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Does the 4% SWR rule work in India?


19 Jun 2022 - Contact Sayan Sircar
7 mins read

The article investigates if you can retire in India with only 25x your expenses saved as retirement corpus.

Does the 4% SWR rule work in India?

Table of Contents

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 40 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.

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 160 such windows from Apr-1979 to Mar-2009, May-1979 to Apr-2009 etc., until Jun-2022.

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) 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.


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Results of the simulation

The following graph shows the portfolio ending values for the 4% rule applied to historical data with yearly rebalancing.

SWR Rule for India

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
  • the failure of the periods ending 2022 may be attributed to the recent fall in equity markets since October 2021

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.

Related:
This article discusses what is rebalancing and why you should do it.

This graph shows how rebalancing, even after taxes, reduces overall risk.

SWR Rule for India without rebalancing

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)
Different SWR for India for 30 years in retirement

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
  • rebalancing in retirement between the various asset classes is a must. It reduces high losses while marginally reducing the highest profits. Here is a guide on rebalancing: Portfolio rebalancing during goal-based investing: why, when and how?
  • 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.

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This post titled Does the 4% SWR rule work in India? first appeared on 19 Jun 2022 at https://arthgyaan.com


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