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

MaxiRobriguez

coyrls said:

MaxiRobriguez said:

The 4% withdrawal is a figure which supposedly means you'll never reduce your capital

That is not the case, the 4% figure (i.e. 4% of the value of your investments at retirement, increased by inflation each year, not a 4% withdrawal each year), was what could be withdrawn, with an acceptable success rate, without running out of money over a defined period.  There are arguments to be had about the method and the assumptions used by studies that led to the 4% figure but it has nothing to do with never reducing your capital.

Mr Money Moustache describes the 4% rate as:

"At the most basic level, you can think of it like this: imagine you have your ‘stash of retirement savings invested in stocks or other assets. They pay dividends and appreciate in price at a total rate of 7% per year, before inflation. Inflation eats 3% on average, leaving you with 4% to spend reliably, forever."

So some very much do see it as a "never reduce capital"

barnstar2077

Because I sat down and worked out how much money I will need, and then decided how much and where I was going to invest to achieve that goal, I can now relax knowing that every month that goes by is another month closer to achieving my dream.

Because I budget I know that once all allotted money has been sent to the right places I am free to spend and enjoy what is left guilt free.

If I made no plan and simply put aside what I could I might not do things that I want to for fear of it affecting me financially years later.  I would also have a nagging feeling in the back of my mind when I did spend money that I might be robbing future me of options.

A plan and a budget is more than just achieving your goals, it is also peace of mind.

EthicsGradient

Thrugelmir 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.

You might be receiving the annuity for another 45 years. Calculate the impact of compounding over that time frame.

But compounding also works for the money that is invested in the annuity. Because they will pay back only 1/60th of the annuity each year if that increases with inflation (60 years would take you to age 115 - way over any life expectancy), they're effectively saying that, after they've taken their profit each year, they don't expect they can invest it to keep up with inflation. Doing a test in a spreadsheet with 45 years (ie to age 100) as the 'average' they'd paid out until, and using the 3% escalating annuity, they think they can return about 2.5%. 

Thrugelmir

MaxiRobriguez said:

coyrls said:

MaxiRobriguez said:

The 4% withdrawal is a figure which supposedly means you'll never reduce your capital

That is not the case, the 4% figure (i.e. 4% of the value of your investments at retirement, increased by inflation each year, not a 4% withdrawal each year), was what could be withdrawn, with an acceptable success rate, without running out of money over a defined period.  There are arguments to be had about the method and the assumptions used by studies that led to the 4% figure but it has nothing to do with never reducing your capital.

Mr Money Moustache describes the 4% rate as:

"At the most basic level, you can think of it like this: imagine you have your ‘stash of retirement savings invested in stocks or other assets. They pay dividends and appreciate in price at a total rate of 7% per year, before inflation. Inflation eats 3% on average, leaving you with 4% to spend reliably, forever."

So some very much do see it as a "never reduce capital"

When did inflation last average 3%? The statement sounds very much dated. 

itwasntme001

MaxiRobriguez said:

coyrls said:

MaxiRobriguez said:

The 4% withdrawal is a figure which supposedly means you'll never reduce your capital

That is not the case, the 4% figure (i.e. 4% of the value of your investments at retirement, increased by inflation each year, not a 4% withdrawal each year), was what could be withdrawn, with an acceptable success rate, without running out of money over a defined period.  There are arguments to be had about the method and the assumptions used by studies that led to the 4% figure but it has nothing to do with never reducing your capital.

Mr Money Moustache describes the 4% rate as:

"At the most basic level, you can think of it like this: imagine you have your ‘stash of retirement savings invested in stocks or other assets. They pay dividends and appreciate in price at a total rate of 7% per year, before inflation. Inflation eats 3% on average, leaving you with 4% to spend reliably, forever."

So some very much do see it as a "never reduce capital"

I do not think he meant "forever" in the literal sense.  I think he meant forever as in until you expect to live till.  The 4% rule is about taking out 4% every year and never have the wealth dip below 0.  No assumptions are made that the capital remains intact.  Works in 95% of cases using historical simulation assuming a normal retirement length.  This means you CAN NOT use the 4% rule for retirement lengths longer than the usual.  Something so many early retirees fail to realise.

Thrugelmir

EthicsGradient said:

Thrugelmir 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.

You might be receiving the annuity for another 45 years. Calculate the impact of compounding over that time frame.

But compounding also works for the money that is invested in the annuity. Because they will pay back only 1/60th of the annuity each year if that increases with inflation (60 years would take you to age 115 - way over any life expectancy), they're effectively saying that, after they've taken their profit each year, they don't expect they can invest it to keep up with inflation. Doing a test in a spreadsheet with 45 years (ie to age 100) as the 'average' they'd paid out until, and using the 3% escalating annuity, they think they can return about 2.5%. 

I'd say that the insurers work on acturial tables and pooled risk. Nothing to do with investing a single pot of money. Government stocks provide a totally predictable income stream and a known capital return. 

coyrls

MaxiRobriguez said:

coyrls said:

MaxiRobriguez said:

The 4% withdrawal is a figure which supposedly means you'll never reduce your capital

That is not the case, the 4% figure (i.e. 4% of the value of your investments at retirement, increased by inflation each year, not a 4% withdrawal each year), was what could be withdrawn, with an acceptable success rate, without running out of money over a defined period.  There are arguments to be had about the method and the assumptions used by studies that led to the 4% figure but it has nothing to do with never reducing your capital.

Mr Money Moustache describes the 4% rate as:

"At the most basic level, you can think of it like this: imagine you have your ‘stash of retirement savings invested in stocks or other assets. They pay dividends and appreciate in price at a total rate of 7% per year, before inflation. Inflation eats 3% on average, leaving you with 4% to spend reliably, forever."

So some very much do see it as a "never reduce capital"

He is completely wrong if he is describing Safe Withdrawal Rate studies.  Of course it is mathematically correct that if you take 4% of the current value of the pot each year it will last for ever but that would be the case for any rate below 100% and so doesn't really tell us anything.  Also there is no combination of investments that will grow at a total rate of 7% every year.  If you have a year where your investments don't increase by the amount you remove, then you will reduce your capital by definition.  Just taking out dividends won't cut it either as that will not stop capital reduction.  There is no sensible strategy that will "never reduce capital".

Linton

In the drawdown context x%/year normally means x% of the initial pot subsequently increasing by inflation each year.  As you say a strategy of a fixed % of the then current pot would not be very sensible.

EthicsGradient

Thrugelmir said:

EthicsGradient said:

Thrugelmir 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.

You might be receiving the annuity for another 45 years. Calculate the impact of compounding over that time frame.

But compounding also works for the money that is invested in the annuity. Because they will pay back only 1/60th of the annuity each year if that increases with inflation (60 years would take you to age 115 - way over any life expectancy), they're effectively saying that, after they've taken their profit each year, they don't expect they can invest it to keep up with inflation. Doing a test in a spreadsheet with 45 years (ie to age 100) as the 'average' they'd paid out until, and using the 3% escalating annuity, they think they can return about 2.5%. 

I'd say that the insurers work on acturial tables and pooled risk. Nothing to do with investing a single pot of money. Government stocks provide a totally predictable income stream and a known capital return. 

When you buy an annuity, you are giving them a single pot of money to invest. The calculations they use to arrive at how much they'll give you back aren't the point; the point is that they'll give you back very little. Their choices - government stocks, or company stocks - won't cover their desired profit and then leave enough for your contribution to keep up with inflation.

DiggerUK

It is bizarre how anybody can consider it plausible, that after continuously  removing funds from the various retirement pots that have been mentioned, that those funds will not eventually deplete over time, possibly to nothing.

It is inevitable that everything we have put by over time will reduce, there is no magic fix to prevent that happening. As soon as the penny drops that there is no philosophers stone, and that once you start spending by taking from your retirement stores, it will eventually go, the better.

There is much spoken and written of work/life balances; that will influence and impact what you eventually do put by. But there seems to be no grasp of the similar nuances needed to be grappled with between a retirement/life balance when the wage isn't there anymore.

Here at Digger Mansions we like to keep things simple, but watch in bewilderment at the intricate schlieffen style plans being hatched....and we all know how long that plan lasted.

It is rather satisfying to find that after eleven years on MSE,  putting our retirement savings in to gold, that we don't have to justify  our decision against the storm of scorn and abuse that we met with along the way.

Keep things simple.._