The 4% rule that can make your retirement money last long

April 23, 2021

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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