In this article we will address a common question from investors:
Can I run a SWP from an equity mutual fund in retirement?
We will add two conditions to this:
the fund chosen is an index fund. It is difficult to do this analysis with an active mutual fund since there are so many funds each behaving unpredictably year-on-year
the equity fund is the only asset in the retirement portfolio
Due to the lack of data for the Indian market, we use Monte Carlo simulation using Nifty 50 Total returns index data since 1999 to model 1,000 retirement paths for SWR ranging from 1% to 5% at 0.5% intervals.
Sample portfolios - 4% SWR / 25x expenses
We will assume that the first yearās withdrawal to be a value between 1% and 5%. The withdrawal amount will be increased by inflation every year. As a practical example, we will take
starting portfolio of one crore
ā¹2.5 lakhs expense in year one; 2.5 * 1.07 = ā¹2.675 lakhs expense in year two etc.
since SWP is a standing instruction, we will edit the withdrawal amount in the mutual fund portal once a year to adjust for inflation
Start
ā¹ 1,00,00,000
Withdrawals ā¬ļø
ā
Year 1
ā¹ 2,50,000
Year 2
ā¹ 2,67,500
Year 3
ā¹ 2,86,225
Year 4
ā¹ 3,06,261
Year 5
ā¹ 3,27,699
We define āsuccessā as ending with a non-zero portfolio, i.e. not running out of money, after a 30-year retirement with an SWR between 1% and 5%. As per the definition of SWR, the starting portfolio value is 1/SWR. So in terms of the first yearās expenses, a 4% SWR is 1/4% = 25x expenses.
Example: success case
(click to open in a new tab)
This case leaves behind a ā¹4 crores corpus for the heirs.
Example: failure case
(click to open in a new tab)
This case runs out of money around halfway into retirement.
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Results
We run 1,000 such simulations for each of the SWRs and calculate the number of cases where there is a non-zero portfolio value after 30 years.
(click to open in a new tab)
Here the āNearly failedā case is equal to an ending value less than or equal to one-fourth of the starting value. Since the starting portfolio is ā¹1 crore, any ending value less than ā¹25 lakhs is a near-miss. At 7% inflation, this ā¹25 lakhs has lost its purchasing power to just ā¹3.2 lakhs in 30 years and will, depending on the SWR, pay for only a few months to a year of retirement expense in the 31st year.
The conclusion is quite clear:
the higher the starting corpus i.e. lower the SWR, the higher the chance of completing retirement
Below 3.5% SWR, the chance of finishing retirement exceeds 80% or 4 times out of 5
At 5% SWR or with only 20x expenses as retirement corpus, there 3 times out of 10 chances of failure by running out of money
Caveats regarding the analysis
we have assumed that the next 30 years behave like the previous 30. Any changes in how the relative risk and returns of the stock market will change the result considerably
the Monte Carlo simulation assumes that the returns follow a Normal distribution where falls are just as likely as rises in the market. In the real stock market, falls are more frequent or further than rises
In a future article, we will cover the following two cases:
combining an equity SWP with two buckets: cash and income
equity SWP with a pension plan - for example, an NPS corpus at 60 where you need to buy an annuity with 40% of the amount and have an option of investing the remaining 60% in an equity fund. We have completed that analysis and the results are not promising for NPS subscribers.
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This post titled What happens if you do an SWP from an index fund in retirement? first appeared on 28 Sep 2022 at https://arthgyaan.com
