Happy New Year! Hope you are all planning on a 2016 of saving, investing and living more intentionally.
Back to the beginning. We are now eleven months into the experiment where Mr Z in Parallel Universe Number 1 pulled the trigger on early retirement. This is a completely fictitious portfolio and just a little experiment, hopefully giving some insight on what it would actually be like through the ups and downs of living off an investment portfolio. Nothing real. So calm yourself down.
At the start of this experiment the fund was £625,000 split 75% to equity and 25% to cash and bonds. That should be enough to withdraw £25k a year (and increase this annually along with inflation) if the 4% Safe Withdrawal Rate is to be trusted.
Each month I assume that the alternative Mr Z has spent every penny of the prior months drawdown, so no cash is left. And he will do this whatever the financial weather, there will be no buckling down the spending hatches if the markets go a bit Norman Bates or spooging a bit more cash in the good times.
In reality you would cut back when the markets are down, you may have some months where you do a little bit of work and get a little bit of side income, you might not spend the full withdrawal amount, etc
The allocation between ETFs, Funds and cash is very simple. This isn’t supposed to be a test of asset allocation, the ‘4% rule’ or any kind of detailed back testing. Think of it more as a thought experiment, would you be able to trust your strategy when things turn south? Chopping and changing strategies, constantly trading, only ever seems to be bad for portfolios in the long run…but we all have to deal with our curious nature and tendencies to meddle in things.
Initial Position at 31/12/2015
First lets have a wee look at where the portfolio would be without anything withdrawn;
Pretty much flat since the end of November with a 0.35% decrease in the overall portfolio, but a nice recovery since the end of September.
A busier to the end of the year for distributions as many of the ETF’s pay year end dividends;
– £584 of dividends from the S&P500 ETF
– £648 of dividends from the FTSE 100 ETF
– £292 of dividends from the Dev. Europe ETF
– £177 income from the U.K. Government Bond UCITS ETF
– £41 in interest on a Cash ISA.
Dividends or interest are assumed to be paid into the cash account before we look at any withdrawal.
Mechanical rules are followed to simplify things, based on the initial asset allocation of 75% Equity and 25% Bonds&Cash.
Distributions will be taken first as income in the month and then any remaining withdrawal will be taken by selling capital, aiming to re-balance towards the 75:25 allocation with any dealing costs picked up by poor Mr Z himself. This should then skim off any parts of the portfolio that are doing well and hopefully give any flagging parts of the portfolio catch up while avoiding drawing on capital unnecessarily.
Doing this every month, rather than quarterly or annually, might not be the best option. It exposes the intrepid Mr Z entirely to the volatility of the markets and the closing price on one fixed day at the end of the month. Still, that’s how we started this.
At the end of December the portfolio was slightly overweight in the Vanguard Lifestrategy fund and the US S&P500 ETF, when compared to our original target allocation, so some of those units are sold.
This results in 6 units from the S&P500 being sold (at £26.39 per unit), 1 units being sold from the Lifestrategy fund (at £136.56 per unit) and the remaining taken from cash.
Following withdrawal the portfolio looks like;
That’s the first year done. £25k of withdrawals and the assets are down nearly £7.5k. The assets generated £13.3k of income;
LifeStrategy – £2,544
S&P500 – £2,810
FTSE100 – £4,661
Dev. Europe ETF – £1,911
Gov’t Bond ETF – £2,373
Cash ISA – £508
Is that a good or bad performance? Not as good as the smashing performance seen at UK Value Investor. It’s simply matched the market performance in the areas it was chosen to, nothing more, nothing less.
Let’s have a quick gander at where we would be with some alternate fund choices;
The darker blue line is the experimental portfolio. The purple line is the most aggressive allocation, with 100% in equities (the 100% equity LifeStrategy fund).
The straight red line is just cash, earning interest and slowly running down, guaranteed to be exhausted at some point.
The green is 100% invested in a government bond ETF.
The light blue line is the Vanguard All-World High Yield ETF, which might have seemed like an attractive choice to use during your drawdown phase.
These portfolios are coming back together after a huge spread in September. The 100% bond option, after flying high in August to November, has finally been reined back in, with the 100% invested in the LifeStrategy fund taking the podium at the end of the year. The high yield ETF is scraping the bottom of the barrel some way off the pace. But it’s all quite tightly clustered, ignoring the all world high yield ETF.
In the long run, we would expect equity to out perform cash/bonds and things are coming back together again. It would have been easy to panic in September if you were that way inclined, selling at a loss in some futile attempt at ‘limiting’ your losses. Sticking to our asset allocation in this experiment has allowed some recovery.
Casting your eye over the graph shows a downward trend for all of the options, suggesting 2015 was a slow year in the markets. The more popular opinions out there suggest that the S&P500 is currently over valued, whist the FTSE100 is undervalued. What does this mean for 2016? WHO KNOWS 🙂
A summary of all the past months are here.
And into 2016
There’s a bit of housekeeping to do.
The withdrawal rate needs to be increased by inflation. But which one, CPI or RPI. They are calculated differently (arithmetic vs geometric mean) and include different components. In the absence of getting too involved and spending the wee hours reading more into the subject, let’s go with RPI. RPI tends to be the higher of the two, making it the prudent choice, and a tougher measure for the experiment. It will also fuel a more decadent lifestyle for the alternative Mr Z.
RPI to the end of November is 1.1%
. This increases our annual withdrawal from £25,000 to £25,275. Who knows what crazy things that extra £23 a month will be spent on.
The ISA interest rate needs updating, the post office rate has reduced from 1.55% down to 1.51% and still seems to be one of the best on the market for easy access. So I’ll stick with that,
And finally some rebalancing.
Part of the experiment is to rebalance annually, towards the initial split;
So from the table above we see that the allocation is currently overweight in the Lifestrategy Fund and the S&P500 ETF, and noticeably underweight in the FTSE 100 and Dev. Europe ETFs.
Rebalancing involves selling 19 units of the LifeStrategy fund, 178 units of the S&P500 ETF and taking £849 from cash. Then purchasing 213 units of the FTSE 100 ETF, 86 units of the Dev. Europe ETF and 17 units of the Gov’t Bond ETF. Leaving us in the following closing position;
Most of the money has flowed between the S&P500 ETF and the FTSE100 ETF.
Again, I’ve taken the simple approach of assuming that any fees have been taken from the drawdown amount, so effectively reducing income in that month. Whilst it might cheapen this experiment a little, it’s a lot easier to administer :).
I have also blindly rebalanced everything in the portfolio, because that’s what I said I would do. Really you would do something more subtle and cost effective, like the 5/25 approach excellently explained here. Again, the method here just makes it simpler although not necessarily more effective.
And there we are, ready for 2016.