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.