A reader says, “How do we forecast returns on a diminishing retirement corpus? My corpus presently returns 13% annually. I have calculated my withdrawal rate in retirement as 2% per year. So, in theory, my corpus would increase by 11% per year in retirement! But, as the corpus starts depleting, I expect the returns will gradually reduce from 13% annually. How do I factor that gradual reduction in expected returns into my retirement calculations?”
I am afraid you are looking at the problem with the wrong lens. The present return of your corpus has no bearing on its future return. You cannot expect the same 13% return to continue, especially since a good chunk is due to the bull run. There will be poor phases when the equity returns or negative over a few years.
The primary question you should ask is how robust your corpus or asset allocation and diversification are to withstand this. We also recommend expecting not more than 9% post-tax from equity in retirement.
Remember that we can use equity to beat inflation in retirement only if the corpus is large enough. Your withdrawal rate of 2% (annual expenses divided by corpus) is excellent. So you can afford to take on “some” equity exposure, but please do not overdo it.
Essentially, I am trying to say that this statement, “So, in theory, my corpus would increase by 11% per year in retirement!” is incorrect. There could also be some pretty poor years in there when your corpus decreases in value due to market movements and your redemptions.
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This statement, “As the corpus starts depleting, I expect the returns will also gradually reduce from 13% annually”, is not entirely correct. The rate at which you will withdraw and the rate at which the remainder of your corpus grows are not (directly) related. The former is governed by inflation and life circumstances. The latter is by the economy and market movements and, of course, your asset allocation.
The overall portfolio return is expected to go down in retirement because, typically, equity allocation will decrease as we age. Assuming you have factored this into your retirement calculation, nothing further needs to be done (assuming your return expectations are reasonable).
I recommend not using portfolio returns to measure corpus growth or depletion. You have the comfort of a low withdrawal rate. So, ensure a balance of safety and growth so the rest will fall into place.
Then you do not have to “factor that gradual reduction in expected returns into my retirement calculations”, and you do not have to “forecast returns on a diminishing retirement corpus.”
See this illustration based on the freefincal robo advisor tool:
For other examples, see:
- Retirement plan review: Am I on track to retire by 50?
- I am 30 and wish to retire by 50; how should I plan my investments?
- Can I retire by age 55? Retirement Planning Case Study
- Case Study: Achieving Financial Freedom for Early Retirement
- How should I plan if I want to retire in 20 years?
- Is it possible to combine a bucket strategy with income laddering after retirement?
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Dr M. Pattabiraman (PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. He has over 14 years of experience publishing news analysis, research and financial product development.
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