How to keep ₹1 cr retirement portfolio going

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When people retire at the age of 60, they generally have to plan for 2-3 decades of non-working life. Those who retire earlier have even longer to contend with. This planning is complicated by the fact that expenses increase every year due to inflation.

Traditionally, financial planners assume a 4% sustainable rate of withdrawal. For a 1 crore corpus, this translates to 4 lakh in the first year and higher amounts in later years due to inflation. However, a new study by Ravi Saraogi, a Sebi-registered investment adviser and co-founder, Samasthiti Advisors, suggests that the actual safe rate of withdrawal is lower. This is because the 4% return takes into account unusually high equity and debt returns in the 1980s and 1990s.

Returns on both equity and debt have been falling every decade in India. Also, the 4% rate of withdrawal has been used by planners in the US, and has been imported for use in other geographies without an examination of their validity outside the US financial markets.

How retirement planning works

Financial advisors have to consider several factors while planning for retirement, inflation being the most important.

Assuming an inflation rate of 5%, you have to plan for a withdrawal rate that increases by 5% every year. In the example of a 1 crore corpus with 4 lakh withdrawal, you have to assume that 4 lakh is withdrawn in the first year, but this increases to 4.2 lakh in the second year and so on.

 

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The second big decision that the planner must make is how to invest the accumulated corpus. Although there are some risk-averse people who want to keep all their money in fixed deposits, financial planners generally assume some money can be invested in equity and some money in debt. A 50-50 equity-debt split or a 40-60 split is common. The idea is that while debt provides steady but low returns in your portfolio, equity, which is more risky, will allow your portfolio to grow. Once the withdrawal rate and the portfolio return are known, you can calculate how long your savings will last.

Historically, the stock market in India has given an average return of 12% over very long periods, but it cannot be used to calculate the withdrawal rate. This is because the stock market is volatile and there will be years when it gives lower than 12% returns or even negative returns. As a retiree, you need income even in bear markets and you are forced to sell some stocks or redeem funds during such times.

“Someone retiring in the year 1992 in India would witness three very different decades of equity returns. In the first 10 years of her retirement (1992-2002), the equity returns as measured by Sensex would be a disappointing 5.5%. In the next 10 years (2002-2012), disappointment would turn to delirium with the equity markets delivering a return of over 17%. In the final decade of retirement, the equity returns would be a good 12%,” Saraogi writes.

Noting the fact that both equity and debt returns have been falling gradually over time, Saraogi used returns since 1980 in order to calculate possible ‘retirement paths.’ He forecasted returns up to 2036 using a conservative assumption—that they will be similar to the lower returns that investors have got from 2000 onwards rather than the high equity market returns of the 1980s or the 1990s.

“The retirement corpus starts at a base of 100, with an asset allocation mix of 40% in equity and 60% in debt. All additions/reductions in the retirement corpus happen on a monthly basis. The retirement corpus accrues income every month, a withdrawal is made from the corpus every month, and re-balancing of the corpus (to bring it back to its 40:60 equity to debt mix) also happens on a monthly frequency. The analysis ignores transaction costs and taxes,” Saraogi writes, outlining the methodology for his study.

According to Saraogi, using a 4% withdrawal rate means that around one third of all possible retirement paths run out of money before the 30-year target period. Using 3% means that only 1/12th of such paths spills out and a 2.6% withdrawal rate further cuts it down to just one out of 40.

“Based on adjusted return data that accounts for falling asset returns, the safe withdrawal rate for India is materially lower than the conventional estimation of 4%—our study pegs the same at broadly 3%. Anything higher, and we will put the safety of a retirement portfolio in jeopardy,” Saraogi writes.

Some financial planners use alternative methods of planning. “We normally calculate the withdrawal rate for only the debt portion of a client’s portfolio. We use a rate lower than the post-tax return on the debt fund or instrument. For example, if the post-tax return on a debt fund is 6%, we might use 4 or 5% as the withdrawal rate,” said Suresh Sadgopan, founder, Ladder 7 Financial Advisories.

However, most financial planners agree on a withdrawal rate that is lower than your return rate—allowing some money to get reinvested and grow your corpus.

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