4% "Safe" Withdrawal Rate?

westv

I'm having a bit of brain drain here.
The 4% "safe" rate.
Is it 4% of the portfolio each year + inflation for the previous year
or is it 4% of the initial pot and then the same amount in subsequent years + inflation?

Triumph13

The latter. Set the income based on a percentage of the starting pot, then index that income every year until you die or run out of funds.

Thrugelmir

3% - 3.5% is nearer the mark given more recent years market performance.

westv

Triumph13 wrote: »

The latter. Set the income based on a percentage of the starting pot, then index that income every year until you die or run out of funds.

Thanks. That's what I thought but my brain suddenly became fuzzled!

HappyMJ

westv wrote: »

I'm having a bit of brain drain here.
The 4% "safe" rate.
Is it 4% of the portfolio each year + inflation for the previous year
or is it 4% of the initial pot and then the same amount in subsequent years + inflation?

The third option will make the fund last exactly 25 years assuming you can equal inflation with the returns the fund gets each year. If the fund loses money you will need to reduce the withdrawal rate the following year.

So..if you retire at 67 the fund will run out when you get to 92 at which point you'll be relying solely on the state pension which currently stands at £155.65 per week. Is that enough when you're 92? It's more than enough for me as I doubt I'll be active enough by then to enjoy it.

AnotherJoe

Its a rule of thumb so I doubt its written in stone anywhere, its not even agreed if it will let the pot last indefinitely or until you die assuming you retire around age 65, but I thought it was a plain old 4% of whatever it is at the start of every year.

ex-pat_scot

The general plan is that you can invest the pot, and invest it in a basket of equity & bonds.
These should generate a long term rate of return of (4% plus inflation).
if you live off the 4%, then the pot should still grow by inflation.

If (a big "if") inflation has averaged 2-3% over the long term, then that means your target rate of return needs to be 6-7% in order that your pot keeps pace with inflation and you do not deplete its worth over time when you decumulate.

A few thoughts on this.

1. it's quite dependent on your investment strategy. You can play about with the portion of assets in equities and bonds (and gold and cash too).

2. Timescale. My gut feel is that the pot still should be considered a long term investment, as it is required to be invested for at least 30 years I hope. As such, i'm still expecting that the lion's share of the capital is in equities. A relatively small amount will be liquid, ready for draw down.

3. income vs accumulating funds. The received wisdom is that income funds (equity funds which are geared towards regular dividend payments) provide a useful stream of liquidity and can be tweaked to provide the required retirement drawdown.

4. Currency. Whilst you may think that you will want to spend most of your time and money in the UK, and as such want to keep most / all of your retirement funds in GBP, you are potentially missing the point that we are a small part of a large global market. I'm therefore trying to get access to the global market by shaping my portfolio in very roughly the same shape as the world market. You can do this through world index trackers (Vanguard are cheap) or at least diversifying your other funds across US, Europe, Asia, emerging markets etc.

5. There's lots of noise as to whether 4% is insufficiently prudent these days for UK.
The research was apparently made in the US, where historic returns have been higher, and excluded costs.
To these two points I counter: there's nothing requiring me to invest in UK and be stuck with the historically lower UK returns. (see 4 above). As for costs: they are a "thief in the night" nibbling away at your pot, but can be minimised to less than 0.25% through careful selection of provider / fund (see Vanguard, again).

I've heard lots of rumbling recently about the imprudence of the 4% SWR, and how it should be 3% or 2.5%.
I think it a blatant overreaction for the following reasons:
1. UK state pension will provide a safety net if I truly miscalculate and run out of funds. It's my long stop insurance.
2. I will ensure that one of my many children have a garden shed in which I could decamp, if (1) fails...
3. EVEN IF I GET ZERO NET RETURN (ie my pot returns only inflation; no more), then taking 4% each year will give me 25 years before pot depletion. At a 3% withdrawal rate, that's 33.3 years. 2.5% would keep me set for 40 years.
If I start at 55, then that takes me to 80, or 88.3, or 95.
Any net investment return would prolong this.
Doesn't this look like a pretty sensible "worst case"?
This can then be ameliorated in several ways, if I experience a sequence of negative returns on the pot:
- reduce spending (!)
- pick up some part time work / online stuff (whatever will have replaced eBay or virtual working by then)
- downsize (in extremis) / lodgers etc.
- equity release

So that's the short answer on the 4% SWR, and my take on it.

dunstonh

There is no safe rate. Its a something someone in the US used for when you are invested in US equities.

If you are not 100% invested in US equities, then it means nothing. Plus, remember US taxation is at source. In the UK it is on the individual (in most tax wrappers). A sustainable rate may apply but you need to match it to your underlying investments.

westv

Thw question was more how is the 4% calculated rather than is the 4% a safe rate.

ex-pat_scot

dunstonh wrote: »

There is no safe rate. Its a something someone in the US used for when you are invested in US equities.

If you are not 100% invested in US equities, then it means nothing. Plus, remember US taxation is at source. In the UK it is on the individual (in most tax wrappers). A sustainable rate may apply but you need to match it to your underlying investments.

Granted, the notion of an easy-to-define Safe Withdrawal Rate is very tempting. However, it is a good starting point for discussion.

And the most important thing I need to remember:
"no plan survives contact with the enemy".


This means a flexible approach, with alternative strategies if things go wrong.
There's (naturally) lots of further reading on t'internet:
https://www.onefpa.org/journal/Pages/Portfolio%20Success%20Rates%20Where%20to%20Draw%20the%20Line.aspx


https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf is a great modelling tool and can get quite sophisticated.


http://firecalc.com/ is the starting point for Monte Carlo modelling.
http://www.cfiresim.com/ is another source.


Understand the limitations of the model.
Read up on what assumptions were used.
Look at the impact of changing portfolio mix.
Add your own assumptions on investment return, one-off expenses.
Don't forget tax (but not NI).

Thrugelmir

westv wrote: »

Thw question was more how is the 4% calculated rather than is the 4% a safe rate.

I'm trying to recollect where I read the explanation. What I can recall is that equities haven't been performing as well since the turn of the 00's. With a high % of the return generated from dividends.