Getting Minted

I’d like to say more about my experience so far of living on 4% (or thereabouts) of my drawdown funds each year. Five and a half years ago I quit my job with a view that I could live on my existing assets if I chose to. I finished work in December 2013 so I regard 1 January 2014 as the start of this new phase. Apart from a two-week assignment in 2014 I haven’t worked since then and I’m not minded to seek work at present, although I don’t absolutely rule it out.

One of the reasons I quit when I did was because I felt I had enough. Financially I felt I had enough assets to live on. At that time the natural income of my investment portfolio had just exceeded my spending. I had reached and gone past the cross-over point as mentioned in “Your money or your life” by Joe Dominguez and Vicki Robin. Working on would have produced more cash than I felt I needed based on my current lifestyle.

I had read of the 4% “rule” – the so-called safe withdrawal rate. That gave me comfort that 4% was a reasonable level of drawdown. My portfolio then, and now, is mostly based on equity income investment trusts with a typical net dividend yield of around 4%. I knew with investment trusts that some income earned is held back from payment in a revenue reserve in better years so it can be released in order to pay the dividend in less good years. These trusts often have long records of maintaining and increasing their dividends. One leading trust has increased its’ dividend every year since 1966. This gave me confidence that the investment income I had in 2013 would be maintained and should increase over time. Historically it had beaten inflation going back twenty years or more.

I wasn’t assuming I would spend less when not working, but I was thinking that I didn’t need to spend more and could maybe spend less, and within reason I could choose when to spend anything significant. This was all of some comfort.

I have shown in the tables below how things have worked out so far in the five years to 31 December 2018.

2013 to 2018 - 4% Rule versus Dividends

Year end	Assets	RPI	4% Rule	Dividends	Spend
2013	100.00
2014		1.6	4.00	3.53	2.92
2015		1.2	4.06	3.81	3.31
2016		2.5	4.11	3.92	3.86
2017		4.1	4.22	4.63	3.90
2018		2.7	4.39	4.89	3.99
Average		2.42	4.16	4.16	3.60
			as % of 2013 assets

The first table compares dividend income received and spending incurred against the guidance of the 4% “rule”, with the percentages calculated on the opening asset balance. I have uprated the 4% rule column each year using the RPI inflation measure. My current natural yield (4.89%) is now above what the “4% safe withdrawal rate rule” would suggest (4.39%) and also above the best flat rate annuities for my age (3.80%).

2013 to 2018 - Assets, Dividends and Spend

Year end	Assets	Growth	Dividends	Spend	Spend %
2013	100.00
2014	100.18	0.18	3.52	2.91	82.69
2015	96.05	-4.13	3.89	3.38	86.88
2016	106.87	11.27	3.87	3.81	98.42
2017	117.30	9.77	4.13	3.48	84.14
2018	105.88	-9.74	4.38	3.57	81.54
Average	105.26	1.47	3.96	3.43	86.74
			as % of year average assets

The second table shows the dividend income received and spending incurred, with the percentages calculated on the average of the opening and closing asset balances for each year. I have also shown spending as a percentage of income, and the growth (or decline) in the asset total.

Dividend income has been stable with an average yield of 3.96% and a range from 3.52% to 4.38%. Capital returns, including unspent income, have been more volatile with average growth of 1.47% and a range from -9.74% to +11.27%. Relying on the dividends enables me to be more relaxed about these capital fluctuations. Not selling the shares enables me to benefit from future capital growth and from dividend increases. Spending about 13% less than the natural yield has allowed me to reinvest a little.

I have chosen to invest in investment trusts in the UK equity and bond income, property direct UK, Asia Pacific excluding Japan (income), global equity income, and UK equity income sectors where the average dividend yields for each sector range from 5.9% to 3.9%. I am consciously selecting from a subset of the world market. I believe my chosen subset can match or beat the FTSE All Share index but not the global index at present. I reference my own returns as an equity investor from 1985 to 2018 and the published historic returns of my main holdings in coming to this view.

Going forward I see two possible threats to my approach. Firstly, inflation in the prices of what I spend my money on. Recently this has been of the order of 2% or 3% and the Bank of England is targeting inflation (CPI) of 2%. In the 1970’s, however, I remember much higher inflation and looking at the history of certain of my investment trusts it is true that their dividends didn’t keep up with inflation in those years. Inflation as calculated is based on a specific basket of goods and hence of continuous consumption. I reckon that my basket of goods will not match that of the statisticians, but more importantly I can choose to take less in my basket if I have to.

Secondly, the consistency and stability of taxes and the financial freedoms that we now enjoy could change. A future Labour government could threaten this with policies that could have an adverse impact on the UK economy, the UK stock market and UK dividend returns, and also a tax and nationalisation regime that could be a threat to investors. You can mitigate the some of this by investing overseas but you may not be able to avoid some of it. These concerns would, however, apply also to other strategies such as total return.

In summary given stability of prices and taxation and government policy generally then I am confident that my approach will suffice. Given the numbers so far it is so far so good.

The 4% “safe withdrawal rate” (SWR) is often mentioned on financial independence blogs (e.g. Monevator) or in books (e.g. Reset). I view it as a guideline based on a specific historical model. I prefer to use natural yield as my guide. Having ceased paid work just over five years ago I have now calculated how that has worked out for me so far.

The 4% approach suggests taking an income, or drawing down, only 4% of your available capital in year one and then increasing that amount by inflation each year. Some commentators suggest this draw down should be reduced to between 2.5% and 3.5% based on current high stock markets and to allow for fund expenses and taxes. Others suggest that a 4% draw down will leave you with a richer legacy to pass on in most cases.

Based on the original capital this 4% approach would start at a 4.00% withdrawal in year one and based on the UK retail price index (RPI) would have increased to 4.06%, 4.11%, 4.22% and 4.39% in the following four years.

The natural yield on my draw down portfolio started at 3.53% and has increased to 3.81%, 3.90%, 4.63% and 4.89%, calculated on the original capital value. This has been helped by a recent tilt to higher yield investments.

Interestingly both the above guidelines average 4.16% per year on the original capital value. The natural yield began 12% below the SWR (3.53% versus 4.00%) but is now 11% above it (4.89% versus 4.39%).

We can now consider how these guidelines compare to what was actually drawn down and spent. Being cautious in year one only 2.92% was spent, but this rose to 3.31%, 3.86%, 3.90% and 3.99% in the following years. This was an average of 3.60% per year on the original capital value and represents 86% of the SWR and 86% of the natural yield.

We can also look at how capital values have moved. Over the five years capital growth was only 3.07% but income exceeded draw down spending by 2.81% meaning that overall capital was 5.88% higher. This shows to me the importance of re-investing some income where possible and not spending capital gains.

Overall over the five years RPI Has increased at a compound rate of 2.42% (just ahead of the Bank of England target), spending has increased at a compound rate of 4.66% (after a low start), but investment income has increased at a compound rate of 7.38%. I’m pleased that the natural yield of income has grown to exceed that of the RPI and of my spending.

I am using tax free ISA’s and capital gains and income tax allowances to minimise taxes. My natural yield is after incurring individual investment trust charges. Low platform fixed fees and minimal transaction charges (as well as any tax charges) are included in my spending.

I aim to remain flexible on both spending and investing according to future circumstances and will use natural yield as a guideline.

The news is full of Brexit news this week with various parliamentary votes happening. There is much concern about whether we leave or postpone or remain, and whether we have a deal or not. I don’t want to get into all that but I do want to consider the investment situation. There are many global issues of concern but Brexit is more particular to Britain and seems to be depressing UK share prices.

According to a Citywire commentator “the UK stock market, which has relatively little connection with the domestic economy is cheap, dirt cheap, trading at a 30 per cent discount to global stock markets and yielding comparatively more than government bonds than at any time in the past 100 years.” According to Investors Chronicle magazine this week the FTSE All Share index has an average dividend yield of 4.27% which is higher than most other markets excepting Australia and Russia.

My way of considering value for money in investment is to look at the dividend yield of investment trusts I would consider owning (or do own). As of yesterday, City of London (CTY) and Edinburgh Investment (EDIN), the two largest investment trusts in the UK equity income sector were yielding 4.4% and 4.3%. By comparison in the global equity income sector Scottish American (SCAM), Henderson International Income (HINT), and Securities Trust of Scotland (STS) were yielding 3.1%, 3.5% and 3.6%. (Murray International (MYI) yields 4.4% but has more of a bias to Asia Pacific, Latin American and emerging market equities.)

My thinking is that the UK is cheaper than global equities from this brief sample with an average 4.35% yield versus an average 3.40% yield. £1 of income is 22% cheaper on these figures. Also, many of the UK registered companies held by these trusts will have global interests and these trusts also hold a small percentage of their assets in non-UK shares.

Looking at the recent history of City of London and Edinburgh Investment from their annual accounts they have only had significantly higher yields at year-end, i.e. above 5%, in June 2009 and June 2010 (CTY), and in March 2009, March 2010, and March 2011 (EDIN), in the aftermath of the financial crisis of late 2008. Those who bought CTY and EDIN ten years ago have enjoyed, I estimate, around 12% to 13% per annum compound growth.

On a simple analysis, I regard any opportunity to buy City of London (CTY) on a yield above 4% should be considered. Given its’ over fifty-year record of yearly dividend increases it suggests you can maybe lock in a safe withdrawal rate of 4% from these dividends.

In conclusion if one can ignore the political and macro-economic background these shares do look cheap to me and are worth considering for purchase. You may think they will get cheaper still, but as ever do your own research.

New (and old) investors are often advised to buy equity index tracker funds rather than actively managed equity funds. A tracker fund will hold shares in order to closely replicate the index it is aiming to track. This avoids any good or bad choices of which shares to hold. It is claimed that trackers beat most actively managed funds because they eliminate the risk of bad choices, but they also charge less in fees.

I have held tracker funds in the past for these reasons but now prefer to hold actively managed funds. If you are new to investing and have limited funds then a tracker is probably a good option for you. It reduces your choice of fund and means you can be very diversified with only one fund. I began investing in equities in 1986 using actively managed unit trusts. In about 1988 the first index tracker funds were launched in the UK and I bought some. I sold my last tracker fund in 2009.

I prefer to hold actively managed investment trusts. I do, however, regularly compare their performance to the index and to the available tracker funds. For the ten years to 31 January 2019 the FTSE All Share Index total return was £264 from a £100 investment. On a quick look I found eight UK All Share tracker funds with ten-year results and these ranged from £221 to £262 and the average was £249. Looking at investment trusts in the UK All Company and UK Equity Income sectors there were thirty-six trusts with ten-year results and these ranged from £192 to £620 and the average was £320. Twelve of the trusts had results lower than £264, but only seven had results below £249.

I currently hold six UK trusts from these sectors that I have held for over ten years. Their performances ranged from £251 to £562 and the average was £334. So, on a ten year view my active funds have mostly bettered the index and the available trackers.

I have chosen to measure against the FTSE All Share Index. Arguably one should measure against a global index and one should use global trackers to diversify across the world. On a quick look I found five global equity tracker funds with ten-year results and these ranged from £290 to £322 and the average was £311. Looking at investment trusts in the global and global equity income sectors there were twenty-four trusts with ten-year results and these ranged from £258 to £1,096 and the average was £425. Six trusts had results of £311 or lower.

I currently hold two global trusts from these sectors that I have held for over ten years and the average performance was £351. The arithmetic average of the eight trusts I have held for over ten years is £338. This bears comparison to the global trackers. I am therefore encouraged in continuing to follow my own individual approach. I still think trackers could be useful for new investors, for investors unable to diversify across several managed funds, and for those unwilling to risk picking the wrong managed funds. I’m prepared to take that risk in my own individual way.

Shares magazine this week has a cover feature on how your ISA can pay you £10,000 a year tax free. It’s worth a read if you are a subscriber.

Spending

It suggests that £10,000 would cover “essential spending” if you are retired and have no mortgage or rent to pay. So I thought I would test that against our essential spending, as defined by me, for 2018. On a first look we’re spending significantly more. If, however, I re-state petrol, public transport, life cover, TV licence, Dentist, Mobile phone, and landline calls as “luxury” spending then we are only 16.71% overspent.

We’re overspent on every category except “other”, but this is to be expected perhaps with a family of four. This exercise does show, however, the importance of knowing exactly how much you are spending in total and by category, and whether you consider it essential or luxury.

Income

The article further suggests that you would need to be looking to have a 5% income yield on your ISA investments. They then suggest five investments yielding between 4.8% and 8%, giving an average of 6.3%. I would suggest that as an investor you would not equally weight these five investments but should overweight the mainstream funds and underweight the higher yield shares and funds thus reducing the yield to 5.7%.

I compared that yield to that of my ISA as at 31 January which is 5.4%. So I think the yield suggested is reasonable so long as you are prepared to look for yields higher than the FTSE100 index.

My holdings are all funds but they include international equities, property and bonds none of which are represented in their recommendations. Only 36% of my ISA holdings are UK equities comparable to those recommended. Also, mine are all in funds (investment trusts), with no individual company shares being held, so they are more diversified.

Capital

The article suggests that capital of £200,000 is required in order to produce £10,000 of income from a 5% income yield. They suggest saving £10,000 each year in an ISA for fifteen years, and assume 4% real growth (after inflation) in order to end up with over £200,000. As the recommendations could produce a 5.7% yield this actually reduces the requirement to £176,000 and the time taken to fourteen years.

Looking at actual FTSE All Share total returns for the last fifteen years shows compound growth of 7.18% each year. The Retail Price Index (RPI, other indices are available) shows compound growth of 3.00% each year over the same time period. This suggests 4.18% per year real return just slightly ahead of the assumption and not enough to reduce the time by another year.

This compares with actual returns for my portfolio of 8.71% each year, or 5.71% after inflation over the fifteen years to 31 December 2018. These returns and assuming an income yield of 5.4%, and an income requirement of £11,671 suggest a target of £217,000, and that it would also take fourteen years.

Conclusion

I find it useful to review published ideas against my own thinking and my own historical experience. In this case saving and investing over fourteen years could produce the required outcome based on recent returns and current portfolio yields in both cases.

Being able to save and invest £10,000 each year for fourteen years would be more of a challenge – but that is for another day.