The markets during May have felt like they have slowly ticked up upwards, despite concerns over the Brexit. Let’s have a look at how the safe withdrawal rate experimental portfolio got on.
The standard recap
We are now 17 months into my experiment, where Mr Z in Parallel Universe Number 1 pulled the trigger on early retirement. This is a completely fictitious portfolio. It will hopefully give some insight into what it would be like living off investments, through the ups and downs that the markets provide. So actually being Financially Independent and living off investments.
At the start of the experiment, the end of November 2014, the investments totalled £625,000 and was split 75% to equity and 25% to cash/bonds. Which represents a fairly aggressive equity allocation for someone in ‘retirement’.
£625k should allow a ‘safe withdrawal’ of £25k a year (which then increases annually along with inflation) if we follow the 4% Safe Withdrawal Rate. 4% of £625k = £25k.
Each month let’s assume that the prior month’s drawdown has been completely spent. And that this will happen whatever the financial weather, there will be no buckling down the spending hatches if the markets go into a kamikaze nose dive or equally splurging on new biros and fancy tea bags in the good times. Luckily, that keeps things simple.
The allocation between ETFs, Funds and cash is very simple. 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 and this shouldn’t be taken as such. 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 31/05/2016
Let us start by looking at where the portfolio would be without any withdrawals, just market movements and income;
Another volatile month, bouncing back up from the relative low in April of £614k to a smidgeon over £625k. What, no growth over 17 months? No, but remember that we have been withdrawing just over £2k every month.
May gives us the annual distribution from the largest holding, the Vanguard LifeStrategy 100% fund;
- £3,502 in dividends from the Vanguard LifeStrategy 100%;
- £166 income from the U.K. Government Bond UCITS ETF; and
- £38 in interest on a Cash ISA.
A total of £3,706 in income for the month, that’s a healthy amount of income. The government bond ETF and the cash ISA have been reliably providing around £200 of income each month, enough to cover the months groceries perhaps. But it is the quarterly or annual distributions from the equity holdings that provide substantial income.
Cashflow management is a big part of living off a portfolio. If you don’t receive enough income in the month, or don’t have enough liquid assets, then you might need to sell assets at an inopportune time. I.e. when their prices are depressed. Equally, if you are too conservative and sit on too much cash and bond like instruments then you will probably miss out on the ‘real’ growth that equity and property type assets tend to offer.
My initial thoughts when setting this up was a 75/25 split between equities/bonds&cash. That was on the basis that portfolios with a higher equity holding tended to fair better in the long run, but 25% of cash&bonds would provide about 5 years of drawdown in the event of a substantial market depression. Giving the equity part of the portfolio time to recover.
The Mighty Withdrawal
We’ll follow simple mechanical rules, based on the initial asset allocation of 75% Equity and 25% Bonds&Cash.
Any distributions will be taken first, as income. Then any remaining withdrawal will be collected by selling capital, with an aim to re-balance towards the 75:25 allocation. Any dealing costs picked up by poor Mr Z himself.
This will mean that the parts of the portfolio that are doing well are sold, and any flagging parts of the portfolio are given a chance to recover.
Doing this every month, rather than quarterly or annually, might not be the best option. Firstly, it will incur dealing costs every month. Secondly, 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 May we don’t need to sell down any capital, on account of the substantial distributions received in May.
Following cash withdrawal of £2,106 the portfolio totals £623k, that’s only £2k down compared to where we started and £9k up from April.
Let’s have a look at the historic values of the portfolio, and include the same portfolio but with no withdrawals for comparison;
Let’s have a quick gander at where we would be with some alternate fund choices;
The test portfolio and the option of simply going 100% in the LifeStrategy100 fund are still heading along a freakishly similar path. Not surprising given 30% of the portfolio is made up of that fund, still, simplicity is always a good option.
The All-World High Dividend Yield ETF option, which might have seemed like the obvious choice, is still having a rough time out there.
The option of all in bonds is still flying along, with a seemingly strong correlation to equities at the moment. With a few more months data I plan to look at the impact of starting the experiment in different months, should give us a nice intro into the murky world of sequence of returns risk.
A summary of all the past months of the safe withdrawal rate experiment are here.
Happy Monday all.
Subscribe. It’s free Help a Zombie out. Like what you read? Share, with the buttons below.