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.
It’s good to see a bit of track record showing in your results.
I would like to think that the SWR doesn’t really matter so much but what does matter is 1) your spending 2) your income
It might sound simple but the position that GFF has been in recently is the horrific realisation that due to the attraction of pensions (salary sacrifice, LISAs & matched contributions) our early retirement assets were too low and not giving enough dividends (or reliable income – thanks P2P).
Having a SIPP throwing off £1000 a month in dividends is great but useless when you are in your 30s.
Addressing that imbalance takes time and effort and consistency – but the fact that from what you are showing (that your Income (investment?) is more than your Spending) means you are streets ahead of us! (Making me a bit jealous!)
Thanks for commenting. I think you need to consider all the options in terms of taxable accounts, ISA and other tax free accounts, and SIPP and other pension accounts. I have a stake in each of these. I may be streets ahead, but I’m decades ahead too!
Would be interesting to know, roughly, what your spend was for a few years prior to 2014 – you hint it was higher – and, whether five years after you pulled the plug, your spend has migrated back to the pre 2014 levels (allowing for inflation, howsoever measured)?
BTW, essentials, vs discretionary spend, is the subject of much debate.
Thanks for your comment. My spend in 2012 and 2013 was about 16% and 11% higher than my spend in 2014, i.e. it was 3.39% and 3.24% of the capital value at 31 December 2013. My spend in 2016, 2017 and 2018 was higher than this, and the average of the last seven years was 3.52%. I haven’t adjusted for inflation but I don’t believe inflation was significant in these years.
Overall our lifestyle has been broadly the same before and after. The increase in spending is likely to be mostly on discretionary spending choices we made.
Re your conclusion – your data may agree even more strongly! If you correct for annual inflation (using RPI Dec- Dec) and assuming all spends are baselined to 2012 £’s, (big assumption seeing as I think you express your annual spend as a %age of a varying capital value) then the inflation adjusted (or “real” if you prefer) average is 3.28% with a somewhat smaller SD too. Your highest real spend would be in 2016, (not 2018) but that was only 5% higher than your 2012 spend.
Enough nurdy stats, the point is that inflation even when relatively low on an annualised basis (2.5% PA) has a non-trivial effect over just 7 years (c. 16% in this case). That is, if your 2012 pound bought 5 eggs, your 2018 pound would have only bought 4, seeing as shops do not intentionally sell fifths of an egg!
Also, how did you manage to keep your real year-to-year spend so flat over 7 years inc. the transition from working to not working – or has it just turned out that way? I ask as our annual spend is, by comparison, all over the place. In our case this is primarily due to occasional 1-off big ticket items (like say a car) but with an underlying discernible trend – which, incidentally, is not flat either?
Thanks for commenting again. You’re giving me a few ideas for future bog posts, e.g. essential and discretionary, inflation, lifestyle, big ticket items, spending choices, recording spending, and expenditure trends. Having kept a record of my spending since I started work (and before) I can say that the compound growth rate is around 5% overall, but has been only 3.10% since 2012. Individual years have been subject to exceptional items or choices in the past and will likely have an adverse impact again, e.g. when our 14-year old car needs replacing!
Happy to have been some help.
Best of luck with your blog – I cannot recall exactly how I found it, but having briefly browsed I then book marked your blog for further reading.
I have liked what I have seen!
You may have guessed this, but I too have been recording spending for a good few years. Again, I am not entirely sure why I started doing this, but over the intervening years have come to appreciate just how useful a resource this can be.
All your proposed topics sound interesting, and, if I may, could I suggest you consider a blog on “ideas for how to categorise your spending”. My observation is that everybody does this their own way – which is fine. However, I realised relatively recently that if you can re-organise, or even just map, your spending groups/categorisation to the 12 COICOP categories (plus the 2 extra UK specials – see e.g. ONS household expenditure survey) you can gain much more insights – e.g. your “official” essentials/discretionary split, approx. how does your household inflation rate compare to published rates, and estimate how much your current lifestyle would cost in other countries, being just a few examples.
Thanks for commenting again. I agree that recording your spending is very useful. The official categories used will be added to the ideas list.