Brexit came clattering onto our plates in June. Let’s have a look at how the safe withdrawal rate experimental portfolio got on with that huge shock;
The standard recap
We are now 18 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 30/06/2016
Let us start by looking at where the portfolio would be without any withdrawals, just market movements and income;
Another month with huge volatility, with an increase of £40k from May’s position. This is just a snapshot on a given day remember, and underlying this the markets are still moving all over the place trying to deal with the uncertainty following the U.K. leaving the E.U.
The Lifestrategy Fund and the S&P500 ETF are both up over £10k respectively. The government bond fund is also up a respectable amount, presumably as money slides it’s way into ‘safer’ asset classes to weather out the storm.
We must remember that the above is denominated in Sterling and that Sterling has taken a bit of a battering against the Euro and the US Dollar following the referendum results. What does that actually mean? For the individual, in the short term, potentially not too much unless you were buying lots of foreign currency in the near future. In the long term? Who knows.
There is a fair amount of income coming our way in June;
- £583 quarterly dividend from the Vanguard S&P500 ETF;
- £1,305 quarterly dividend from the Vanguard FTSE100 ETF;
- £1,169 quarterly dividend from the Vanguard Developed Europe ETF;
- £166 income from the U.K. Government Bond UCITS ETF; and
- £40 in interest on a Cash ISA.
A total of £3,262 for June, not quite up to May’s £3,706 in income, but still enough to cover our assumed withdrawal for the month. It has been bolstered by moving exchange rates and so distributions denominated in USD and EUROs being worth more in £s.
Months like these would be grand when it comes to living off a portfolio, the withdrawal is more than covered by income. And that is psychologically much easier than having to sell assets to generate an income. It’s almost as if the portfolio is looking after itself, skimming off some income for you leaving to to crack on with the rest of your life.
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.
Once again, following some generous dividends, we don’t need to sell down any capital.
Following cash withdrawal of £2,106 the portfolio totals £661k, that’s £36k up compared to where we started. It’s easy to celebrate these things, perhaps taking the gain as a sign of our sage like portfolio building powers. As ever the best thing to do, is to stick to the plan, which in this case is to balance towards the 75% equity / 25% bonds&cash split and carry on.
Let’s have a look at the historic values of the portfolio, and include the same portfolio but with no withdrawals for comparison, to see how the journey has been so far;
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 holding hands and heading along a very similar path. 30% of the test portfolio is made up of that fund, with the rest being in other equities/bonds/cash. The Test portfolio does look less volatile by a small margin, indeed the standard deviation is 21,299 for the Lifestrategy fund compared to 17,216 for our fund. Asset allocation really does work.
Interestingly this is the first month for some time where simply going 100% in cash is the worst performing option.
A summary of all the past months of the safe withdrawal rate experiment are here.
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