Withdrawal Strategy Post Retirement

For most of you, the difference between going for an international vacation or looking for a local and cheap outing in your retirement will totally depend upon how soon you start saving. It is not the ‘timing’ that is more important while investing in any of your financial goals, but it is actually the ‘time’ that you give to the investment. Compounding, which according to the great Albert Einstein is the eighth wonder of the world, plays a major role in making your investment grow.


Therefore, if you think that you are quite young to worry about the retirement, think again and look around, you may find people who have insufficient amount for savings and are instead cutting corners to meet their ends. Therefore, undoubtedly, retirement planning should be your utmost financial goal. In India, many of you believe that your children will take care of you in your golden days. You should be clear that your children are not your retirement fund. It will be a mistake to assume that they will share your retirement burden. Hence, start saving now and let your hard-earned money work harder for you.

The importance of the retirement planning is becoming even more significant with the advancement of the medical field, which is leading to an increased average life of an individual. Hence, the earlier you know the amount you need at your retirement, the less painful transition you will experience in your golden years. It will help you in amassing enough corpuses, so that you outlive your savings instead of the other way round. More importantly, many of us are employed in a private sector, which means you do not have choice for a state-sponsored pension. This means you are on your own when you are retired and hence, it is in your hand to design an achievable path for your retirement fund.

What is the ideal amount you should withdraw after retirement?

After understanding the importance of planning for the retirement, carefully work towards creating your retirement corpus based on the various assumptions and enjoy sitting at the desired corpus at the time of your retirement.

Thankfully, now that you are sitting at the desired corpus, the next question would be as to how much you should withdraw every year from your corpus, so that you do not outlive your retirement corpus.

Conventional wisdom says you can take 4 per cent from your savings the first year of retirement, and then that amount plus the amount of inflation for each year, without running out of money for at least 3 decades. The idea of 4 per cent rule dates back to 1990s, when California-based financial planner named William P. Bengen proposed it in 1994. According to this rule, if they withdraw 4 per cent of their nest eggs the first year of retirement and adjust that amount for inflation thereafter, their money would last at least 30 years.

For example, if you retire with Rs.2 crore in your portfolio. In your first year of retirement, you withdraw Rs.8 lakh. (Rs.2 crore x 0.04 equals=Rs.8 lakh.) The following year, you withdraw the same amount, adjusted for inflation. Assuming 4 per cent inflation, you should withdraw Rs.8.32 lakh (Rs.8 lakh x 1.04 equals=Rs.8.32 lakh).

Then, Rs.8.32 lakh figure might be more than 4 per cent of your remaining portfolio, depending upon how the markets fluctuated during your first year of retirement. Don't worry about that—you need to calculate 4 per cent only once.

Sanctity of 4 per cent

Mark Twain observed, “All generalisations are false, including this one!” The value of our investments and the amount we spend every year, is much dynamic, often due to the forces outside our control. Moreover, these studies are based on the historical returns of the US market and the study was done more than 25 years back.

The rest of the story will try to identify how much money you can spend each year in the retirement plan with a backdrop of the Indian context, along with the latest historical returns of different asset classes.

The Study

To arrive at an appropriate level of withdrawal from your retirement corpus, we assume different scenarios where you have invested in different asset classes and at different proportions. We have also assumed that you will use mutual fund as an investment tool. Therefore, all the exposure to equity will assume that you have invested in large-cap dedicated fund. Similarly, all the debt returns is calculated based on the assumption that you have invested in long duration debt funds. For example, cash component of your retirement fund is assumed to have been invested in liquid funds. The historical returns are calculated for the period during 2004-2019. To calculate inflation, we have taken Consumer Price Index (CPI) of the same period. During some of this period, we had double digit inflation, such as in year 2013.

Once these historical returns are calculated, we work on different scenarios where a retiree has parked his investment. We also assume that the retiree will have a life span of at least 78 years, if he retires at the age of 60. However, most likely, we will live till the age of 85 or maximum of 95 years. After that, we ran a Monte Carlo Simulation 5,000 times to check different scenarios. We have further assumed that your retirement corpus is Rs.20 lakh.

Scenario 1

Invested only in stocks: This type of retiree is an aggressive investor and has other backups too. He will only invest in large-cap dedicated equity mutual fund. So if he withdraws 4 per cent from his retirement corpus every year, in 94 per cent of cases, he can easily manage with this withdrawal.

The following graph shows the simulation of 3,000 cases out of total 5000 cases to explain as to what will happen if a retiree withdraws at 4 per cent withdrawal rate from portfolio constituted of only equity mutual funds. The black line shows the amount remaining even after a retiree dies. Besides, there are some cases where the retiree will have corpus in excess of Rs.3 crore even after his demise.


The following table shows the result of simulation in case of a different withdrawal rate. The average outcome means, out of all the simulated lives, on an average, a retiree will have that amount in his retirement corpus. Similarly, minimum outcome shows the worst case scenario whereas; maximum outcome shows the best case scenario. Therefore, if equity market has a good run then, you might leave more than Rs.3 crore for your heir.



Scenario 2

Invested only in debt : If a retiree is a conservative investor and do not believe in taking any risks; in his retirement days, he will invest only in debt funds. These investments show lower volatility in returns and almost no negative returns in the duration of 3 to 5 years. At a 4 per cent withdrawal rate in almost 13 per cent of the cases, you might outlive your retirement corpus. Below, there is a graphical representation of the simulated lives.


The following graph shows different withdrawal rate and the related information.


Scenario 3

Invested in combination of debt and equity:

If a retiree is a moderate risk taking investor, he invests in a mix of debt and equity. We have assumed that 50 per cent of his retirement corpus goes into equity and rest 50 per cent into debt. This type of asset allocation will help you to contain the loss that a pure equity investor had suffered in the year 2008 and 2011; however, it also limits the exponential gain of 2009 and 2014. Nevertheless, the aim of retiree is not the wealth maximisation and hence, can choose this asset allocation. At a 4 per cent withdrawal rate, there is not a single chance where you outlive your retirement corpus. Below, there is a graphical representation of the simulated lives.


The following graph shows different withdrawal rate and the related information:


Conclusion

It is important for all of you to be clear that these success rates are based on returns history of only 15 years, which may be a very short period. These 15 years include some of the black swan events such as the period of 2008 that saw value of equity falling by more than 50 per cent in a year.

Moreover, going forward, there is very low likelihood that we will see inflation in double digit which was the case in 3 out of 15 year period of our study period.

Nonetheless, we have tried to overcome this with simulation of more than 1,000 times that covers most of the likely scenarios.

Hence, our study clearly shows that if you are a retiree with good health 4 per cent withdrawal rate with investment in mix of equity and debt, it will help you to live comfortably during your retirement without the fear of outliving your retirement corpus. In other cases, there is a little chance of outliving your retirement corpus.