Ah sunny Saturday mornings. The perfect time to draw the curtains and tap some shit into Excel and then WordPress 🙂 (EDIT: Mr Z ended up in the sunshine for a couple of hours sanding bits of wood, restoring an old metal crate from the 1940s, scraping his knuckles, swearing and having a good time)
I start this post just after eating a hearty breakfast of a three egg omelette filled to the brim with cheese and avocado. Fatty fatty pig pig, I hear you cry. I have just finished my March Mini-Experiment of a 24 hour fast, so pipe down.
We have hammered passed to end of February already, enough pre-amble.
The standard recap
Back to the beginning. We are now 14 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 the experimental fund totalled £625,000 and was split 75% to equity and 25% to cash/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. I.e. 4% of £625k = £25k.
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 into a kamikaze nose dive or splurging on new biros and fancy tea bags in the good times.
In reality you could 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. All helping to make your portfolio that much more resilient.
The allocation between ETFs, Funds and cash is very simple and largely chosen at random at the start of the experiment. This isn’t a test of asset allocation, rebalancing, the ‘4% rule’ or any kind of detailed back testing. Think of it more as an ongoing thought experiment, would you be able to trust your strategy when things turn south? Failure or success of this one isolated case is so very far from testing the actual robustness of the 4% rule. 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 29/02/2016
First, a peek at where the portfolio would be without any withdrawals, just market movements and income. A bit of a recovery following that volatile January;
Increases across all the holdings in our fictitious funds…including bonds! Bonds continue to do creepy unexpected things, as if they are driven purely at the quantum level. So much for them being overvalued, or are they? Who knows.
Featureless February on the income front;
– £179 income from the U.K. Government Bond UCITS ETF
– £38 in interest on a Cash ISA.
Nothing to write home about, but still enough to buy groceries for the month.
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 February we are overweight compared to our targeted 20% bond allocation (thanks to the bond ETF increasing in value…AGAIN) and slightly when compared to our 20% S&P500 allocation.
This results in 68 units from the UK Gov’t Bond ETF being sold (at £22.01 per unit), 15 units sold from the S&P500 ETF (at £26.44 per unit) and the remaining, being the dividends and interest, taken from cash. This tops us up to the new £2,106 monthly withdrawal, having been increased from £2,083 at the start of January to account for inflation.
Following withdrawal the portfolio totals £610k. Comparing it to the portfolio with no withdrawals;
The portfolio is now £15k down on where we started, but remember that this includes just over £29k of withdrawals. With no withdrawals the portfolio would have increased to £637k, a £12k increase sounds OK until you realise that’s only 1.9% over 14 months. It has been a turbulent 14 months, mind you.
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 UK 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 on the spread once again, following the recent volatility. The test portfolio and all in the LifeStrategy100 fund are trundling along in a similar fashion, whilst if we were 100% in the All-World High Dividend Yield ETF we’d be in the worst position out of the examples shown. The bond fund price has increased along with the other options in February, so once again it is looking like the most attractive option.
Long term expectation tells us that shares should outperform bonds in the majority of cases, so we may well see a reversion to that at some point in the future. For now, Mrs Bond is heartily pointing and laughing at puny Mr Equity.
A summary of all the past months are here.
Thankfully the end of capitalism didn’t emerge in January or February like some of the financial press seemed to hint at. It’s almost as if sensationalism sells stories.
The experiment is doing a good job of highlighting some of the polar opposites of someone drawing on a fund (alternative Universe Mr Z) compared to someone early on in their accumulation phase (the real Mr Z). I’d quite like some depressed prices, so that in the long run I am buying a higher yield, whereas the alternative Mr Z would prefer increasing prices or at least something a bit more steady to ensure the long term survivability of his fund. Sequence of returns risk is a fucker once you are out of the accumulation phase, and I for one would be pretty jumpy for the first few years.
Happy weekend all.