The 4% rule of withdrawal has long stood as a cornerstone of planning, advising retirees that their savings will last 30 years if they withdraw 4per cent of their retirement fund annually, adjusted for inflation.

As economic environments evolve and individual financial situations diversify, the one-size-fits-all nature of this rule is increasingly called into question. This article explores the limitations of the 4per cent rule and introduces a more nuanced approach to planning retirement finances, particularly for diverse investor profiles and different geographic economic conditions.

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The Simplicity and Shortcomings of the 4 per cent Rule

The 4per cent rule, originating from William Bengen’s 1994 study, assumes a balanced portfolio of 50per cent equities and 50per cent bonds. This allocation might not align with every investor’s risk tolerance, potentially exposing them to higher volatility or inadequate growth.

The 4per cent rule is also predicated on a retirement age of 65 and a lifespan extending to 98, assumptions that do not accommodate those retiring earlier and those who will need their funds to stretch further.

It also employs a static 2per cent inflation assumption, a figure that falls short in higher inflation environments such as India, where both inflation and returns are typically elevated.

Strategies should fit changing needs

Modern retirement strategies must consider several factors more comprehensively:

Sequence of Returns Risk: Continuing to withdraw aggressively when markets suffer a significant draw down in early years of retirement, can dent the longevity of the corpus by upto 10 years. This risk can be mitigated by adopting a staggered bucket strategy, ensuring that no withdrawals are made from equity investments in the initial 3-5 years of retirement.

Variable Inflation Rates: Recognising that inflation rates can vary significantly across countries and over different periods of time is crucial. For instance, higher inflation rates in India necessitate a different approach, factoring in local economic conditions and expected rates of return on investments.

Earlier or later retirement: Many youngsters want to retire earlier than 65 and many pre-retirees want to continue working as long as possible. Accommodating individual circumstances while coming up with a withdrawal plan is critical, else the investor runs the risk of leaving behind too much money which could have been used for a better lifestyle or the risk of running out of money when still healthy and raring to go.

Early planning: It is one thing to arrive at the point of retirement and then wonder how much you should have, or how much you should withdraw. It is a completely useful thing to begin planning well in advance for retirement. Knowing the goalpost helps to plan well. We need a way of figuring out well ahead of time how much to target given different risk profiles, changing return expectations and expected timelines.

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A New Framework for Retirement Planning

To address these complexities, we propose a scale to assess the corpus required, expressed as a multiple of current living expenses, based on the retiree’s risk profile and expected rate of return relative to inflation:

Conservative Investors: Those aiming for returns that align closely with inflation might consider a ratio of Rate of Return to Inflation Rate of 1. Meaning, they expect their investments to grow at the same rate of inflation. The corpus required would be based on the investor’s current age and planned retirement age.

Someone aged 30 planning to retire at 60 might need 85 times their annual expenses as corpus.

If annual expenses today are Rs. 10 lacs and if returns on portfolio matches inflation rates – then he / she will have a retirement target of 8.5 crores to accumulate over the next 30 years to generate a 10 lac equivalent annual income adjusted for inflation.

Moderate Investors: Those anticipating returns at 1.5 times the rate of inflation, will need less. For the same individual, the corpus required would be 68 times their current annual expenses.

Aggressive Investors: Investors expecting double the inflation rate in returns would require even less — about 56 times the annual expenses for someone aged 30 retiring at 60.

These scales assume life expectancy of 100 years, provide a more tailored approach, allowing investors to plan based on their unique financial situations and risk appetites.

Not Simple, But Nuanced

The traditional 4 per cent rule offers a valuable starting point for retirement planning but falls short in accommodating the diverse economic realities and personal circumstances faced b

y today’s retirees. By considering factors such as risk tolerance, varying inflation rates, and personal retirement timelines, retirees can adopt strategies that better protect their financial futures.

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As the financial landscape becomes increasingly complex, our strategies for planning retirement should become finer and more nuanced. This may not be as simple or inherently intuitive as the 4% rule, but is a more flexible and personalised approach. It not only ensures financial security but also aligns with the retiree’s lifestyle preferences and goals.

The author is a certified financial planner and co-founder and head of financial planning at House of Alpha Investment Advisers Pvt. Ltd.