The 4% rule

aroominyork

My understanding of the 4% rule is that an inflation adjusted 4% withdrawal each year should – with a 60/40 equity/bond portfolio? – last 30 years. Is that correct?

Does anyone know of an open source spreadsheet where you can enter different rates of investment return/inflation/withdrawals to test scenarios?

masonic

That's the conclusion drawn from historical data for someone living in the USA.

There are various sites that allow you to test alternative assets and get local interpretations. The latest being portfoliocharts.com

There is also portfoliovisualizer.com for deeper analysis.

InvesterJones

There's an excellent spreadsheet here if you sign up for James' newsletter.

https://james-shack.co.uk/savings-calculator

Link came from this video:
https://www.youtube.com/watch?v=S9y8tsaZ3b4

dunstonh

My understanding of the 4% rule is that an inflation adjusted 4% withdrawal each year should – with a 60/40 equity/bond portfolio? – last 30 years. Is that correct?

There is no 4% rule in the UK.   It was a US study based on a shorter life expectancy than today using US currency and markets.       An equivalent for 25 years in the UK is 3.5% but longer than that is 3%.

aroominyork

dunstonh said:

My understanding of the 4% rule is that an inflation adjusted 4% withdrawal each year should – with a 60/40 equity/bond portfolio? – last 30 years. Is that correct?

There is no 4% rule in the UK.   It was a US study based on a shorter life expectancy than today using US currency and markets.       An equivalent for 25 years in the UK is 3.5% but longer than that is 3%.

Is that saying that 3% withdrawals would be expected to erode a pot after about 30 years? That suggests that with say 2.5% inflation and gilts returning about 4%, equities would be expected to gain 6.5% pa for a 60/40 portfolio to grow 5.5% (6.5*0.6 + 4.0*0.4 = 5.5). Markets do better than that over the medium term.

masonic

aroominyork said:

dunstonh said:

My understanding of the 4% rule is that an inflation adjusted 4% withdrawal each year should – with a 60/40 equity/bond portfolio? – last 30 years. Is that correct?

There is no 4% rule in the UK.   It was a US study based on a shorter life expectancy than today using US currency and markets.       An equivalent for 25 years in the UK is 3.5% but longer than that is 3%.

Is that saying that 3% withdrawals would be expected to erode a pot after about 30 years? That suggests that with say 2.5% inflation and gilts returning about 4%, equities would be expected to gain 6.5% pa for a 60/40 portfolio to grow 5.5% (6.5*0.6 + 4.0*0.4 = 5.5). Markets do better than that over the medium term.

It's sequence of returns risk that dramatically reduces SWR. You can't assume a stable average return, even a low one. There will always be ups and downs, and the occasional lost decade. There was a peak to trough drop of 50% in the 1970s for a 60:40 portfolio. That would lead the retiree to withdraw 8% of the reduced value of the portfolio, greatly accelerating its depletion.

aroominyork

But if you have buckets and rebalance so that, crucially, you do not sell equities at a loss, doesn't that mitigate?

masonic

aroominyork said:

But if you have buckets and rebalance so that, crucially, you do not sell equities at a loss, doesn't that mitigate?

The models I'd suggest you use assume you will rebalance to maintain 60:40, so you would not need to sell any equities if equities were selectively falling, but it wouldn't have helped much in 1972, because bonds fell significantly too (-46% over 2 years).

That was part of a longer term trend, see https://monevator.com/bond-market-crash/

Albermarle

aroominyork said:

dunstonh said:

My understanding of the 4% rule is that an inflation adjusted 4% withdrawal each year should – with a 60/40 equity/bond portfolio? – last 30 years. Is that correct?

There is no 4% rule in the UK.   It was a US study based on a shorter life expectancy than today using US currency and markets.       An equivalent for 25 years in the UK is 3.5% but longer than that is 3%.

Is that saying that 3% withdrawals would be expected to erode a pot after about 30 years? That suggests that with say 2.5% inflation and gilts returning about 4%, equities would be expected to gain 6.5% pa for a 60/40 portfolio to grow 5.5% (6.5*0.6 + 4.0*0.4 = 5.5). Markets do better than that over the medium term.

Just ignoring the argument about the exact % for now. 
The withdrawal % is not aimed at reducing the pot to zero in 30 years, but is aimed at reducing the chance of the pot running out in 30 years to a very low % , say 5.
There is a very good chance that at 3 or 4%, you might find that in 30 years, your pot is double than from where it started. 

tacpot12

For most pensioners in the UK, I would argue that a Safe Withdrawal Rate is above 4%. The state pension entitlement that most people will have means that much of their essential spending is covered by the state pension. This means that they only need their discretionary spending to be covered by withdrawals from their personal pensions. This gives much greater flexibility to adjust your savings when the stock market isn't doing well. 

dunstonh

aroominyork said:

But if you have buckets and rebalance so that, crucially, you do not sell equities at a loss, doesn't that mitigate?

But then you are beaking the 60/40 model by introducing other methods.  And over the long term, rebalancing reduces returns in most periods but can improve them in a minority.   The main benefit of rebalancing is to retain tolerance to a volatility level.

Buckets will reduce sequencing risk but could also create backend risk where the reduced return on x% of your money could hurt if you live longer than expected.      A popular method with bucketing at the moment is to retain 60% equities (if that is your chosen equity exposure) but use cash instead of bonds within the 40% for x years worth of income draws.   

The debate then goes onto how many years.   The first decade of this millennium saw equities fall in value over 10 years.   US equity fell by more than global equity exc UK.  Are many people going to retain 10 years worth of income as cash in their modelling?    

When you look at a "safe" withdrawal rate, you need to consider worst case scenarios.   There are not many scenarios which are at the very bottom end but if you are using the word "safe", then they need to be considered.    Also, UK inflation average is around 4.9% over the last 70 years.  So, using a too low an assumption can really hurt models.