Investments & Financial Planning

Estimating retirement corpus – Learn the thumb rule to calculate

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How much should I save for my retirement and when should I retire?

These two questions are like uninvited relatives. One cannot chase them out but at the same time got to treat them special.

Americans love numbers to the extent that they measure everything with a pinch of stats (cups of coffee consumed or the number of honks, in key F, their gas-guzzling cars have blared – I am not sure what is the use of the latter one). No other country loves numbers like America. Every part of their life, however trivial it could be, is bombarded with statistics. In my opinion, most of the stats (commercial ones) are influenced by marketers to increase market share, destroy competition, and ultimately drive “unlimited profits” to the shareholders!

I will talk about these mind-blowing trivial statistics and how convoluted logic is used to pursue one’s agenda – in another article.

Right now – another thumb rule is on your way. And that is “4% Rule”!

What is the 4% Rule?

The retirement pool or fund is no exception to the whirlpool of stats. Amongst them, the “4% rule” is probably the simplest. This rule answers the fundamental question of what should be the size of your investment portfolio when you retire? The rule helps you plan for a corpus that would enable you to enjoy the current lifestyle till your last breath. Generally, one lowers his/her standard of living after retirement. If you plan well in advance and accumulate enough corpus, maintaining your current standard of living should not be an issue.

Then let’s delve into the mechanics of it.

First step is to define your current & retirement lifestyle.

Second step is estimating your yearly expenses to maintain your current lifestyle and then make adjustments to reflect changes in your post-retirement lifestyle.

Third step is estimating your retirement age and arrive at the “corpus” amount.

Define Your current & retirement lifestyle.

This should be your retirement corpus when you retire. You must invest this sum – say 50% in equity and 50% in bonds. Collectively it can give an average of 7% yearly returns.

Let us say you retire at the of 60 and this corpus will take you through for another 25 to 30 years. You can start withdrawing 11 lacs from the corpus in the first year.

How Inflation affects Retirement Corpus?

You might ask what about inflation? That’s a very important aspect that can jeopardize any financial plan. The 4% rule is built in such a way that you can withdraw enough money to maintain the same lifestyle despite inflation, say 3 to 4%. So, you can withdraw in the second year an amount of (11 lacs + 33K for inflation) and third-year withdrawal will be 11.67 lacs and so on.

Caveats

    • This is just a thumb rule – consult your financial advisor for detailed advice.
    • This corpus is only to maintain regular expenses. Any extraordinary major expenses like college admission, children’s wedding is not covered. One should create separate funds for them.
    • Financial discipline is paramount – DO NOT withdraw big chunks from the corpus. This will affect future earnings and might lead to financial distress.
    • Not applicable in hyperinflationary economies like Venezuela.
    • Pension is not considered

Although there have been several studies to indicate 4% rule sufficiently takes care of ups and downs in the economy. However, for many skeptical and conservative investors like me 4% rule might not be good enough. I personally would go for the 3% rule. That means I will start my retirement with a corpus of around 3.67 crores instead of 2.75 crores. Arriving at the corpus amount is just a start – one needs to carefully manage his investment portfolio by reviewing periodically and suitably adjusting/reallocating assets as and when required.

Do let me know your thoughts in the comment section.

Read also: Double your Money

Deepak Kanchi is a Chartered Accountant. He also attended GMP at University of Chicago Booth School Business. He has worked in India and Middle East in various Finance roles. Currently he is based out of Bengaluru. He has wide range of interests from science to management to history.

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