Key takeaways
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Due to various circumstances, many of us may not be able to reach the ideal retirement target number
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To deal with this we work backwards from our net worth to know how much we can spend
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Ravi Saraogi’s research seems to suggest we can spend between 3 to 3.5% of one’s net worth to ensure a 95% plus chance your money will last through retirement
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Note that Ravi’s research seems to suggest that increasing equity allocation beyond a point could actually be detrimental to how much you can spend in retirement
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With an example 3 crore net worth, this means you can safely spend 9 lakhs in the first year of retirement. This amount can be increased by inflation for each following year
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If you have no option but to spend more than 3.5% of your net worth, you can do so but you are taking a greater risk of running out of money during retirement
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To give you a feel for the level of increased risk should you increase spending beyond 3.5%, I present a set of Monte Carlo analysis results.
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This way you can increase your spending with some clear data on the risk level being taken
Looking at challenges in the face & preparing for them
In earlier articles, I have explained how you can calculate how much you “ideally” need in order to retire. But that’s the ideal scenario and often all kinds of unexpected issues & circumstances hit us in life that cause deviations from the ideal.
What happens if, you started investing late, had other family, health or education commitments or for any other reason you’ve reached your retirement age & don’t have the “ideal” amount saved up / invested when you reach retirement?
Well, it’s simple. You just work backwards from how much you DO have. You fit your expenses to meet how much you have saved up at that time. In effect you cut your coat according to the cloth you have available.
Ravi Saraogi’s research
Research by Ravi Saraogi in the Indian context suggests that in the first year, you can safely spend between 3 to 3.5% of what you have. This spend rate, according to Ravi’s research ensures a 95% plus probability that irrespective of how the stock market performs during your retirement years (what’s called sequence of returns risk) you will not run out of money over a 30 year retirement period.
Below is a summary of his research findings.
The rows in the table below refer to varying levels of Equity vs Debt. The columns indicate the data for retirement periods of 25, 30 & 35 years. Given the increasing age to which people live these days, one is better off assuming a 35 year retirement period.
Notice in particular how with increases in equity allocation the safe withdrawal rate (SWR) increases but only up to a point & then starts decreasing. So, if you are interested in maximising the amount you can safely spend during retirement, it may not be wise to take your equity allocation much beyond 50%. This is contrary to what most advisors tend to recommend. In my experience, most advisors tend to recommend higher levels of equity allocation but as you can see from the data above, that may not be in your best interests.
Example: Amount one can spend with a 3 Crore net worth at start of retirement
Here’s how you can calculate how much you can spend in retirement: Let’s assume 3 crores is your net worth on the date you retire. So here’s what you can spend in the FIRST year of retirement assuming a conservative 3% withdrawal rate: 3,00,00,000 X 3 / 100 = 9 lakhs
What you spend the following (2nd year) year is what you spent in the preceding year increased by the rate of inflation. So if one assumes inflation of 6% per annum, the following year you can spend 9 lakhs X 1.06 = 9.54 lakhs
What you spend the following year (3rd year) is what you spent in the preceding (2nd) year increased by the rate of inflation. i.e. 9.54 lakhs X 1.06 = 10.11 lakhs and so on.
The table below shows the set of values for acceptable spending for the first 5 years or retirement for the above example.
If you would like a simple excel template to calculate how much you can safely spend today based on your net worth, email me on mezjan@investmentcoach.co.in
But what if the 3 to 3.5% spend figure is an unrealistically low expense figure for me?
This is not an ideal situation to be in and is truly a last resort. But if you absolutely have no choice and feel it is genuinely impossible to live within 3.5% of your net worth, then you spend the bare minimum above 3.5% of net worth but be aware of the potential risk you are taking by doing that.
What specifically is the risk you would be taking? An increased probability that your money will run out during your lifetime.
Increasing risk levels as you increase spend rate
The tables below are sample Monte Carlo simulation illustrations (based on data for India) of how the probability of running out of money increases as your withdrawal rate increases.
To read the data below just focus on the first column & the last column. The first column indicates the withdrawal rate used. The last column indicates the percentage of cases (i.e. 30 year periods) in which the money lasted a full 30 years. You can ignore the middle column but if you are interested, it is showing how much (on average) a 1 Crore corpus would have grown to during the 50 year period.
The tables that follow essentially show the above data for various combinations of equity & debt.
As you can see, the percentage of times you don’t run out of money keeps dropping as you increase the withdrawal rate.
You will observe from the data in the tables below, that a 3% withdrawal rate gives you a 95% plus chance that your money won’t run out over 30 years of retirement. A 3.5% withdrawal rate gives you around about a 90% chance and a 4% rate gives you about an 80% chance.
In the worst case scenario, you could decide on a higher than 3.5% withdrawal rate by looking through the range of numbers in the tables below and take a call on what level of risk of running out of money one is willing to take.
30:70 Equity debt Monte Carlo simulation data
The table below shows data for a person with 30% in equity & 70% in debt
40:60 Equity debt Monte Carlo simulation data
The table below shows data for a person with 40% in equity & 60% in debt
50:50 Equity debt Monte Carlo simulation data
The table below shows data for a person with 50% in equity & 50% in debt
60:40 Equity debt Monte Carlo simulation data
The table below shows data for a person with 60% in equity & 40% in debt
70:30 Equity debt Monte Carlo simulation data
The table below shows data for a person with 70% in equity & 30% in debt
Lastly, if you end up spending more than 3.5%, in parallel, one needs to look at ways of enhancing one’s skills to be able to activate other sources of income through work of some kind.
Disclaimer: I am not a financial advisor. My articles are meant for people who are not savvy or well versed with personal finance and investing and find it difficult to grasp all the jargon typically used when discussing such topics. I hope to be able to demystify investing and make it as simple as possible for everyone. I’ve invested in Mutual funds for approx. 24 years. I’ve also been a diligent student of the subject of investing over the past 24 years learning & applying the writings of luminaries in the field. In these articles I’m merely sharing my experience & learning from that investing journey and the books of luminaries in the field in the hope that it might help others in some way. I am in no way directly or indirectly claiming to be a hot shot investor who has generated exceptional or even above average returns during my investment journey. However, I am quite confident that even if all you do is learn from my mistakes, educate yourself on sound investment principles & develop good financial habits you will benefit greatly. Please ensure that you consult a financial advisor before taking any decisions or actions concerning your personal finances or investments. I shall not be liable.