theory? To arrive at that, we need to equate the present values of all the contributions and payouts, which when simplified gives us the required annual rate of return r for the time t in years for such a scheme to work:

r = 3^(1/t) - 1

For t = 10 years, r works out to be around 11.62% p.a.

The important thing to note is that the rate of return needs to work out to be at least 11.62% p.a. throughout the contribution period as well as withdrawal period to make this scheme work. If this does not seem feasible, the contribution period needs to be increased by a few years, so as to decrease the required rate of return. Alternatively, the payout period needs to be decreased to a few years instead of forever, and this will also decrease the required rate of return, though a different equation needs to be applied to arrive at it. Another important caveat is that if during the contribution / SIP period even if investment is made in equity-oriented funds to generate higher returns, as we move closer to the withdrawal / SWP period, the corpus amount needs to be shifted in stages to a less volatile category such as hybrid funds. Otherwise, withdrawing directly from a depleted equity-oriented fund during the occasional and unpredictable market crashes, may redeem disproportionately more number of units than expected.

In reality, contribution and withdrawal requirements are seldom so linear. Normally, over the SIP period, investors would like to top-up their contributions every year as their earnings rise. And during the SWP period, investors would like to withdraw more each year to keep up with inflation for their expenses. So, in summary, the best course of action would be to consult a financial planner well-versed in financial concepts, who can create a detailed customized plan suited to your specific requirements.