Drawdown: safe withdrawal rates

michaels

I am beginning to wonder just what are the 'fundementals' as the opportunity for profit going forward would seem to be much lower.

However the monetary fundamental of savings looking for a return seems to go in the other direction, along with monetary easing their is basically oodles of money and nowhere for it to go. Bonds can pretty much only go one way in terms of capital values and yields are negligible, gilts are even worse, cash returns nothing if you are lucky so the only option for possibly inflation beating returns is equities, hence no reduction in equity prices despite a reduction in yields.

We basically seemed to have entered a world where the chance of any sort of real return has pushed risk premia down to zero.

In the past negative real returns would have driven consumption rather than saving but with an aging population in the vast majority of the wealth controlling parts of the world there is no desire to do anything but save.

mark55man

agreed - plus the pandemic has made people more cautious about debt and savings.  certainly for me.  I've always been more about pension saving than right now saving and I am going to have to rethink that a little.  Fortunately as I am over 55 I can still do a bit of both to take advantage of tax relief, without locking the money away for ever

cfw1994

Not so sure I agree with the pessimistic premis of "We basically seemed to have entered a world where the chance of any sort of real return has pushed risk premia down to zero."
As Jamesd quoted earlier: "given the cyclicality of markets, an opportunity will inevitably present itself".   I'm an optimist on the human ability to drive forwards: on most measures, despite the awful news we read every day in the press, the world is a better place than it was yesterday.....
IMHO, now is perhaps a great time to invest.  Certainly I would be reducing any drawdown at such a time, but these things *are* cyclical, and I firmly believe we *will* come out of this.  Other opinions are, of course, equally valid....

michaels

IN general the marginal return of each extra unit of investment is diminishing so if we live in a world where everyone is trying to sacrifice consumption now for consumption in the future then interest rates (the return on forgoing consumption) can certainly turn negative and even adding on a risk premium does not mean that real returns have to be positive.

jamesd

A couple of posts about the Guyton-Klinger rules that may be of interest:
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https://forums.moneysavingexpert.com/discussion/comment/77665104/#Comment_77665104

BritishInvestor said:

I think you'd need to be very happy with potential the cuts in real income if using Guyton-Klinger and if a poor series of returns was encountered in early retirement, especially if the guardrails were applied annually.

Being willing to skip inflation increases or take cuts above inflation is the trade off for starting at 5% instead of 3.2% (5.5% used in the guard rail calculation). For those unfamiliar with G-K, the withdrawal statement linked to earlier includes those rules, part including guard rail prosperity and inflation rules being:

"your Annual withdrawal amount will increase by the prior year’s inflation rate, unless:

A) you decide instead to keep your withdrawal amount the same in some years.

B) next year’s WD amount would make your WD Rate more than 6.5%. If so, next year’s WD amount is reduced by 10% from what it would have been with the inflation adjustment.

C) next year’s WD amount would make your WD Rate less than 4.3%. If so, next year’s WD amount is increased by 10% from what it would have been with the inflation adjustment.

D) neither B nor C applies, but the prior year’s investment return was negative. If so, your WD amount remains the same as it was the prior year."

A fairly severe worked example might be a 40% equity drop in a 65:35 £500k mixture followed by nil investment growth and nil inflation (a simplifying alternative to 2% each). 5.5% initial, upper guard rail 20% higher at 6.6%, lower (prosperity) 20% lower is 4.4%. For comparison 4% rule (UK 30 years before costs) at 3.7% is £18,500 and an age 55 single life RPI annuity with 5 year guarantee quotes 1.624% which on £500,000 is £8,120. This initially looks like:

Year 1 take 5.5%, £27,500 and see equity drop, ending value £370,000.
Year 2 planned taking is £27,500 after 0% inflation increase, which is 7.4% of £370,000. Above upper guard rail 6.6% so reduce by 10% to £24,750. Ending value £345,250.
Year 3 planned £24,750 is 7.2% of £345,250 so reduce to £22,275. Ending value £322,975.
Year 4 planned £22,275 is 6.9% so reduce to £20,047. Ending value £302,928.
Year 5 planned £20,047 is 6.61% so using that extra digit cut to £18,042. Final value £284,886. (4% rule final value £305,000)
Year 6 planned £18,042 is 6.3%, below 6.6% so no change. Final value £266,844.
Year 7 planned £18,042 is 6.8% so reduce to £16,237. Final value £250,607.
Year 8 planned £16,237 is 6.5%. Final value £234,370.
Year 9 planned £16,237 is 6.9% so reduce to £14,613. Final value £219,757.
Year 10 planned £14,613 is 6.7% so reduce to £13,151. Final value £206,606. (4% rule final value £212,500).

Ten years in G-K has paid more and is now paying enough less than 4% rule to have recovered from most of the earlier lack of the pessimism that's built into the 4% rule but more cuts will be needed. Both remain well above the annuity £8,120 final value £nil. Note that this is with G-K on a tougher 40 vs 30 year path.

Within G-K calculators there can be adjustments to limit the drop potential. One is to cut by 20% instead of 10% if the upper guard rail is exceeded, so it more rapidly adjusts towards a long term stable value that's higher, a change I like. Another is to set an income floor, which can reduce initial income; I tend to use annuity or DB alternatives.

Beyond G-K parts of a pot can be using different rules.

Personally I like the lower initial pessimism of Guyton-Klinger because it tends to favour higher income at younger ages, which is desirable if age-related spending decrease is expected.

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https://forums.moneysavingexpert.com/discussion/comment/77690094/#Comment_77690094

Bobziz said:

Anyone care to share their experience of replenishing their depleted cash reserves after a market slump ?

Routine rebalancing will take care of it. Like this if using the Guyton-Klinger rules from the withdrawal statement linked to in an earlier discussion:

"All interest and dividend distributions are taken in Cash and held in your investment account(s). Capital gain distributions are reinvested in IRA accounts and held in Cash for after-tax accounts.

Following years with positive returns that cause an equity category to exceed its target allocation, the excess amount is sold and reinvested in Cash or Fixed Income to fund future WDs.

Yearly WDs are funded from equities when markets are favorable and from fixed income when they are not, using this priority: 1) Cash; 2) Selling Fixed Income assets; 3) Selling Equity assets in descending order of the prior year’s performance. No WDs are funded by selling an Equity asset after a negative return year as long as Cash or Fixed Income assets are able to fund that year’s WD amount."

For the March 2020 drop the second paragraph would have led to equity selling to generate cash in previous years and that would remain intact after a short drop. The first paragraph already provides a regular cash flow to help fund withdrawing.

jamesd

I'm planning to update the first post with a guide to income to take while getting familiar with this subject. At present I'm planning to say something along the lines of:

1. take number of years to state pension age and deduct your state pension times that many years from your pot
2. take up to 6% of the remaining pot plus the state pension income as your initial income
3. do not increase with inflation and do not continue this for more than three years

Taking 6% will be most controversial but because of the lack of inflation increases it'll be safe even if used long term and in the short term it favours what people tend to want, more income at younger ages.

Any thoughts on how better but still very succinctly to get to an income level that's sustainable but intended to be short term during learning?

mark55man

Interested to see what feedback you get, but for me there is a clash of intent between 1. which implies you can do this with a variable number of years and 3. which suggests you should only do this for 3 years. 

I think you either should add a 4. which what to do after 3 years, or explain 1. better in terms of "you are going x years early so your need x*SP reserved" but this calculation just gives you and indicative income for the first 3 years and then you need to recalculate (and what that might be)  

jamesd

6% with no inflation increases is OK long term compared to 4% or 3.7% with inflation increases or GK starting at 5.5% for the first year and the 6% then always skipping increases. Three years is just to give some sort of end date to try to counter any tendency to do it forever and end up taking too little income long term but it's the duration that I don't want to be too long or too short.

ukdw

Interestingly, if we assume 2.5% inflation for 30 years that adds up to about 100%.  

So if you take 6% with no inflation increases for 30 years, then you will probably end up drawing roughly the same annual amount in 30 years time as someone who took 3% now, and then added inflation increases each year.

So if they both work, I would rather have double the amount now - and let it slowly decrease in real terms, especially as things like SP rises and tax band changes are still likely to give a small increase in net income each year.

Thrugelmir

Is this 6% fixed irrespective of market fluctuations, i.e.  a £100k portfoilio would be drawn down at the rate of £500pm for the first 3 years?  It will then be neccessary to recalculate the portfolio value every month on the day that the sale is effected. The monthly 6% drawdown being reset on month 37 for the following period. 

What's the portfolio going to be that you use?  If it's not a multi asset fund how do you propose to rebalance, or decide which asset to sell to realise the funds.