You can find a little background here, behind the investigation. I am just interested in how it would play out if someone did follow the 4% rule blindly. There have been plenty of academic pieces on what a safe withdrawal rate would actually be and the results seem to vary greatly, from as low as 2% up to as high as 10%. Which is no surprise given the complexity of the task at hand. The country you base the study in, the index you assume equity or bonds have followed, the split of your asset allocation, your treatment of tax and fees, allowance for any ‘management action’ (e.g. reducing spending during a downturn), if you are following historic indices or stochastically projecting funds, etc etc etc.
It feels like 4% would be OK as long as you were flexible. By this I mean having enough flexibility to reduce your outgoings in the harder times (not living just above the breadline), adjusting your investments to suit current circumstances and having the ability to generate extra income if needed (flipping burgers maybe).
Understanding how our investments react to the environment and our own needs for income and capital will be key to ensuring we don’t spend FI eating out of wheelie bins and living in a tree. I am hoping that by updating my little case study each month it will force me to consider what is happening and how I would react. In an ideal situation we would be able to match our expenses with our investment income exactly and face no risk in retirement.
For example if we could look into a crystal ball and predict with 100% accuracy our expenses each month then we could construct a theoretical portfolio that would exactly match these expenses, say from zero coupon bonds. But we neither have the patience or the required foresight for this. An index linked annuity would provide us with a constant income stream but are currently expensive and tie up capital, doesn’t leave us much for emergencies. Dividend paying equity can provide us with a good stream of income, but it is far from guaranteed and your capital is at risk. Interest on a cash balance would provide income and the capital would be protected but we would be exposed to fluctuating interest rates and inflation risk. And so the list goes on.
In reality we will probably be exposed to a diversified portfolio of assets to try and mitigate away the specific risk associated with each of the equity classes. Or maybe in a few years there will be some super-cool, cheap income generating asset that is 100% safe and we can all achieve guaranteed FI…
I’ll keep track of the monthly updates here on this page (links to individual months are below). The blue line in the chart below represents the fund and the other three are extreme variations of it, for comparison.
And a comparison of the hypothetical portfolio versus one with no withdrawals;
May 2016 – Interest of £38 and dividends of £3,668, leaving the portfolio with an overall increase of £8,949 after withdrawals and market movements, at £623k.
April 2016 – Interest of £38 and dividends of £206, leaving the portfolio with an overall decrease of £7,809 after withdrawals and market movements, at £614k.
February 2016 – Interest of £38 and dividends of £179, leaving the portfolio with an overall increase of £5,629 after withdrawals and market movements, at £610k.
January 2016 – Interest of £38 and dividends of £218, leaving the portfolio £10,030 down after withdrawals. Pretty tough start to 2016!
December 2015 – Interest of £41 and dividends of £1,702, leaving the portfolio £6,124 down from the prior month after withdrawal. A bit of year end rebalancing done.
November 2015 – Interest of £41 and dividends of £180, for an overall increase of £6,753 after drawdown. Actually nearly back up to where we were last November, despite 11 months of withdrawals.
October 2015 – Interest of £42, distributions received of £225 and an overall movement of £21,573 after drawdown. Bit of recovery going on there. Back up to £612k.
September 2015 – Interest of £42, distributions received of £2,017 and an overall movement of (£13,467) after drawdown. That’s a decrease of £53k since the lofty highs of March.
August 2015 – Interest of £43, distributions received of £228 and an overall movement of (£24,237) after drawdown. Another rough month for our intrepid dimension traveller.
July 2015 – Interest of £45, distributions received of £181 and an overall movement of £11,372 after drawdown. Clawing back a bit of the prior months decline.
June 2015 – Interest of £43, distributions received of £3,036 and an overall movement of (£30,004) after drawdown! Markets took a battering!
May 2015 – Interest of £44, distributions received of £2,728 and an overall movement of £4,792 after drawdown
April 2015 – Interest received of £44, distributions received of £240 and over all movement of (£7,033) after drawdown.
March 2015 – Interest received of £41, distributions received of £177 and overall movements of £5,206 after drawdown.
February 2015 – Interest received of £42, distributions received of £183 and market movements of £8,697 for an overall decrease of £9,192 pre-drawdown.
January 2015 – Interest received of £42, distributions received of £238 and market movements of £12,704 for an overall increase of £12,624 pre-drawdown.
December 2014 – Interest received of £40, distributions received of £1,470 and market movements of (£4,700) for an overall decrease of £3,200.