Does the FIRE 4% rule work in neutral sideways markets?

MarkCarnage

One positive for gold is that with cash rates going to virtually zero around the world, and talk of negative rates, the opportunity cost argument against holding gold has pretty much disappeared. Also, and importantly, the trashing of fiat currency argument has more weight. All of which is why I've added it directly or indirectly over the last year from a zero base. 

But I still don't kid myself that it has a yield. 

MaxiRobriguez

I too have added an allocation to gold, but only small single figures, with the rest split between equities (c85%) and cash.

2unlimited91

Sailtheworld said:

2unlimited91 said:

Sailtheworld said:

What if you could get 3.6% and keep the capital? Fannying about with elaborate financial concoctions (aka a few sums) and you could get a reasonable idea of the risks involved and whether they were worth it.

Why do you hate annuities?

Annuities are the answer to the problem of how to use capital to achieve the maximum possible secure income over one's remaining lifetime. You're not offering a rival answer to the same problem, but an answer to a different problem, i.e. how to maximize a not-really-secure-but-it-will-probably-be-OK-provided-that-you-can-be-flexible-about-what-income-you-draw-if-it-comes-to-that income while also preserving the real value of the capital.

You draw money from a pot so need to think about the risks of a long retirement. Alternatively you could take an annuity and think about the risks of living a short retirement instead.Slightly different problem but same thought process. I can't imagine spending a working life building capital and then losing control of it in exchange for a secure income. I think I'd prefer to build in a margin of error and enjoy managing my finances anyway. I can always change my mind later.

Wow. I didn't expect you to make me change my mind (not something that really happens in these discussions ), but after you've spelled out your attitude to annuities, it seems even stranger to me than it did before.

You seriously want to be a rich corpse? You can't keep control of your capital when you're dead. The way I look at it: ensuring you have a sufficient income for your remaining life is taking control of your finances.

Dying just after buying an annuity would be a loss in many ways (the things you wouldn't get to do; the people you wouldn't get to see grow up), but it isn't a financial loss. You had a sufficient income for the spending needs of your remaining lifetime; the income and the needs are both gone; the latter is a tragic loss, the former isn't because the income is no longer needed.

That all is assuming that you would only buy an annuity to cover your expected spending. If you chose to buy one with capital that you were planning eventually to give away to other people or causes, then that would be taking a genuine financial gamble on your own longevity, which would lose if you die early. I wouldn't recommend using annuities like that.

You would "prefer to build in a margin of error", i.e. save more than necessary for your retirement, rather than buying an annuity. Certainly there is no need to buy an annuity, if you means are comfortably more than your needs are ever likely to be. Most people don't have that luxury, however, so it is not just a question of preference.

tibbles209

2unlimited91 said:

You would "prefer to build in a margin of error", i.e. save more than necessary for your retirement, rather than buying an annuity. Certainly there is no need to buy an annuity, if you means are comfortably more than your needs are ever likely to be. Most people don't have that luxury, however, so it is not just a question of preference.

The thing is though, annuities are so expensive that the withdrawal rate from a sensibly invested pot to match the income would be so low that there would be very little risk of capital depletion indeed. Best buy 3% escalating single life annuity for a 60 year old is about 2.42% at the moment. If you kept your capital invested and withdrew 2.42% with a 3% annual uplift you would be extremely unlucky to die with lower real-terms capital than you started with, whereas if you bought the annuity all of your capital is gone. While you would not personally benefit from the preserved capital after your death, if you have any loved ones who would inherit your pot that could be life changing for them. 

Now admittedly if you are retiring much later (i.e. age 70) the annuity rate is more like 3.94% which in a minority of cases would not be supported indefinitely by drawdown, although even with a 0% real rate of return you would not run out of capital until at least age 95. So essentially you would need to live longer than most and have worse investing luck than most historical circumstances to end up worse off than having bought an annuity. For some people any risk whatsoever, no matter how tiny, is not worth taking for the sake of the probability of a much more favourable outcome which is fair enough and an annuity is for those people, but surely you can understand why others would prefer the high probability of a better outcome while accepting the very small risk of ending up worse off. 

It also doesn't need to be all-or-nothing. Some people buy annuity income which is just enough (in conjunction with state/ DB pension) to secure their basic income requirements, and then use drawdown for the remainder.

2unlimited91

tibbles209 said:

2unlimited91 said:

You would "prefer to build in a margin of error", i.e. save more than necessary for your retirement, rather than buying an annuity. Certainly there is no need to buy an annuity, if you means are comfortably more than your needs are ever likely to be. Most people don't have that luxury, however, so it is not just a question of preference.

The thing is though, annuities are so expensive that the withdrawal rate from a sensibly invested pot to match the income would be so low that there would be very little risk of capital depletion indeed. Best buy 3% escalating single life annuity for a 60 year old is about 2.42% at the moment. If you kept your capital invested and withdrew 2.42% with a 3% annual uplift you would be extremely unlucky to die with lower real-terms capital than you started with, whereas if you bought the annuity all of your capital is gone. While you would not personally benefit from the preserved capital after your death, if you have any loved ones who would inherit your pot that could be life changing for them. 

Now admittedly if you are retiring much later (i.e. age 70) the annuity rate is more like 3.94%

Yes. IMHO, the age to consider buying an annuity is around 70, not 60. Even if you are retiring at 60.

which in a minority of cases would not be supported indefinitely by drawdown, although even with a 0% real rate of return you would not run out of capital until at least age 95. So essentially you would need to live longer than most and have worse investing luck than most historical circumstances to end up worse off than having bought an annuity. For some people any risk whatsoever, no matter how tiny, is not worth taking for the sake of the probability of a much more favourable outcome which is fair enough and an annuity is for those people, but surely you can understand why others would prefer the high probability of a better outcome while accepting the very small risk of ending up worse off. 

Well, the 0% rate of real return is a bit of a red herring. Even if you could achieve that (from cash, or whatever), a drawdown strategy will actually use a lot of equities, and the biggest risk is then of large negative returns in the first few years of drawdown, and that that will do irreparable damage to the drawdown pot size, given that you are also drawing from it in those years. So equities could have compound returns well above 0% over the first 25 years of your drawdown, but you could have run out of capital before well the 25 years are up. Or rather, if you're doing drawdown sensibly, you'd have had to reduce spending prudently to avert the risk of running out of capital. And perhaps after you reduced spending, equities would then bounce back strongly enough that, with hindsight, you'd realize reducing spending was unnecessary after all. But you couldn't know that at the time. These are the kinds of issues you need to consider when using drawdown, not just the theoretical probability of success.

It also doesn't need to be all-or-nothing. Some people buy annuity income which is just enough (in conjunction with state/ DB pension) to secure their basic income requirements, and then use drawdown for the remainder.

Absolutely.

tibbles209

Well, the 0% rate of real return is a bit of a red herring. Even if you could achieve that (from cash, or whatever), a drawdown strategy will actually use a lot of equities, and the biggest risk is then of large negative returns in the first few years of drawdown, and that that will do irreparable damage to the drawdown pot size, given that you are also drawing from it in those years. So equities could have compound returns well above 0% over the first 25 years of your drawdown, but you could have run out of capital before well the 25 years are up. Or rather, if you're doing drawdown sensibly, you'd have had to reduce spending prudently to avert the risk of running out of capital. And perhaps after you reduced spending, equities would then bounce back strongly enough that, with hindsight, you'd realize reducing spending was unnecessary after all. But you couldn't know that at the time. These are the kinds of issues you need to consider when using drawdown, not just the theoretical probability of success.

You would indeed need to consider sequence of returns risk and this accounts for the minority of cases where you could end up worse off, although there are strategies (bond tent with rising equity glidepath, various drawdown rate adjustment rules depending on market conditions etc.) that can somewhat mitigate this risk. 
If you genuinely attribute no value whatsoever to preserved inheritable capital after your death and want an easy and entirely risk-free retirement then annuities are the way to go. 

Audaxer

tibbles209 said:

2unlimited91 said:

You would "prefer to build in a margin of error", i.e. save more than necessary for your retirement, rather than buying an annuity. Certainly there is no need to buy an annuity, if you means are comfortably more than your needs are ever likely to be. Most people don't have that luxury, however, so it is not just a question of preference.

If you kept your capital invested and withdrew 2.42% with a 3% annual uplift you would be extremely unlucky to die with lower real-terms capital than you started with, whereas if you bought the annuity all of your capital is gone. 

If sensibly invested, at a low withdrawal percentage like 2.42%, increasing with inflation, I agree that you are unlikely to run out of capital, but I'm not so confident that you would have at least the same level of real-time capital that you started with, especially if there was a bad sequence of returns at the start of your retirement?

EthicsGradient

Audaxer said:

tibbles209 said:

2unlimited91 said:

You would "prefer to build in a margin of error", i.e. save more than necessary for your retirement, rather than buying an annuity. Certainly there is no need to buy an annuity, if you means are comfortably more than your needs are ever likely to be. Most people don't have that luxury, however, so it is not just a question of preference.

If you kept your capital invested and withdrew 2.42% with a 3% annual uplift you would be extremely unlucky to die with lower real-terms capital than you started with, whereas if you bought the annuity all of your capital is gone. 

If sensibly invested, at a low withdrawal percentage like 2.42%, increasing with inflation, I agree that you are unlikely to run out of capital, but I'm not so confident that you would have at least the same level of real-time capital that you started with, especially if there was a bad sequence of returns at the start of your retirement?

However, the comparison isn't with "the same level of real-time capital", it's with "no capital". A retiree would like their capital to keep up with "given my revised life expectancy, can my investments still cover that comfortably?". So if average life expectancy was another 30 years at age 60, with a fair chance of beating that by 10 (ie getting to 100), by 75 it may be 20 years, but the chances of going 10 over that (ie to 105) will be lower.

I think the lowest risk of all would be an index-linked annuity, since that gives you the same standard of living in retirement, year after year. With a fixed increase, you'll be better off in later years if inflation undershoots (nice, but you might have liked the option to take a bit more earlier, when you saw inflation had kept lower for several years), or you might fail to keep up with inflation.

An advantage of investing it in shares is that, if inflation does go high, so should the revenues and profits of the stocks you own.

tibbles209

Audaxer said:

If sensibly invested, at a low withdrawal percentage like 2.42%, increasing with inflation, I agree that you are unlikely to run out of capital, but I'm not so confident that you would have at least the same level of real-time capital that you started with, especially if there was a bad sequence of returns at the start of your retirement?

When I play around with modelling software (using a 70/30 global portfolio and a 40 year retirement) I am getting a higher real-terms ending balance about ~85% of the time, with the median real-terms ending balance being ~4x the initial balance, and a failure rate (i.e. running out of money before the end of the 40 years) of about 2.5%. 

2unlimited91

When you use drawdown in practice, you would surely be flexible about the withdrawal rate. If it starts going badly, you wouldn't blindly keep going and risk being part of the 2.5% failure rate: you'd reduce spending before it comes to that. And on the other hand, if you're off to a favourable start, you might reasonably choose to increase spending (if you value increased spending more than increased bequests).

This flexibility is going to affect the amount left over. Presumably, it would make the extreme outcomes (very large or very small amounts left over) less likely.

However, there is also the factor that, if you are are perhaps 30 or 35 years into your projected 40-year retirement, and your pot has declined significantly in value, and you are now thinking there is a serious chance of exceeding the 40 years after all, so it's looking a bit dicey whether you pot will last out, you might choose to annuitize some or all of your pot, even at a relatively late stage, to eliminate that risk.

All these factors mean that the likely amount left over, in a realistic drawdown scenario, may be rather different from what the models, which only cover an inflexible drawdown strategy, imply.