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Weekend reading: There is no safe withdrawal rate

Good reads from around the Web.

A US researcher called Wade Pfau has been wading through the weeds of retirement investing for the past several years. I’ve featured his work here many times.

An article in Financial Planning [1] this week is perhaps the most accessible summary yet of his findings.

I’d say Wade’s biggest contribution has been to unmask the 4% withdrawal rate “rule” as an accident of history that was never meant to carry the hopes of every last wrinkly American on its shoulders.

And if the 4%-rule was adopted unthinkingly in the US, its importation into the UK was even more anomalous.

After all, the initial data that alighted on 4% as being a safe withdrawal rate was always US-derived.

Yet many UK writers and bulletin board pundits have put forward the 4% rule as if it’s a third Law of Finance.

Wade looks almost exclusively at the US market, but the article does include some international statistics – including a grim one for UK investors.

The half-as-lucky generation

All told, the article’s [1] thrust is pretty hard reading:

New research shows that Americans retiring in 2015 need to be far more conservative in their withdrawal rates during retirement.

The historic 4% annual withdrawal rate is over two times the level that Americans can safely withdraw without expecting to outlive their assets.

The real safe withdrawal rate, accounting for fees and today’s stock and bond market levels, is under 2% per year.


Now, I will say I’ve long been more optimistic [2] about future returns than today’s low rates would imply – at least when it comes to equities.

I also think the US valuation situation is more extreme than the UK one, and that UK investors will see higher returns than US investors from here.

The US stock market looks expensive to me. The UK market? Not so much.

Still, what do I know that the world’s collective investing dollars does not?

The more important takeaway is that there was never any such thing as a Safe Withdrawal Rate. It was always going to depend on starting valuations, an unknowable future, and personal circumstances.

So any such target withdrawal rate – high or low – is at best a rule of thumb.

A Southern gentleman never spends his capital

I tend to leave discussions about all this to my passive minded co-blogger, The Accumulator.

That’s not just because he finds it much more fascinating than I do – and I have a low boredom threshold.

It’s also because I am a clear oddity, whereas his path towards early retirement is a much more middle of the road affair.

True, he’s ultra-frugal. More so than me.

But I am a monomaniacal active investor who suggests other people invest passively for their own good. I don’t even really notice I’m saving 50% or more of my earnings, it’s just what I do. It just happens. It’s probably genetic, if not mildly aspergic.

In addition, I plan to someday live off investment income [3] and never spend my capital, which in some respects makes the Safe Withdrawal Rate irrelevant for me (or at least changes the frame of the problem).

But very few people will be able to do this – at least not unless they’re born wealthy to start with. The maths and human psychology just doesn’t work for most.

If they earn enough to make saving enough to eventually live off their capital a realistic possibility, then in most cases they’ll get used to a far higher standard of living well before then than their portfolio will throw off in income alone

And if they don’t earn enough? Well, they don’t earn enough.

Sorry. Life isn’t all ha ha ha, hee hee hee.

Do it his way

In contrast, The Accumulator earns fairly well but hardly bulge bracket, lives simple but saves hard, fully intends to run down his capital, and bridles at talk of investing specifically for dividends and the like as specious active investing nonsense.

And that world view is a much more sensible one for most people, because planning to spend your capital means you’ll need much less of it in the first place.

Living off your capital implies an inefficient use of that capital, because your plan is basically to die with it still invested.

If instead you spend your capital, you can retire earlier or you can have more slap-up dinners at Nandos once you do.

Those extra chicken wings and curly fries are the pay-off in a bet that you’re making that your heart will run out before your cash does…

Get a new plan

If I were however planning to spend my capital, I’d do a few things.

Firstly, I’d almost certainly plan to at some point buy an annuity with a portion of my pot.

Creating a minimum income floor [4] like this gives you some of the benefits of living off your capital, in exchange for effectively spending it and betting you’ll outlive your actuary’s best guess.

The inflation-linking would be expensive, but I’d do it anyway.

And yes, annuities look poor value right now. But I wouldn’t do this unless I had a fairly sizable pot to play with – that’s what I expect to have, and this is about what I’d do.

(I can’t really tell you how I’d retire early without much money, because I wouldn’t.)

Secondly, I’d investigate the various dynamic withdrawal strategies that have been put forward, including by Wade Pfau himself.

Essentially these boil down to “spend less when your investments do poorly”. Seems like common sense to me, but perhaps it is best codified.

Finally, I wouldn’t under-estimate the difficulty of actually spending your capital when you do pull the ripcord.

I know myself well enough to understand I could probably never do this (or at least not until very late in the game), which is why it isn’t in my plan.

But even pragmatic financial freedom seekers might be surprised how difficult spending money is.

Would you like to make a withdrawal?

It’s one thing to spend your money as a 65-year old who has simply flopped over the line at the end of the traditional 40-year rat race.

But if you’re someone who has saved extra-hard all your life and retired early (or even, and better, if you’ve transitioned to an opt-in-and-out lifestyle where you make money when you want to, doing what you want to), then it’s going to be tough to start splashing the cash.

If you don’t believe me, ask a real early retiree like Jim at SexHealthDeathMoney [5].

Jim warns that:

The pain of cashing in investments just to live from month to month is almost physical.

If you don’t empathize with Jim, then – unless you’re very lucky in business, the lottery, or with who you were born to – I doubt an early escape from the 9-5 is going to be a problem that concerns you.

From the blogs

Making good use of the things that we find…

Passive investing

Active investing

Other articles

Product of the week: Santander [21] has upped the monthly fee on its 1-2-3 account from £2 to £5. I’ll respond by being kicking myself up the backside and transferring over more of my more monthly bills to benefit from the cashback. If you’re already running a tighter ship or you’re wondering what else is out there, The Guardian’s latest survey [22] of the alternatives finds 1-2-3 will still remain top for many people. But if you do fancy something new, check out the £100 cashback offer from Nationwide [23], as reported by ThisIsMoney [24].

Mainstream media money

Some links are Google search results – in PC/desktop view these enable you to click through to read the piece without being a paid subscriber of that site.1 [25]

Passive investing

Active investing

Other stuff worth reading

Book of the week: I had dinner with an old business friend in the week. Or rather he had dinner. Despite me explicitly warning ahead of time that I would definitely have eaten a meal I’d been slow-cooking before our three-hours-away rendezvous, he didn’t bother eating or more likely didn’t pay attention, took advantage of the blatantly gouging Steak Night in the gastropub we went to, ate most of the full works in front of me before asking the staff he’d already befriended for an extra knife and fork so I could try a bit as it was supposedly our “first date” and generally made a racket. In all this and other stuff he was, as always, charming and infuriating at the same time. I wish we’d had the new business book The Genius of Opposites [42] when we’d started our company more than a decade ago. It might have gone better. Then again we’d presumably also have had a time machine, so all bets would have been off.

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  1. Note some articles can only be accessed through the search results if you’re using PC/desktop view (from mobile/tablet view they bring up the firewall/subscription page). To circumvent, switch your mobile browser to use the desktop view. On Chrome for Android: press the menu button followed by “Request Desktop Site”. [ [45]]