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The 4% Rule

Including Financial Independence and Retiring Early (FIRE)
1nvest
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Re: The 4% Rule

#288517

Postby 1nvest » March 4th, 2020, 5:09 pm

Extending that table to factor in different annualised gains, whilst 0% ends with zip remaining, a 1% CAGR would see £96K inflation adjusted amount remaining at age 85, whilst a 3.66% would have you ending with a similar inflation adjusted amount as at the start ...

Alaric
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Re: The 4% Rule

#288520

Postby Alaric » March 4th, 2020, 5:26 pm

xxd09 wrote:Now the consensus is 3-3.5% for the classic 60/40 portfolio


But why be 40% in Bonds?

1nvest
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Re: The 4% Rule

#288534

Postby 1nvest » March 4th, 2020, 5:53 pm

Alaric wrote:
xxd09 wrote:Now the consensus is 3-3.5% for the classic 60/40 portfolio

But why be 40% in Bonds?

Isn't that like asking why not be in leveraged stock. Broadly firms have debts, they're a form of leveraged position. With leverage you have higher volatility, that compounds down to a similar reward overall as non-leveraged, so all you achieved was to scale up the volatility. Scaling down the leverage can achieve the same reward, with less volatility (better risk adjusted reward).

US data, but similar for the UK, https://tinyurl.com/w62fxrc If broadly the same reward, albeit with 100% zig zagging around 67/33 so sometimes ahead, sometimes comparing (subject to choice of start and end dates).

xxd09
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Re: The 4% Rule

#288585

Postby xxd09 » March 4th, 2020, 10:28 pm

Alaric-I am actually 65% in Bonds
Made my pile and 30% equities does the job for me plus 5% cash
xxd09

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Re: The 4% Rule

#288602

Postby PinkDalek » March 5th, 2020, 1:19 am

Alaric wrote:If you earn absolutely nothing on an investment, a withdrawal rate of 4% lasts 25 years.


Yes it would last 25 years, plus quite a few additional years! You apply the 4% to a reducing balance.

Ignoring fees etc.

ursaminortaur
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Re: The 4% Rule

#288603

Postby ursaminortaur » March 5th, 2020, 2:01 am

PinkDalek wrote:
Alaric wrote:If you earn absolutely nothing on an investment, a withdrawal rate of 4% lasts 25 years.


Yes it would last 25 years, plus quite a few additional years! You apply the 4% to a reducing balance.

Ignoring fees etc.


The 4% rule usually refers to taking 4% of the pot value in the first year and then that amount increased by inflation each subsequent year so that you have a consistent income in real terms.
To last 25 years your investments would need to consistently grow by the rate of inflation each year (ie your calculation above but in real rather than nominal terms). In the real world though investments don't grow that consistently and markets have booms and busts.

1nvest
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Re: The 4% Rule

#288607

Postby 1nvest » March 5th, 2020, 3:10 am

xxd09 wrote:I am actually 65% in Bonds
Made my pile and 30% equities does the job for me plus 5% cash

Some small cap tilt helps IMO, as does some gold https://tinyurl.com/yxy6f6zf

Noteworthy viewtopic.php?p=282836#p282836
Distributions paid by Funds that hold more than 60% of their assets in interest-bearing, or economically similar, form at any time in an accounting period are treated as a payment of annual interest for UK resident individual Investors.
and the associated later comment
If you hold a Vanguard fund with 40% equity content, it's all treated as interest. If you hold the underlying ETFs as 40% equity and 60% fixed interest, that's treated as 40% dividend and 60% interest. Whether that's good or bad depends on your personal tax position, but it means you can hold investments with a choice on how you are taxed.

PinkDalek
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Re: The 4% Rule

#288697

Postby PinkDalek » March 5th, 2020, 1:16 pm

ursaminortaur wrote:
PinkDalek wrote:
Alaric wrote:If you earn absolutely nothing on an investment, a withdrawal rate of 4% lasts 25 years.


Yes it would last 25 years, plus quite a few additional years! You apply the 4% to a reducing balance.

Ignoring fees etc.


The 4% rule usually refers to taking 4% of the pot value in the first year and then that amount increased by inflation each subsequent year so that you have a consistent income in real terms. ...


Okay, thanks for the explanation but that wasn't clear to me from the first extract above. Especially at 01:19 GMT. :)

If you earn absolutely nothing on an investment yet take an increased amount in real terms, then the pot won't last 25 years.

Or am I misunderstanding again?

scrumpyjack
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Re: The 4% Rule

#288700

Postby scrumpyjack » March 5th, 2020, 1:24 pm

The problem with this strategy of estimating how much you can take from the pot til your expected date of death is that when you get to 3 or 4 years from that date you are going to be extremely worried that you will have nothing in 3 years if still alive. That is not conducive to a relaxed old age!

You really need to plan based on the upper end of your life expectancy, unless much of your guaranteed income is in an indexed linked pension.

Alaric
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Re: The 4% Rule

#288701

Postby Alaric » March 5th, 2020, 1:30 pm

PinkDalek wrote:If you earn absolutely nothing on an investment yet take an increased amount in real terms, then the pot won't last 25 years.

Or am I misunderstanding again?


It's no more sophisticated than arithmetic. If x * y = 100%, then a solution is x = 4% and y = 25. If x relates to the initial investment amount, then increasing the take reduces the period over which the sum will last.

If risk free bonds only earn 1% in money terms and even corporate bonds only 4%, then a higher equity component is needed if the withdrawal is to be 4% or 4% increasing with an inflation measure.

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Re: The 4% Rule

#288706

Postby PinkDalek » March 5th, 2020, 1:36 pm

Alaric wrote:
PinkDalek wrote:If you earn absolutely nothing on an investment yet take an increased amount in real terms, then the pot won't last 25 years.

Or am I misunderstanding again?


It's no more sophisticated than arithmetic. If x * y = 100%, then a solution is x = 4% and y = 25. If x relates to the initial investment amount, then increasing the take reduces the period over which the sum will last. ...


Okay, good, so you agree with me when I queried what you were saying earlier in the thread?

Edit: I should have written If you apply the 4% to a reducing balance.

ursaminortaur
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Re: The 4% Rule

#288709

Postby ursaminortaur » March 5th, 2020, 1:39 pm

PinkDalek wrote:
ursaminortaur wrote:
PinkDalek wrote:
Yes it would last 25 years, plus quite a few additional years! You apply the 4% to a reducing balance.

Ignoring fees etc.


The 4% rule usually refers to taking 4% of the pot value in the first year and then that amount increased by inflation each subsequent year so that you have a consistent income in real terms. ...


Okay, thanks for the explanation but that wasn't clear to me from the first extract above. Especially at 01:19 GMT. :)

If you earn absolutely nothing on an investment yet take an increased amount in real terms, then the pot won't last 25 years.

Or am I misunderstanding again?


Almost.

If you earn absolutely nothing on an investment, take 4% of the pot in the first year and then take an increased amount in nominal terms each subsequent year (even if that is exactly the same amount in real terms since the inflation rate is greater than zero), then the pot won't last 25 years.

1nvest
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Re: The 4% Rule

#288737

Postby 1nvest » March 5th, 2020, 3:46 pm

fca2019 wrote:The answer is never, the theory is you live off the gains and not the principal.

Spending just dividends when invested in a broad stock index is theory is indefinitely sustainable but risks the dividends (and stock value) halving or more - and staying down for decades. You only have to look back a little over a century ago for such a situation. Spanish flu etc. and stocks in inflation adjusted terms fell considerably as did dividends. That could have left you having to live on half or less of the income of before and little in the way of re-diverting the depleted capital values into safer alternatives (other than also accepting low levels of income).

Looking at recent index linked gilts (inflation bonds), and the real yields across the board (short to long dated) are pretty close to -2.5%, so for someone with £600K who retired at age 57 and had a additional £8K state pension arising from age 67, they might draw 18K/year (3%) and see that last until age 90.



In the above the capital value was reduced by -2.5%/year in reflection of -2.5% real yields on current index linked gilts. Being inflation bonds the effects of inflation are mitigated, they're inflation adjusted values (the £18K income rises with inflation each year).

If instead perhaps 80% was allocated to a index linked gilt ladder such as above, along with a 20% allocation to stocks and stocks did OK, offsetting the -2.5% overhead of index linked gilts (achieved a 0% after inflation collective reward), then the SWR might be increased to 3.5% (£21K/year inflation adjusted income)


Stock heavy allocations have served well for much of time - until they don't, and there are instances of such periods of 'failures'. The US and UK have been historic good case outcomes, for others stocks have been far less successful. Since the very high inflation and interest rates of the 1970's stocks, bonds, house prices etc. have all done very well, in part having gains uplifted by the transition of high to low interest rates (declining interest rates uplifts prices). From very low inflation/interest rates, forward time that historical flotation effect is more inclined to be absent, or worse, see the opposite side of that coin (declining prices as interest rates rise). A primary risk is that of inflation/interest rates that spike, and from such very low present day levels they don't have to spike that high in order that valuations might halve or more, along with dividends also halving or more along with them.

Drawing 4% from a £600K stock heavy could work out fine, perhaps even seeing none of the capital being depleted - maybe even considerably expanded (great for heirs) but what if its dividend and capital values did halve. Drawing 8% from £300K has a low probability of success. Alternatively seeing £24K/year spending halved to £12K/year may also not be a viable option.

A difficult decision and when presented with such choices along with indecisiveness a good approach is to equally split between the choices. Worst case perhaps seeing a 25% reduction in income rather than half.

Larry Swedroe takes that further and opts for even less stock exposure but in higher risk/reward stock (30% allocation). In a similar vein I quite like the first of these three asset allocations https://tinyurl.com/qo8a8c6 (scroll down to the Portfolio Growth chart and click/tick the 'Inflation Adjusted' checkbox). Note the settings for that asset allocation include a 4% SWR Yes US data, so a right tail (good/great) outcome market relative to others, as ever there are no guarantees.

PS In US scale, UK FTSE 250 is small cap, and as UK stocks pay a relatively high dividend compared to US stocks might also be considered as being somewhat comparable to US Small Cap Value. Instead of a 10 year treasury bond fund, a simple high street 5 year fixed income ladder, but with the first run in instant access is a reasonable choice IMO. i.e. buy each of 2, 3, 4 and 5 year bond funds, hold each to maturity and roll into another 5 year.

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Re: The 4% Rule

#288750

Postby pbarne » March 5th, 2020, 4:47 pm

One way to avoid worrying about a very small pot of money near the tail end is to annuitize at say age 75 when rates are more favourable. That's how I have my plan set up.

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Re: The 4% Rule

#288761

Postby fca2019 » March 5th, 2020, 5:44 pm

@1nvest, interesting post. I think you have to consider upside risks as well as downside. My thoughts on conservative SWR.. To have a super safe withdrawal rate, add in other sources of income, you risk accumulating a large and growing surplus to hand to your descendants. And what's the point, so we can maintain and update spreadsheets and pretty graphs for life :lol: surely at some point savings should be drawn down and spent.

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Re: The 4% Rule

#288983

Postby roger4 » March 7th, 2020, 3:20 am

I think I am possibly being a little dense here. Before I retired, I lived on my salary. Any balance left over after spending was saved into a short term account. Now I have retired and I live on my pensions. Any balance left at the end of the month goes into short term savings account. Occasional large expenditures are/were funded from the savings account.

Fretting over a theoretical percentage seems totally unnecessary and a waste of energy.

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Re: The 4% Rule

#288985

Postby Itsallaguess » March 7th, 2020, 6:08 am

roger4 wrote:
I think I am possibly being a little dense here. Before I retired, I lived on my salary. Any balance left over after spending was saved into a short term account. Now I have retired and I live on my pensions. Any balance left at the end of the month goes into short term savings account. Occasional large expenditures are/were funded from the savings account.

Fretting over a theoretical percentage seems totally unnecessary and a waste of energy.


Are the pensions you're currently living on classed as 'defined benefit' pensions though Roger?

If they are, then you're correct that *for you*, it would seem a complete waste of time 'fretting' over withdrawal rates, as they would be inconsequential for you personally, and would be something that *your pension provider* has to worry about, whilst you're *guaranteed to receive* the level of payout you're currently receiving, plus any assumed RPI/CPI uplift over the years...well done if that's the case, and especially if you also find yourself with excess funds each month to put into savings....

For others, however, who might not have the privilege of receiving defined-benefit pensions, things are completely different.

*They* are in control of their pension pot, and *they* have responsibility over the rate of depletion of that pot, and so in those circumstances it is often very much worth 'fretting about' as to what rate of depletion to use, to enable the optimum draw-down of that pot in terms of available-funds-over-time....

Slightly off-topic in terms of this particular reply, but it also regularly strikes me when I read these types of threads that it makes a massive difference to these 'fretting scenarios' if some posters simply have the pleasure of having *too much money* for their intended retirement lifestyle.

Whilst it's absolutely commendable that people find themselves in such a position, it rather misses the point to be able to say that people don't need to worry about it, only because someone in such a good position doesn't have to worry about it themselves...

It's simply the case that many people do have to worry about it, and especially during these enlightened 'pensions-freedom' days, where the man on the street gets the chance to play pension-provider to their good selves....

They didn't even teach basic household economics during the schooling period of the people retiring nowadays, never mind investment-level draw-down rates.

Good luck to them I say, especially if they're switched on enough to want to continue their education in this area to help achieve the best chances of their success...

Cheers,

Itsallaguess

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Re: The 4% Rule

#288988

Postby ReallyVeryFoolish » March 7th, 2020, 8:15 am

I have to say, I think Itsallaguess is spot on there. The next generation are simply not going to have the luxury of defined benefits pensions that in effect arrive like a salary cheque does each month. It never ceases to amaze me how even very bright people in very responsible jobs know virtually nothing about personal finance. The vast majority of pople I know who are in a pension scheme have no idea how it works or where their money is. It scares me to think that in a couple of decades or so, millions of people will be retiring and suddenly they will have responsibilty for investing a considerable sum to generate an income. Likely >99% of thse people will have no clue where to start. Unfortunately a lot of these same people will fall prey to weath managers or financial advisors whose first priority is enhancing their own wealth rather than those of their clients.

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Re: The 4% Rule

#289028

Postby gnawsome » March 7th, 2020, 11:49 am

ReallyVeryFoolish wrote:... Unfortunately a lot of these same people will fall prey to weath managers or financial advisors whose first priority is enhancing their own wealth rather than those of their clients.

We are all now potential 'Profit centres'
Whether for the window cleaner, double-glazier, take-aways, estate agents or collectors hiding under some charity banner - we are all grist to the mill.

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Re: The 4% Rule

#289035

Postby ursaminortaur » March 7th, 2020, 12:25 pm

Itsallaguess wrote:
roger4 wrote:
I think I am possibly being a little dense here. Before I retired, I lived on my salary. Any balance left over after spending was saved into a short term account. Now I have retired and I live on my pensions. Any balance left at the end of the month goes into short term savings account. Occasional large expenditures are/were funded from the savings account.

Fretting over a theoretical percentage seems totally unnecessary and a waste of energy.


Are the pensions you're currently living on classed as 'defined benefit' pensions though Roger?

If they are, then you're correct that *for you*, it would seem a complete waste of time 'fretting' over withdrawal rates, as they would be inconsequential for you personally, and would be something that *your pension provider* has to worry about, whilst you're *guaranteed to receive* the level of payout you're currently receiving, plus any assumed RPI/CPI uplift over the years...well done if that's the case, and especially if you also find yourself with excess funds each month to put into savings....


That also obviously applies if you used your money to buy an annuity which exceeds your expenditure (especially if it one which rises with inflation). Given today's annuity rates though you obviously need a bigger pot to purchase such an annuity than you did when rates were much higher and many would rather take the risks of using drawdown instead which potentially provides a larger income than an annuity and the possibilty of leaving money for beneficiaries. If you are using drawdown though it is useful to have some guidance as to how much you can reasonably safely withdraw which is where Bengen's study and otherscome in. I suppose as an alternative you could just look at what an annuity would provide. Since Bengen's study looked at an initial withdrawal which then rose with inflation the appropriate comparison would be with an annuity rising by RPI (or assuming inflation stays relatively low maybe escalating at 3%) but when you look at that you find the rates are much lower than Bengen's 4% until you are in your 70s eg

https://www.hl.co.uk/retirement/annuities/best-buy-rates



per £100,000


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