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

Linton

Based on my experience of 15 years of retirement......

Planned spending in retirement falling below what your investments can generate is something that many people will experience.  Those who dont will either have made high risk plans or have the misfortune to have retired at what turns out to be a bad time.

At the start of retirement it makes sense to be cautious for a few years.  In the majority of cases what will happen is that the pot will increase in size or at least be significantly larger than planned - the risks the original plan mitigated against dont happen.  So it makes sense to replan for what is now extra cash drawdown over a shorter time frame. The shorter the time frame the greater the safe drawdown.

However at some point the available expenditure may exceed what can be sensibly used for day to day living.  There is little joy in spending for the sake of it, at least for us, and extra stuff just makes the house untidy.  Excess capital can therefore be kept for deserving beneficiaries,  or used for lump sum expenditure to enhance one's life. In our case we have given some away to family and charity, up-sized our house, and take long haul holidays every few years.

Linton

Malthusian said:

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A symptom of this problem is people who say 4% is too optimistic (it isn't) due to misconceptions about how decumulation works - which don't apply to you if you are happy spending less than 4%. Typical misconceptions include "it's not safe because yields are less than 4%" (the 4% rule allows for some capital depletion), which is lurking behind the first half of the OP. 

I would take a different approach here.

 ISTM one should plan on spending at the lowest level you would feel perfectly acceptable for the long term with very cautious assumptions.  Planning on that basis implies one would not be happy with a lower income than planned.  The advantage is that the risks are on the upside - you are likely to have more money than you planned rather than less. The former being a much easier problem to handle.  

A second point is that planning on achieving your income with a steady depletion of capital is highly risky particularly if you are retiring early with perhaps 35-40 years of living off your capital - you do not know how long you will live so it is sensible to be pessimistic (from a financial point of view). Safely covering 35-40 years should be pretty close to permament sustainability and if you really do deplete your capital in the early years you run the risk of negative compounding.  Lower capital means a lower return in £ terms which increases your depletion rate.

A more fundamental criticism is that I do not believe in basing retirement plans on a Safe Withdrawal Rate anyway.  Better in my view to assume an expenditure in inflated £s and a % investment return and then calculate how much money you would have left at the end of some optimistic lifespan using a year by year spreadsheet.  The effect of crashes can be simulated by explicitly encoding a fall in capital as can one-off capital expenditure.

EthicsGradient

Malthusian said:

If 2% is all you need you may as well buy an inflation-linked annuity.

I thought I'd check what annuity rates currently are, just to see what they imply about sustainable rates of withdrawal. If Hargreaves Lansdown are accurate, we find that for a 55 year old, they pay just 1.6% for one linked to RPI, though 2.0% for one escalating at 3% a year. The former seems very ungenerous; and also implies they think inflation will be more than 3% pa over the long term. Which is surprising, and depressing.

Linton

EthicsGradient said:

Malthusian said:

If 2% is all you need you may as well buy an inflation-linked annuity.

I thought I'd check what annuity rates currently are, just to see what they imply about sustainable rates of withdrawal. If Hargreaves Lansdown are accurate, we find that for a 55 year old, they pay just 1.6% for one linked to RPI, though 2.0% for one escalating at 3% a year. The former seems very ungenerous; and also implies they think inflation will be more than 3% pa over the long term. Which is surprising, and depressing.

Annuities are generally very low if you start them early.  The problem is that they are absolutely guaranteed and so must be based on government bonds, which of course are now returning very low, if any, interest.  So an annuity at the moment will no virtually nothing more than give you your own money back minus a small % for the pension company.  The theory is that people who die early pay for those that die late, but nowadays few people die in their 50s and the effect does not become significant until you are perhaps in your 80s.

itwasntme001

Linton said:

EthicsGradient said:

Malthusian said:

If 2% is all you need you may as well buy an inflation-linked annuity.

I thought I'd check what annuity rates currently are, just to see what they imply about sustainable rates of withdrawal. If Hargreaves Lansdown are accurate, we find that for a 55 year old, they pay just 1.6% for one linked to RPI, though 2.0% for one escalating at 3% a year. The former seems very ungenerous; and also implies they think inflation will be more than 3% pa over the long term. Which is surprising, and depressing.

Annuities are generally very low if you start them early.  The problem is that they are absolutely guaranteed and so must be based on government bonds, which of course are now returning very low, if any, interest.  So an annuity at the moment will no virtually nothing more than give you your own money back minus a small % for the pension company.  The theory is that people who die early pay for those that die late, but nowadays few people die in their 50s and the effect does not become significant until you are perhaps in your 80s.

They also tend to hold a significant amount of corporate bonds.  Given where government bonds are trading now, to reduce the reinvestment risk implicit in their strategy, they will need higher returns from "safer" assets such as corporate bonds.  If they held purely government bonds, annuity rates would be even lower.

They used to offer GARs and DB pension schemes in the private sector quite commonly 30-40 years ago.  These generous schemes severely underestimated the reinvestment risk, and given real interest rates have fallen sharply into negative territory, it is easy to see why these schemes are pretty much non-existent.

Audaxer

AnotherJoe said:

4% is the historical max you can take out (and there are various tricks to increase that) but better to be on say 2% providing what you need, and then if there is a 50% crash, well no worries.

If all someone plans to withdraw is 2% plus inflation, I am not sure it is worth the risk of investing it. If for example you had £100k in cash savings, even at 0% interest, and you withdrew £2k per year increasing at 2% per year for inflation, you would still have nearly £19k left after 30 years. 

Thrugelmir

CreditCardChris said:

Thrugelmir said:

Unsure what the FIRE 4% rule is. The original study (for which the detailed data was never published), was based on the US markets with a split of 50% equities and 50% US Treasuries. Nor were fees factored into the findings. 

Dividends are far from guaranteed. Nor do all companies either pay them or at a rate which is sufficient to provide a high level of income. 

The 4% rule is basically the percentage you can theoretically withdraw from your capital each year without it losing significant value over a long period of time and I think it's workout out based on the last 100 years of market data. So bull markets, bear markets and sideways markets, withdrawing 4% should still allow your capital to at least maintain it's value with inflation.

If you can provide a link to the source I'd be most interested.  The Credit Suisse Global Investment Returns Year Book is a good source of information to gain an understanding of long trends properly. 

Sailtheworld

Thrugelmir said:

CreditCardChris said:

Thrugelmir said:

Unsure what the FIRE 4% rule is. The original study (for which the detailed data was never published), was based on the US markets with a split of 50% equities and 50% US Treasuries. Nor were fees factored into the findings. 

Dividends are far from guaranteed. Nor do all companies either pay them or at a rate which is sufficient to provide a high level of income. 

The 4% rule is basically the percentage you can theoretically withdraw from your capital each year without it losing significant value over a long period of time and I think it's workout out based on the last 100 years of market data. So bull markets, bear markets and sideways markets, withdrawing 4% should still allow your capital to at least maintain it's value with inflation.

If you can provide a link to the source I'd be most interested.  The Credit Suisse Global Investment Returns Year Book is a good source of information to gain an understanding of long trends properly. 

It started with this chap's work. http://www.retailinvestor.org/pdf/Bengen1.pdfs. It seems to be one of those things which captures the Internet's imagination with people proving it and debunking it on a regular basis. It's a rule of thumb only - people are missing the point if they're arguing about whether 3%, 4% or 5% withdrawals are 'safe'. They all require substantial savings and nobody ever (or ever will) will take 4% as a single income stream from a single pot.

The Credit Suisse yearbook looks like a good read and gives long run averages for global equities and bonds. It even takes a stab at predicting future returns (3.5% ahead of inflation for global equities and zero for bonds). All useful information but you can't model retirement drawdown based on this alone. It would be flawed to simply assume 3.5% returns vs 4% drawdown and see how long your money would last. The missing piece of information is variability of returns.

That's what the 4% rule is based on by using very long term returns as a base but applying past market variability to see how many times the investor would have run out of money. You could easily do this in Excel with a Monte Carlo simulation and different standard deviations of return. It's not very real World because, in reality, nobody would slavishly withdraw cash from savings if they saw it being depleted faster than projected.

Of course the future will be different from the past but as a rule of thumb, rather than a commandment, having 25 x annual spending as savings would put most people most of the time in the retirement zone.

kinger101

Malthusian said:

Nobody in the history of finance has ever retired on a drawdown fund and withdrawn 4% of the initial fund each year and increased their withdrawal by the rate of inflation every single year, without paying any attention to the fund value, until death or fund exhaustion. If you disagree then name two people who did.

Not disagreeing with the need for flexibility but
(a) we cannot know how every fund ever in existence was drawn down,  therefore your statement is non-falsifiable.
(b) and then you've asked us to name two people, when just one would disprove your assertion.

Notepad_Phil

Audaxer said:

AnotherJoe said:

4% is the historical max you can take out (and there are various tricks to increase that) but better to be on say 2% providing what you need, and then if there is a 50% crash, well no worries.

If all someone plans to withdraw is 2% plus inflation, I am not sure it is worth the risk of investing it. If for example you had £100k in cash savings, even at 0% interest, and you withdrew £2k per year increasing at 2% per year for inflation, you would still have nearly £19k left after 30 years. 

If you could guarantee that inflation would remain at 2% then I'd agree - however I'm pretty sure that there will be at least some outbreaks of higher inflation from time to time which could cause problems, even if someone is being proactive with where their money is kept.

Mrs Notepad and myself are in our fifties, early retired, and are in the lucky position where we are not great spenders and can comfortably live on a withdrawal rate of less than 3% (the natural yield of our retirement portfolio) and although we do have a significant chunk in cash (in case of situations like now where dividends are cut) the majority is in equities.

We've done that to a) hopefully help with any inflationary outbreaks that may arise, b) hopefully mean that money is still available should either of us live to 100+ (both our mothers are 90+ and in good health, c) leave money for care (though hopefully not for another 30+ years at least), d) if anything is left then more money for inheritance.