Since it’s the beginning of a new year, everywhere I see only resolutions, plans, outlooks and so on. This is also that period during which financial media cover lot of investment strategies for 2017. While reading one of such personal finance article, came across a term called Safe Withdrawal Rate (SWR)
What is Safe Withdrawal Rate?
Most of the personal finance literature focus on where to invest and how to build an optimal portfolio. Safe Withdrawal Rate (SWR) is common term used from retirement planning context. Put in simple terms, Safe Withdrawal Rate is nothing but a percentage of your annual investment in retirement portfolio that can be expensed without depleting your investment in real terms ( i.e accounting inflation rates)
This helps in calculating the retirement corpus for you. Since Safe Withdrawal Rate is essentially the margin to beat inflation, it can also be considered as the maximum percentage that you can withdraw for yearly expenses from the retirement corpus.
William Bengen and the 4% rule
As you might have guessed; going by a particular rate always may not be ideal. One may have bad year followed by stellar year with high portfolio returns. Willian Bengen, a financial planner decided to back test this idea across various portfolio compositions
Bengen found that with a 50/50 allocation to the US stocks and bonds, at most 4.15% could have withdrawn from their savings at the end of each year; and thus came the popular 4% rule. Here is the complete paper written by Bengen (Determining Withdrawal Rates using Historical Data)
More financial planners and academicians have done various studies and improvements on top of Bengen’s study; most famous being The Trinity Study. Here is a Forbes article on the same.
Here is another study by Peter James Lingane titled Making Money Last.