HYDERABAD: Fire (financial independence, retire early) is all the rage these days. There’s plenty of literature and attention given to the size of a corpus one should save to be financially independent. But if your goal is to retire early, the key also lies in keeping a limit on your annual withdrawals.
Among the options, the four per cent rule is popular, considered safe and is adopted globally. But it works on the premise that most of the savings comprise investments in stocks and bonds and hence withdrawals primarily include interest accruals and dividends.
Financial planners arrived at the four per cent figure using historical data on stock and bond returns over the 50-year period. But if your savings include sizeable bank deposits or small savings schemes, public provident fund etc, the percentage of withdrawals will have to factor in the fixed interest income component, unlike equities and bonds, where income is calculated based on hypothesis.
There’s no one-size-fits-all method to determine the withdrawal rate. Based on individual households’ expense, a conservative safe withdrawal rate should be arrived respectively to prevent depletion of retirement savings prematurely. Such a rate should be identified based on the portfolio’s value at the beginning of retirement. Knowing the withdrawal rate also informs how much you need to save for retirement.
Another alternative to the safe withdrawal rate is dynamic updating, a method that in addition to considering projected longevity and market performance, factors in the income you might receive after retirement and re-evaluates how much you can withdraw each year based on changes in inflation and portfolio values.
Irrespective of whether you follow a safe withdrawal rate or a dynamic approach, there are some do’s and dont’s to be followed. First among them is adherence to the withdrawal rate. If you adopt a four per cent rule, ensure not to exceed it even once to avoid a spill-over affect on the portfolio.
Second is keeping pace with inflation. One way is setting a flat annual increase of four per cent per year, which is the Reserve Bank of India’s inflation band currently or adjusting withdrawals based on actual inflation. The former provides steady and predictable increases, while the latter effectively matches income to cost-of-living changes.
Lastly, the pre-determined withdrawal rates may not work if your savings include high-risk investments, prone to market volatility.