How to keep ₹1 cr retirement portfolio going

Traditionally, financial planners assume a sustainable withdrawal rate of 4%. For a €1 crore corpus, that means translated €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 advisor and co-founder of Samasthiti Advisors, suggests the actual safe withdrawal rate is lower. Because the return of 4% takes into account unusually high returns on equity and debt in the 1980s and 1990s.

Returns on both equity and debt have been falling in India every decade. Also, the 4% withdrawal rate was used by planners in the US and imported for use in other regions without checking its validity outside US financial markets.

This is how retirement savings work

Financial advisors must consider several factors when planning for retirement, with inflation being the most important.

Assuming an inflation rate of 5%, you have to reckon with a payout rate increasing by 5% per year. In the example of a €1 crore body with €4 lakh deduction, you have to assume that €4 lakh is deducted in the first year but this increases to €4.2 lakh in the second year and so on.

The second big decision that the planner has to make is the investment of the accumulated corpus. Although there are some risk-averse people who want to put all their money in fixed deposits, financial planners generally assume that 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 offers stable but low returns in your portfolio, equity, which is riskier, allows your portfolio to grow. Once the payout rate and portfolio return are known, you can calculate how long your savings will last.

Historically, the stock market in India has returned an average 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 returns less than 12% or even has negative returns. As a retiree, you need income even in bear markets and are forced to sell some stocks or return funds at such times.

“Someone retiring in India in 1992 would see three very different decades of stock returns. In the first 10 years of its retirement (1992-2002), the total return on shares measured by Sensex was a disappointing 5.5%. Over the next 10 years (2002-2012) disappointment would turn into delirium as the stock markets returned over 17%. In the final decade of retirement, stock returns would be a good 12%,” writes Saraogi.

Given that both equity and debt returns have gradually declined over time, Saraogi has used returns to calculate possible “retirement paths” since 1980. He projected returns through 2036 on a conservative assumption — that they resemble the lower returns investors have seen since 2000, rather than the high stock market returns of the 1980s or 1990s.

“The bond corpus starts at a base of 100, with an asset allocation mix of 40% equity and 60% debt. All additions/reductions in the retirement corpus are monthly. The annuity corpus generates income each month, one withdrawal is made from the corpus each month, and the rebalancing of the corpus (to bring it back to its 40:60 equity-to-debt mix) also occurs monthly. The analysis ignores transaction costs and taxes,” writes Saraogi, outlining the methodology of his study.

According to Saraogi, using a 4% withdrawal rate means that about a third of all possible retirement paths will run out of money before the 30-year target period. Using 3% means that only 1/12 of those paths will expire, and a 2.6% RTP further reduces them to just 1 in 40.

“Based on adjusted return data, which accounts for falling investment returns, the safe payout rate for India is significantly lower than the conventional estimate of 4% – our study suggests around 3%. Anything higher and we will compromise the safety of a retirement portfolio,” writes Saraogi.

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

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

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