You can live on 4% (so far so good)

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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 endAssetsRPI4% RuleDividendsSpend
2013100.00
20141.64.003.532.92
20151.24.063.813.31
20162.54.113.923.86
20174.14.224.633.90
20182.74.394.893.99
Average2.424.164.163.60
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 endAssetsGrowthDividendsSpendSpend %
2013100.00
2014100.180.183.522.9182.69
201596.05-4.133.893.3886.88
2016106.8711.273.873.8198.42
2017117.309.774.133.4884.14
2018105.88-9.744.383.5781.54
Average105.261.473.963.4386.74
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.

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