Well, it’s been raining for about a billion hours straight in the UK, so it’s about time to start writing up my sweet SWR experiment.
The standard recap
We are now 22 months into this 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. Being “Financially Independent” and living off investments, then.
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 would 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 is 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 20ft swell of downward volatility or will there be any splurging on new biros and fancy tea bags when the financial sun is beaming. Suspiciously, that also 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 31/10/2016
Let us start by looking at where the portfolio would be without any withdrawals, just market movements and income;
It’s worth splitting out the income, we’re all about clarity around here. It’s pretty dry on the income front, this month;
- £154 income from the U.K. Government Bond UCITS ETF; and
- £42 in interest on a Cash ISA.
A total of £196 for October, pretty small compared to the cacophony of income in September.
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.
Some basic wizadry in Excel tells me that Mr Z needs to sell 6 units of the LifeStrategy fund, for £991, and 28 units of the S&P500 ETF for £929. Which, when combined with £187 of cash, gives us a lovely base curry sauce..,no, it gives us the total £2,106 withdrawal for the month.
After taking out those units and passing the proceeds of £2,106 to Mr Z we are left with £704k in the fund.
A quick graph will help to show the progression of the fund over the last couple of years;
Things are changing, the government bond options falls again whilst the options with at least some equity climb once again. The government bond option was flying and now sits £75k below the front runner, which is all in the Vanguard LifeStrategy 100% fund.
At this point, cash is clearly the worst option. There’s still £597k in cash, but that’s £134k less than the best performing option. Admittedly there’s no volatility to deal with (OK, strictly the underlying interest rate has volatility) but the premium you’re paying for the smaller volatility is looking pretty expensive. It also demonstrates the pain you can receive by sitting on cash, everyone and their pug were saying markets were overvalued in 2014, yet sitting on cash has worked out the worst option.
A summary of all the past months of the safe withdrawal rate experiment are here.
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