The accumulation phase in retirement planning is essential, but so is the spending phase. What if you spend too much in the initial years and run out of funds?
The 4% thumb rule can solve this problem. If you withdraw 4% of your portfolio each year after retirement, the kitty can last you at least 30 years.
For example, on retirement at 60, you have an investment of ₹5 crore. If you withdraw ₹20 lakh every year, or 4% of your portfolio, your money can last you until you turn 90.
A US-based financial advisor William P. Bengen first articulated the 4% withdrawal rate. He looked at historical data of stock and bond markets. He realised that if an individual withdraws 4% every year from the portfolio after retirement, the corpus will last for a minimum of 30 years, irrespective of market conditions.
It is a conservative approach towards making sure your retirement corpus doesn't get exhausted prematurely. When you're saving for retirement, there is also a lot of uncertainty about life expectancy, market performance, and inflation.
All of these have a direct impact on your investments. You need to be careful about how much you withdraw from it every year to meet your expenses.
The 4% rule tries to protect your savings from such factors by inhibiting retirees from withdrawing beyond a certain percentage from their corpus.
There are times when the thumb rule may not work. For example, a severe market downturn can significantly erode the value of equities in a person's portfolio. It may also not work if the retiree is not loyal to the rule every year.
A lot also depends on your asset allocation and investment avenues. If you are 100% in debt products, the rule may not work. When researching, Bengen looked at a portfolio of 50% equity and 50% bonds.
Equity, typically, offers a higher return than debt. If a person's retirement portfolio is not in equities, the withdrawal rate will need to be below 4%.
Use thumb rules as guiding principles and adjust things based on what works for you.
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