Simple guide for Nifty and BankNifty Options: The 4% Rule

Introduction

This blog outlines how effective is the 4% rule also known as SAFE WITHDRAWAL RATE or simply the rate at which you can spend your money without ever running out of money.

This is an easy way to calculate how much money an individual will need to retire and stay invested to not run out of money. It was created using historical data on stock and bond returns over a 50-year period.

Understanding the 4% rule

The 4% rule is a rule of thumb used to determine how much a retiree should withdraw from a retirement account each year. This rule seeks to provide a steady income stream to the retiree while also maintaining an account balance that keeps income flowing through retirement. Experts are divided on whether the 4% withdrawal rate is safe, as the withdrawals will consist primarily of interest and dividends.

The Four Percent Rule helps financial planners and retirees set a portfolio's withdrawal rate. Life expectancy plays an important role in determining if this rate will be sustainable, as retirees who live longer need their portfolios to last longer, and medical costs and other expenses can increase as retirees age.

What about inflation?

While most individual stick and abide by the "Four Percent Rule" of keeping withdrawal rate constant, some do increase the rate to keep pace with inflation. Possible ways to adjust for inflation includes:

Setting a flat annual increase of 2% per year.
Adjusting withdrawals based on actual inflation rate.

When 4% rule should be avoided?

There are several scenarios where 4% rule might fail. A severe market downturn can erode the value of high-medium risk investments much faster like COVID pandemic where Nifty fell by 30% by end of Q1 2020 compared to Q4 2019 (which results in downfall of most of the index funds, exchange traded funds etc).

The rule also fails if an individual is not disciplined and violates the rule by doing a major purchase since it can bring down the principal invested which directly impacts the compound interest that retiree depends on for sustainability.

Thinking beyond the 4% rule

The biggest mistake one can possibly make with the 4% rule is thinking that you have to follow it to the letter. It can be used as a starting point—and a basic guideline on how much to save for retirement—25x (or the inverse of 4%) of what you’ll need in the first year of a 30-year retirement from your portfolio. But after that, it is better adopting a personalized spending rate, based on your situation, investments, and risk tolerance, and then regularly updating it.

Here are few suggestions;

Spread your portfolio in multiple layers. Invest in large cap, mid-cap, small cap and hybrid mutual funds.
Invest time to learn about stock market and invest a portion of your saving in trading in futures and options too (Read - https://simplifyingoptions.blogspot.com/2020/10/options-play-book-for-nifty-and.html).
Based on your age, choose the right mix of debt and equity exposure in mutual funds.

Short guide for mutual fund investment

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Account opening links:

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To open account with groww, click here --> Use Groww for Direct Mutual Funds

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Disclaimer:
Investing in stocks/mutual funds or any other instruments are subject to market risks. Any strategies or trades that are described here are only for educational purpose. Please do your own research or consult your financial advisor before investing