Foolishness of the 4% rule

Secret2ndAccount

itwasntme001 said:

27 pages of time and effort spent on trying to come to some sort of conclusion on a "safe" withdrawal rate and how best to accomplish it.  Surely time better spent actually enjoying life by spending some of the money?  If there is a 1 in 2 or 1 in 3 chance of getting cancer in a lifetime, surely time better spent keeping fit and healthy and not stressing or worrying over safe withdrawal rates?  And so what if you run out of money into old age.  You will be cared for by the state anyway.

Better to just have a very rough sense of how much you can spend and set appropriate allocations.  No need to get so accurate about these things and certainly no need for 27 pages.

Perfection is the enemy of good/action/progress etc.

I propose that we double the number of posts per page. Then it would only be 14 pages. Lot less clicking.

Audaxer

NedS said:

I am playing devils advocate here, but it's kind of a serious question too...

Given a well diversified portfolio of global assets, why wouldn't 4% increasing with inflation be achievable.

I am going for a different less popular approach, of only drawing the natural yield from my portfolio. I hold CTY as a core holding in my portfolio, a UK equity income investment trust currently yielding 4.95%. Compared to a globally diversified portfolio, it is very poorly diversified, only holding 60-100 predominantly UK based equity holdings, and mostly higher dividend payers at that. Yet over the last 50+ years they have been able to increase the dividend yield every year and those rises have beaten inflation over the long term. Being an investment trust, the manager is able to hold back some income in reserve to cover periods of distress (Covid) thus minimising sequence of return type risks. Capital appreciation is up around 3-fold over the last 30 years, and depending on the time of purchase you would have got anywhere from around 4 to 5.5% initial dividend yield on your investment. So my question is if they can achieve the holy grail of a 4-5.5% starting yield rising with inflation over 30 years AND grow capital 3-fold from a severely limited investment universe of FTSE UK dividend paying equities, why is it so hard to imaging that the same would not be achievable from a globally diversified portfolio of assets given everyone tells me a natural yield approach is far less optimal that a total return strategy over the long term.

Given that my natural yield strategy gives me the income I need from my portfolio with little risk of ever running out of capital as I'll never be required to sell any units (and I actually plan on buying more by reinvesting anything over a 5% yield and I'm currently achieving a 6% yield), why would I take the extra risk of a SWR total return approach where no one can agree on what a sensible SWR is or how it should be adjusted over time.

Note: I use CTY as an example of what is achievable, and I hold it as part of a well diversified income portfolio. I also hold growth-based assets as part of a diversified growth portfolio too.

A fair point and I have made a similar point before, in that someone who retired 30 years ago with only CTY as a holding would have had a continuous rising dividend of over 4% of their starting capital. However we don't know if it will continue for the next 30 years, and therefore I only have a relatively small holding of CTY in my income portfolio. I'm retired and have held it for over 4 years and from a Total Return perspective, it's one of my poorest performers over that time, so although I like the dividends, I'm happy to stick with a more diversified portfolio.

Just to clarify one point, it is not the CTY yield that has increased for decades, it is the actual dividend. I'd be quite happy for the yield to fall as that would mean the capital balance was increasing as well as the actual dividend.

Thrugelmir

Audaxer said:

NedS said:

I am playing devils advocate here, but it's kind of a serious question too...

Given a well diversified portfolio of global assets, why wouldn't 4% increasing with inflation be achievable.

I am going for a different less popular approach, of only drawing the natural yield from my portfolio. I hold CTY as a core holding in my portfolio, a UK equity income investment trust currently yielding 4.95%. Compared to a globally diversified portfolio, it is very poorly diversified, only holding 60-100 predominantly UK based equity holdings, and mostly higher dividend payers at that. Yet over the last 50+ years they have been able to increase the dividend yield every year and those rises have beaten inflation over the long term. Being an investment trust, the manager is able to hold back some income in reserve to cover periods of distress (Covid) thus minimising sequence of return type risks. Capital appreciation is up around 3-fold over the last 30 years, and depending on the time of purchase you would have got anywhere from around 4 to 5.5% initial dividend yield on your investment. So my question is if they can achieve the holy grail of a 4-5.5% starting yield rising with inflation over 30 years AND grow capital 3-fold from a severely limited investment universe of FTSE UK dividend paying equities, why is it so hard to imaging that the same would not be achievable from a globally diversified portfolio of assets given everyone tells me a natural yield approach is far less optimal that a total return strategy over the long term.

Given that my natural yield strategy gives me the income I need from my portfolio with little risk of ever running out of capital as I'll never be required to sell any units (and I actually plan on buying more by reinvesting anything over a 5% yield and I'm currently achieving a 6% yield), why would I take the extra risk of a SWR total return approach where no one can agree on what a sensible SWR is or how it should be adjusted over time.

Note: I use CTY as an example of what is achievable, and I hold it as part of a well diversified income portfolio. I also hold growth-based assets as part of a diversified growth portfolio too.

A fair point and I have made a similar point before, in that someone who retired 30 years ago with only CTY as a holding would have had a continuous rising dividend of over 4% of their starting capital. However we don't know if it will continue for the next 30 years, and therefore I only have a relatively small holding of CTY in my income portfolio. I'm retired and have held it for over 4 years and from a Total Return perspective, it's one of my poorest performers over that time, so although I like the dividends, I'm happy to stick with a more diversified portfolio.

Just to clarify one point, it is not the CTY yield that has increased for decades, it is the actual dividend. I'd be quite happy for the yield to fall as that would mean the capital balance was increasing as well as the actual dividend.

Over the past two years the share price has fallen over 7%. Showing the extent to which the managers are having to draw on reserves to both maintain and increase the level of dividend. Hardly surprising given the level of dividend cuts due to the pandemic. 

Audaxer

Say for example someone retired 3 years ago with an investment pot of £200k needing an income of £8k per annum rising with inflation (i.e. a withdrawal rate of 4%), but decided not to drawdown from their pot for these initial 3 years and use cash savings instead. After the last 3 years, say the untouched pot is now worth £250k, but they still just need to drawdown 4% of the original £200k. If we add on 3 years inflation to the original £8k per annum that would now amount to starting at roughly £8,600 per annum withdrawals. That equates to only 3.44% of the current value of £250k, which is obviously a much safer withdrawal rate. 

I therefore think if you can afford it, it is safer to keep enough cash to drawdown in the first few years of retirement, even if your pot is rising, but I'd be interested to know whether others agree?

Sea_Shell

Audaxer said:

Say for example someone retired 3 years ago with an investment pot of £200k needing an income of £8k per annum rising with inflation (i.e. a withdrawal rate of 4%), but decided not to drawdown from their pot for these initial 3 years and use cash savings instead. After the last 3 years, say the untouched pot is now worth £250k, but they still just need to drawdown 4% of the original £200k. If we add on 3 years inflation to the original £8k per annum that would now amount to starting at roughly £8,600 per annum withdrawals. That equates to only 3.44% of the current value of £250k, which is obviously a much safer withdrawal rate. 

I therefore think if you can afford it, it is safer to keep enough cash to drawdown in the first few years of retirement, even if your pot is rising, but I'd be interested to know whether others agree?

We have sort of done this by default, for the last 2 years, as we were under 55 so weren't able to access and pensions, and haven't touched our ISAs.  During that time our investments have done well.

We are now moving into the true drawdown phase.

MK62

Audaxer said:

Say for example someone retired 3 years ago with an investment pot of £200k needing an income of £8k per annum rising with inflation (i.e. a withdrawal rate of 4%), but decided not to drawdown from their pot for these initial 3 years and use cash savings instead. After the last 3 years, say the untouched pot is now worth £250k, but they still just need to drawdown 4% of the original £200k. If we add on 3 years inflation to the original £8k per annum that would now amount to starting at roughly £8,600 per annum withdrawals. That equates to only 3.44% of the current value of £250k, which is obviously a much safer withdrawal rate. 

I therefore think if you can afford it, it is safer to keep enough cash to drawdown in the first few years of retirement, even if your pot is rising, but I'd be interested to know whether others agree?

The "problem" with this is that the starting "pot" was never just the invested £200k.....you also need to include the c£25k cash used to fund the first 3 years.
So the starting withdrawal was actually 3.55%, not 4%.

[Deleted User]

I therefore think if you can afford it, it is safer to keep enough cash to drawdown in the first few years of retirement, 

If one does not have enough DB income then having a cash wedge is important.  Lets say 5 years’ worth of required withdrawals.  And I would refill it every year from investments unless its a major bear market. 

If using the “bucket” approach then cash/liquidity  is needed to cover bucket number 2 (contingency).  The size of this bucket would remain stable, so as investments (hopefully) grow, it may be a smaller percentage of your net worth.  And then withdrawal percent wouldn’t apply to the contingency bucket but only to the invested “discretionary spending” one. 

NedS

MK62 said:

Audaxer said:

Say for example someone retired 3 years ago with an investment pot of £200k needing an income of £8k per annum rising with inflation (i.e. a withdrawal rate of 4%), but decided not to drawdown from their pot for these initial 3 years and use cash savings instead. After the last 3 years, say the untouched pot is now worth £250k, but they still just need to drawdown 4% of the original £200k. If we add on 3 years inflation to the original £8k per annum that would now amount to starting at roughly £8,600 per annum withdrawals. That equates to only 3.44% of the current value of £250k, which is obviously a much safer withdrawal rate. 

I therefore think if you can afford it, it is safer to keep enough cash to drawdown in the first few years of retirement, even if your pot is rising, but I'd be interested to know whether others agree?

The "problem" with this is that the starting "pot" was never just the invested £200k.....you also need to include the c£25k cash used to fund the first 3 years.
So the starting withdrawal was actually 3.55%, not 4%.

I agree. I would include all assets in your model, including the cash savings, when making the initial determination. The wrapper in which they reside (pension, ISA, GIA, cash etc) is irrelevant.

What would you do if after 3 years you'd spent your cash and your £200k pot had halved in value to £100k due to a particularly bad period - would you then continue your retirement drawing only £4k income, or maybe you'd return to work to build that pot back to £200k again so you could afford to retire?

Audaxer

MK62 said:

Audaxer said:

Say for example someone retired 3 years ago with an investment pot of £200k needing an income of £8k per annum rising with inflation (i.e. a withdrawal rate of 4%), but decided not to drawdown from their pot for these initial 3 years and use cash savings instead. After the last 3 years, say the untouched pot is now worth £250k, but they still just need to drawdown 4% of the original £200k. If we add on 3 years inflation to the original £8k per annum that would now amount to starting at roughly £8,600 per annum withdrawals. That equates to only 3.44% of the current value of £250k, which is obviously a much safer withdrawal rate. 

I therefore think if you can afford it, it is safer to keep enough cash to drawdown in the first few years of retirement, even if your pot is rising, but I'd be interested to know whether others agree?

The "problem" with this is that the starting "pot" was never just the invested £200k.....you also need to include the c£25k cash used to fund the first 3 years.
So the starting withdrawal was actually 3.55%, not 4%.

Okay, so if you classed the whole pot as £225k with the £25k as a cash buffer, you probably would want to keep the cash buffer as the 3 years have been positive. You therefore would probably drawdown from your investments rather than cash, so you still keep the cash buffer for the bad years.

Maybe my example would have been better if someone had £250k in total to start, including £50k in cash. Then they could have used £25k of the cash for the first 3 years, and now have investments worth £250k but still have £25k to use as a cash buffer. So the withdrawal rate on the total pot left of £275k, would only be 3.13%. So if you can afford it I think it is better to use cash for the first few years and still have a big enough pot to have a cash buffer for future years. Some would say that is too much cash to hold, but I think it seems safer than drawing from your investments in the early years?

MK62

I use a form of cash buffer approach myself, so I wouldn't disagree with you there.......of course, that can take many forms, but whichever you use there is an opportunity cost in rising markets. That's the trade off for the peace of mind you get.