This article shows the maximum withdrawal in SWP form that you can take out from a retirement portfolio to make it last 30 years.
Does the 4% SWR rule work in India?
You are reading this article.
How much retirement corpus is enough?
Retirement, like death and taxes, is inevitable. There are very few professions, like doctors or lawyers, where the retirement date is not well defined since these professionals can work for as long as they wish or can. However, for salaried employees, each offer letter has a well-defined retirement date known when the employee starts the job. Retirement, as we have argued before, is the one financial goal for which you cannot take a loan solely because you do not have any income to pay it back.
Hence, investing for retirement is an unavoidable financial goal for most of us, leading to the inevitable question: How much retirement corpus is enough?
This article will examine the popular SWR rule for determining whether a retirement corpus is enough in India. We will use historical data to simulate checking what possible SWR values are for India.
Background on the Trinity Study and the 4% SWR rule
…the Trinity study is an informal name used to refer to an influential 1998 paper by three professors of finance at Trinity University. It is one of a category of studies that attempt to determine “safe withdrawal rates” from retirement portfolios that contain stocks and thus grow (or shrink) irregularly over time - Wikipedia.
The Trinity study said, using US historical stock and bond market data from 1925 to 1995, that:
if your annual expense in the first year of retirement is X
AND if your retirement corpus is 25X
THEN your corpus will last 30 years in retirement
WHILE you grow that expense of X / year as per inflation
Since X/25X = 4%, this is the origin of the name ‘4% rule’. Effectively a stock and bond corpus where you withdraw 4%, i.e. the Safe Withdrawal Rate or SWR, in the first year and keep increasing the withdrawal rate with inflation, and then the portfolio lasts 30 years.
The following points must be kept in mind before using the 4% rule:
the data period was until 1995. Almost 30 years have passed since then
bond yields were a lot higher in the US before the 2000s
the study only works for a 30-year retirement
The section below will examine how the 4% rule works for India.
Did you know that we have a private Facebook group which you can join for free and ask your own questions? Please click the button below to join.
Historical data for India
Unlike the Trinity researchers who had access to data from 1925, we have a stock market index only since 1979, which means that we have just above 40 years of data, given that Sensex’s historical value goes back only to April 1979. Coupled with this, since we are running a 30-year simulation, we have a limited number of windows to run the simulation. We have 180 such windows from Apr-1979 to Mar-2009, May-1979 to Apr-2009 etc., until Jan-2024.
We use PPF data to proxy for debt fund returns and a standard 60/40 equity/debt asset allocation. We use realistic assumptions for taxes assuming a 10% loss due to tax on yearly rebalancing and 5% tax on selling monthly. We take inflation at 7%.
At the beginning of each window, we start with a one-crore portfolio. However, this starting amount does not really matter since we work in percentage terms, and any figure can be chosen without changing the result or conclusion. We keep 60% of the amount in equity (represented by Sensex TRI) and 40% in debt (using PPF returns). Every month we withdraw a small amount from the portfolio for monthly expenses. This monthly amount over the first twelve months is the SWR.
We will check three metrics:
% of cases where the portfolio does not run out of money in 30 years
the maximum value of the portfolio at the end of 30 years for all the
simulations
the minimum value of the portfolio at the end of 30 years for all the simulations
The minimum value is the most critical metric since it tells us how close that case came to running out of money in 30 years.
The following graph shows the portfolio ending values for the 4% rule applied to historical data with yearly rebalancing.
A few observations:
over time, the returns have steadily reduced
the risk exposure in the portfolio remains constant at a fixed allocation (e.g. 60/40) to both equity and debt. This observation flies against the opinion of many investors that equity allocation has to be reduced in retirement
We will show a case where the portfolio is not rebalanced annually for curious readers. As evident, both the positive and negative ending values are more than the rebalanced case since the dampening effect of systematic rebalancing is absent.
This graph shows how rebalancing, even after taxes, reduces overall risk.
A few observations:
without rebalancing, the debt component goes to zero more frequently. This result is expected since rebalancing transfers profits continuously between equity and debt, allowing buying low and selling high
the entire portfolio variation is due to the equity portfolio movement. The investor has zero control over this section, and it behaves like a 100% equity portfolio risk-wise
Compilation of results
We now repeat the simulation with various SWRs from 4% (25x) to 2% (50x), both with and without rebalancing, and produce the results below:
(click to open in a new tab)
The above table shows, without doubt, that for a 30-year retirement:
The 4% rule does not work in India
Other notable points are:
higher the corpus saved before retirement and the lower the SWR, the better are the chances to last the entire retirement
this data takes 30 years as the retirement horizon. Due to rising longevity, for most people, retirement will be longer than that
interest rates are falling globally, and the return from the debt portfolio will reduce over time
Indian stock markets are just over 40 years old. There is not enough data to meaningfully analyse various economic situations, especially long-term sideways markets or consistently low-interest rates
Under such a situation, the only alternative available to investors is to invest as much as possible using a calculator like goal-based investing retirement tool to create and review their retirement portfolio at least once a year.
What's next? You can join the Arthgyaan WhatsApp community
You can stay updated on our latest content and learn about our webinars.
Our community is fully private so that no one, other than the admin, can see your name or number. Also, we will not spam you.
For resident Indians 🇮🇳:
For NRIs 🇺🇸🇬🇧🇪🇺🇦🇺🇦🇪🇸🇬:
Share on WhatsApp:
To understand how this article can help you:
If you have a comment or question about this article
The following button will open a form with the link of this page populated for context:
If you liked this article, please leave us a rating
Disclaimer: Content on this site is for educational purpose only and is not financial advice. Nothing on this site should be construed as an offer or recommendation to buy/sell any financial product or service. Please consult a registered investment advisor before making any investments.
This post titled Does the 4% SWR rule work in India? first appeared on 19 Jun 2022 at https://arthgyaan.com
