There was a write-up by the editor cum owner of a very popular website on Mutual funds. The writer has claimed that a retiree could invest his/her retirement corpus into balanced/Hybrid funds and withdraw 4% every year. The link to the write-up is here.
This got me thinking to check out the validity of this claim. Remember, in retirement, one needs to be prudent with money. It is like saying the river is 3 feet deep on average and I can easily wade through it. A person of 5 and a half foot tall walk across easily, right? WRONG. The statement hides the fact that there are one of two places where the river is 15 foot deep! Retirement planning is to ensure that the worst of market situation does not derail the plan. Old age is already miserable, let us not complicate it by becoming a pauper!
Back testing
Let us check out the claim by doing back-testing. I have selected SBI Hybrid fund regular plan Growth as this fund was launched 25 years bank 31 Dec 1995 and was one of the earliest balanced funds. I have downloaded the NAV data from the website of SBI mutual fund.
Case 1: Investment on 01 Jan 1996
I will assume that the retirement corpus is Rs. 1 Crore and it is invested as a lump sum on 1st Jan 1996. The systematic withdrawal will be once a year. Why not monthly SWP? That is to simplify the process and keep the table small and easy to comprehend. The assumption is the money will last 30 years. Every subsequent year, the withdrawal will be increased by the rate of inflation. The historical CPI inflation rate is taken from this source.
At the end of 25 years, the remaining investment is worth 3.78 crores which is far greater than the minimum required to cover the next 5 years which is 95.74 Lakhs. The expected value to support remaining years is the multiplication of the current year’s withdrawal and the remaining years.
Extreme volatility can be observed in the value of the investment and it has happened twice, once in 2000 and the second time in 2008. It is only for the brave heart to withstand such drastic the value of investments. It has been a good time to make the investment in Jan 1996. What happens if the start of investment is at the peak of a bull market? Will this still remain a good strategy?
Case 2: Investment on 01 Jan 2000
If one had done the investment in Jan 2000 at the peak of the bull market, the money would have run out by Jan 2012 in just 12 years!
Case 3: Investment on 01 Jan 2005
If one had done investment in Jan 2005, the situation after 15 years would have been very good with more than sufficient money for the next 15 years!
Case 4: Investment on 01 Jan 2007
If investment was done in Jan 2007, then the situation after 13 years would have been reasonable. However we see such volatility that on a number of occasions, the value of investment is much lower that the money required to cover future expenses. So again this is not for any normal person!
Conclusion
Post retirement, the most important thing for a person is to sleep peacefully with financial security. One cannot do investments where luck of timing and market performance becomes critical. It is better to use a bucket strategy with safe investment in one and prudent market exposure in the other. It is better to be safe than sorry!