What caught my eye this week.

Today would be embarrassing if Monevator was an old-fashioned print magazine (as opposed to an old-fashioned ‘weblog’!)

I’d be scurrying past the newsstands. Trying to avoid my cover story – already written by Wednesday due to magazine print deadlines – about the bull market disguising how last year’s mega-winners had cratered in 2021.

That post looks less topical this Saturday morning. Because in case you hadn’t noticed – in which case, collect your merit badge from The Accumulator by the door – markets were roiled on Friday by fears of a new Covid variant that seemingly has just been spun-up in someone’s body-lab in South Africa.

This ‘Omicron’ variant has more mutations than a Chernobyl-era chicken, and on the surface a transmission rate that makes Delta look about as speedy as an epistolary 18th Century love affair.

The City fears it’s seen this movie before. So traders have dumped first, and will ask questions over the weekend. At least the potential for a speed bump in that bull market, then.

To only rub salt into the wound, this was also the week I decided that the ‘Covid corner’ section of our weekend links had run its course. Oops!

Turn, turn, turn

In some ways though Friday’s reversal of fortune amplified the point I was set to make. Which was that nothing – ever – lasts forever in the markets.

If you’re a halfway active investor, you’ll remember that lockdown darlings like Zoom Video and Peloton were recently all the rage. Their shares skyrocketed while fund managers and everyday traders were using their products every day.

But as Will Hershey on Twitter recounts via a handy table, such shares – lauded as inevitable winners of a work-from-home revolution – have since crashed 35-70% from their highs.

On the Compound Advisors blog, Charlie Bilello makes the same point, adding:

after a year like 2020, [stock picking] almost seemed easy.

Had you purchased virtually anything in the high growth/tech/IPO/SPAC space, you would have outperformed the S&P 500 by a wide margin.

Right on, Charlie. I walloped the market in 2020.

But in 2021? Not so much!

Anyway, on Friday some of these 2021 reversals then reversed themselves again. At one point Zoom was up over 13% on the day, Peloton soared, and vaccine maker Moderna ended the session 21% higher on the not-unreasonable assumption that it might be busy retrofitting its vaccine for the new party pooper.

Some of those spikes were short-covering, I think. But it was also a reality check for investors that the pandemic was far from over.

Eight miles high

I’ve been following markets closely for 20 years. Even so I’m still amazed at how apparently unshakeable narratives crumble over time.

You had to own dotcom stocks in the 1990s. You were an idiot for believing in the Internet by 2003. UK private investors only cared about small cap oil and gas shares by the mid-naughties. Nobody should own equities in 2008 and 2009 – investing was all a con. The market was pumped-up and inflated by 2015. Retail share trading was finished by 2019 and we were all going to index – and then along came RobinHood and meme stocks. Government bonds could only crash said many Monevator commentators six weeks ago. They’ve since spiked higher. And so on.

Much of this stuff is only apparent if you’re naughty active investor. At the index level you tend to see broader, steadier moves.

That’s certainly not a reason to abandon index tracker funds – indeed for 99% of people it’s another great reason to own them. (If you want to keep enjoying sausages, never visit a sausage factory.)

Nonetheless, passive investors will someday face their own narrative shift. The market will crash and it won’t bounce back for a good while. “Buy and hold is dead!” we’ll hear. We’ve been through that cycle at least twice in the lifetime of this website alone.

And then that in turn will pass. In investing, never say never again.

Have a great weekend everyone!

*Horace, via the dean of value investing Ben Graham.

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The answer to the question “How much should I put in my pension?” is surprisingly simple.

You need enough in your pot to sustainably generate a comfortable retirement income that will last you the rest of your life.

This post enables you to estimate how much pension pot you need to deliver that income.

Once you hit your target number, you can fire your job, and start a brand new life doing whatever you please.

Your pension pot target number depends on knowing how much income you can live on in retirement.

That might sound like an impossible ask. But you can arrive at an estimate using the method explained in our How much do I need retire? post.

With that retirement income target in hand, you need only complete one more step to calculate how much you should put in your pension.

The ‘How much should I put in my pension?’ calculation

Here’s a quick example that’ll show you how much you need in your pension pot.

Imagine that you want a retirement income of £15,000 on top of your State Pension.

The size of pension pot you need to retire is:

£15,000 divided by 0.03 = £500,000

Where:

• Your required annual income = £15,000 (not including other income sources such as the State Pension.)
• Your sustainable withdrawal rate = 3% (or 0.03)

In this example, you can retire once your pension pot hits £500,000.

That target amount should generate £15,000 in inflation-adjusted income for your entire retirement – assuming your pension is invested in global equities and government bonds. More on this below.

• Substitute the £15,000 above with the retirement income you need from your pot.
• Divide your income figure by 0.03 to discover how big your pension pot should be.
• Add your State Pension and any other reliable income sources to tally your total retirement income.

Run this calculation twice if you’re part of a couple.

Account for tax using the tips in last week’s post.

Is that all I need to know?

The calculation really is that simple.

What’s more complicated is explaining why this approach is the best way to estimate how much pension pot you need.

You also need to adjust your numbers for inflation and the tax-free status of your Stocks and Shares ISAs, but that’s mercifully straightforward.

Keeping up with inflation

The example above produces £15,000 income from a pension pot of £500,000 at today’s prices.

If you’re retiring years from now – rather than today – then your numbers must be updated for inflation. Otherwise, you’ll lose purchasing power as prices rise.

All you need do is adjust your number once a year by the UK’s CPIH annual rate of inflation.

For example: let’s say inflation is 2.5% one year from now.

Just multiply your pension pot target figure by 2.5%:

£500,000 x 1.025 = £512,500

You need £512,500 in your pension pot to generate enough retirement income after 2.5% inflation.

Let’s double-check that pot will produce enough inflation-adjusted income:

£512,500 x 0.03 = £15,375

Your 3% withdrawal rate now delivers £15,375 in retirement income.

If you multiply our original £15,000 income figure by the inflation rate of 2.5% you get £15,375.

Hallelujah! The calculation checks out.

Do this once a year and your target number and retirement income will keep pace with CPIH inflation.

Stocks and Shares ISAs

Many people retire with a mix of pensions plus Stocks and Shares ISAs.

Calculate the target figure for your ISAs in exactly the same way as for pension pots.

If you want £5,000 of annual retirement income from your ISAs then divide that figure by the 3% sustainable withdrawal rate to work out your ISA target number:

£5,000 / 0.03 = £166,667

To gauge how much retirement income your ISAs will generate…

Multiply your ISA’s value by the sustainable withdrawal rate:

£166,667 x 0.03 = £5,000

This calculation applies to invested Lifetime ISAs and Stocks and Shares ISAs, but not to cash ISAs.

While we’re here, usually pensions beat ISAs for retirement saving, but not absolutely always.

Our pensions vs ISAs piece illustrates why tax relief and employer contributions mean most people will be better off favouring pensions.

However a clear-cut case for using ISAs in retirement is to shelter your pension’s 25% tax-free lump sum.

By getting your tax-free lump sum reinvested within ISAs as quickly as you can – subject to the ISA annual allowance – you can generate a tax-free income for the rest of your days.

The 25% tax-free lump sum – Incidentally, our 3% withdrawal rate assumes you will reinvest any 25% tax-free lump sum you take from your pension. If you take that money and reinvest it (whether in ISAs or in taxable investment accounts) then it still counts towards your overall retirement income. Money isn’t withdrawn unless you intend to spend it. Apply the 3% sustainable withdrawal rate to all your investments to understand how much annual retirement income they can deliver.

The sustainable withdrawal rate

We’ve used a 3% withdrawal rate to calculate the income your retirement pot can sustain.

This is the percentage you can withdraw from your pension (and other investments) in the first year of retirement.

That amount is your baseline retirement income figure.

You then increase your income figure for annual inflation every year thereafter to pay yourself a consistent retirement salary.

(That means the 3% element is only used in year one.)

But why a 3% withdrawal rate?

Leading retirement researchers have concluded this is the amount you can withdraw while minimising the risk of running out of money during a retirement lasting 40 years or more.

You’ll often hear that higher withdrawal rates than 3% are achievable. Usually that’s because people gloss over the problems of unpredictable future investment returns on retirements.

Happily, the State Pension – and any defined benefit pensions you’re lucky enough to have – don’t suffer from unpredictability to the same degree.

They should both deliver a reliable stream of inflation-proof income throughout your retirement, so long as UK PLC doesn’t go bust.

But few of us can live comfortably on the State Pension. Fewer still are lucky enough to enjoy defined benefit pensions these days.

The problem with pension pots

Most people in the UK now have defined contribution pensions. These do not offer a guaranteed income.

Instead you own a pot of investments in assets such as equities and bonds.

You generate an income from the pot by selling off these assets and spending the proceeds, along with the dividends and interest they pay.

However the income level you can safely spend depends on the investment returns of your assets. Those returns are inherently unpredictable.

If you withdraw too much too soon from your pot, your money could run out before you die.

Yet if future investment returns are strong, you’ll be positioned to withdraw a higher income than the 3% sustainable withdrawal rate suggests.

The retirement dilemma is you could spend too little (bad) or too much (really bad).

Running out of money is worse than not knowing what to do with it all.

Therefore, it’s best to use a lower withdrawal rate which drastically reduces that possibility, without setting you an impossible retirement savings target.

The 3% rate is derived from the worst investment return sequences world markets have suffered in the past 120-odd years.

It further depends on you holding a pretty aggressive asset allocation of 70% global equities and 30% UK government bonds.

If you’ve previously come across ‘the 4% rule’ then it’s worth you understanding why a 4% withdrawal rate may be too optimistic.

To find out more about the sustainable withdrawal rate check out:

• Our quick explainer on a suitable sustainable withdrawal rate for UK investors.
• How to improve your sustainable withdrawal rate.
• Why we chose a 3% sustainable withdrawal rate.

Beware simplistic assumptions

Watch out for media sources or pension income calculators that base your retirement on assumptions like: “Your investments will grow by 5% a year.”

Such simplifications are too risky because they assume your pension pot will grow every year.

But everyone knows that investments can go down, as well as up.

The big mistake the standard calculations make is to use a simple average growth number that ignores losses.

Let’s detour through a quick illustration of the problem.

Constant growth scenario

This scenario assumes positive returns every year:

• Year 1 return: 25%
• Year 2 return: 25%

Simple average return: 25+25 = 50 / 2 years = 25%

A £10,000 investment would grow to £15,625 at 25% per year. Very healthy.

Volatile return scenario

This scenario includes losses, just like real investment returns:

• Year 1 return: 100% growth
• Year 2 return: -50% growth

Simple average return: 100-50 = 50 / 2 years = 25%

£10,000 grows to £20,000, but falls back again to £10,000 in year 2. We made no gain.

Both scenarios showed a 25% simple average return, but one is much worse than the other.

Unfortunately for us, our world looks more like scenario two.

What makes things even worse for retirees is that you’re drawing down your portfolio by spending it over time.

And in fancy terms, as a spender you’re subject to sequence of returns risk.

In simple English – the stock market could slump early in your retirement, meaning you need to withdraw a bigger chunk of an already-dwindling pot. You’d then have less money invested to benefit from any market rebound.

There’s no escaping the fact that sometimes investments inflict large losses. 

Major downturns can permanently damage your retirement prospects, even if declines in the market prove temporary.

Don’t keep it simple

This all makes it dangerous to use simple average investment growth numbers when judging how much pension you need.

The next example reinforces this warning.

Assume you start retirement with a heady £1,000,000 in your pension pot.

You withdraw 5% or £50,000 in income every year:

A constant annual return of 5% means that your pension pot’s growth exactly covers your spending every year. Your wealth never drops below £1,000,000.

This portfolio’s simple average return is 5% over four years.

But as we’ve noted, in the real world investments are volatile. We take losses as well as gains.

The next table shows how losses can knock a big hole in a pension pot early in retirement.

We start with the same £1,000,000 pension pot. But a 50% loss in the first year cuts our pot to £500,000.

Then we withdraw our £50,000 retirement income. Our pot is down to £450,000 by the end of the year:

Our bad luck continues with another 50% loss in year two.

Thankfully the losses are temporary. The market bounces back strongly in the next two years.

Overall, we’ve experienced the same simple average return of 5%.

But our pot looks very different compared to the sunny constant growth scenario.

It’s shrunk to £318,000 instead of sitting pretty at £1,000,000.

The volatility of returns has left us in a far more precarious situation.

Recovering from losses

A major issue is that large losses require much greater gains to recover the lost money:

• A 10% loss is recovered by an 11% gain.
• But you need a 100% gain to recover from a 50% loss.

The 60% gains in the previous example were nowhere near enough to make us whole after that nightmare two years.

And a steep hill becomes a mountain to climb when you’re forced to sell your investments at low prices to pay your bills in retirement.

This inescapable truth is why the best retirement researchers advocate using a 3% sustainable withdrawal rate.

A 3% rate keeps withdrawals low enough – especially early on – to enable you to ride out historically bad investment returns, should you be unlucky enough to experience them.

Many happy returns

I’ve focused on the downside to show you why it’s important to use a cautious and sustainable withdrawal rate.

But investment volatility can work in your favour, too. A brilliant sequence of returns can boost your portfolio to giddy heights. Here’s hoping!

Ultimately, navigating the “How much should I put in my pension?” dilemma does involve an element of luck. As in poker, you can be dealt a terrible hand or a Royal Flush.

The important thing is to play your cards well and avoid being wiped out.

That’s what a 3% sustainable withdrawal rate helps you to do.

Take it steady,

The Accumulator

PS – If your State Pension and/or defined benefit pensions arrive later in your retirement, then you can increase your sustainable withdrawal rate a little.

This means you’ll work your pension pot harder at the outset, until your other pensions arrive to relieve the pressure later.

This is a complex area but if you want to follow one researcher’s solution then follow the walkthrough in this post. See the ‘Investment fees and the State Pension SWR bonus‘ section.

PPS – If you’re close to retirement, here’s the decumulation strategy I put in place to help me manage my volatile retirement funds.

This article on why you should write a will is by The Mr & Mrs from Team Monevator. Check back every Monday for more fresh perspectives from the Team.

Although The Mr & I only stumbled across the Financial Independence movement (FI) as we advanced into middle age, in general we’ve been a pair of early birds. We were quick off the blocks in terms of marriage, mortgage, and starting a family.

Yet as the offspring of older parents, we’ve also been at the coalface of ageing earlier than many friends.

Their parents are still in their 70s. Of our six collective parents and step-parents, only one – a spry 89-year-old – remains alive.

I’m certain that having elderly parents endowed me with melancholy tendencies. In fact I’ve probably given more headspace to contemplating death than I have to my post-FI goals.

And I’m not alone in this morbidity: The Mr regularly updates his funeral playlist!

The Mr: My funeral will be awesome. I’m just sorry I won’t be there.

The Mr & I wrote our first wills at 24 and 23 respectively. Even though back then we’d barely an asset between us.

Planner or pantser?

Planning for death is unusual for a pair of twenty-somethings. The Mr & Mrs are statistical outliers – early birds, again.

Yet I’m still surprised whenever someone I know tells me they know they ‘ought’ to get round to writing a will.

Flying by the seat of your pants – doing things in the nick of time – looks exciting. But it raises the risk of failure.

During the coronavirus pandemic, however, the UK experienced a rise in people writing wills. Forbes reports that the average age for someone writing a will has fallen from 50 in 2019, to just 47 in 2020.

My hunch is that Monevator readers (being a money-savvy lot) are more likely than average to have drawn up a will. Wealth begins to amass even in the early stages of pursuing FI, and pursuing freedom requires planning.

And given the energy and effort we invest into accumulating for our future selves, it’s odd not to pay attention to what happens once you’ve no further need of your funds.

Is there no place, organisation, or person that you would like to benefit?

The Mr: Apparently charities receive over £3bn a year from legacies, so that is something you may want to think about.

Of course, there’s a legal process to wind up the estates of those who die intestate (that is without a will). The Citizen’s Advice Bureau has a breakdown of likely outcomes in different situations.

What is less obvious is the additional time – and money – it can take to track down assets or even beneficiaries in the absence of a clear directive. This adds an extra dollop of uncertainty for the bereaved, and at a time when they may be struggling to cope, both mentally and practically

According to Unbiased, an association for financial advisors, in 2017 up to 31 million UK adults were at risk of dying without leaving a will.

If you’re one of those 31 million, then I would urge you to put ‘write a will’ at the top of your To Do list. (Or else ‘review will’ if it’s been a while since you last revisited it and your circumstances have changed.)

Write a will wherever you are on the path to FI. Get it done regardless of current age, state of health, and life expectancy. Write a will irrespective of whether you live with others, or alone, and with no known relatives.

The Mr: The reality is that none of us know what the future holds. Think of writing a will as reducing the gamble that something happens to your possessions after death that you wouldn’t want.

Too young to die?

We’re all gamblers at heart. We’re betting on living long enough to hit our financial independence numbers and to then reap the benefits.

Why else would we sacrifice present resources for the promise of future rewards?

Pandemic aside, the odds are good. Figures from the Office of National Statistics show that:

• UK life expectancy at birth (2017-2019) was 79.4 years (males) and 83.1 years (females).

• Life expectancy for those already aged 65 years rises to 83.8 years (males) and 86.1 years (females).

But any deck of cards contains jokers.

For example, the same statisticians calculated that 1% of children born in England and Wales in 2019 will lose their mother before reaching their sixteenth birthday. Figures for fathers were harder to extrapolate, but were estimated to be even higher, at around 2%.

Long-ish odds, and yet I shouldn’t want to call them.

My mother died before I left school or met The Mr. For all her dreams of traveling on the Trans-Siberian Express or learning to play the piano, she never got close to retirement.

Anyone in their 40s or upwards will have some contemporaries who, sadly, did not live out the usual lifespan.

The Mr & I plan to end our days in a tidy manner. We don’t want to burden our kids or the state. Our financial planning assumes that we reach a ripe old age – let’s go for an aspirational 90 years – without a marriage bust-up, dependent adult children, or more than three years of expensive end-of-life care each.

Future forward

Drafting a will is not just a mechanism for disbursing your assets once you no longer need them. It is a part of your legacy to a world without you.

Even though life has a habit of disrupting the best-laid plans, The Mr & I hope to leave behind a positive legacy.

Something that doesn’t seem unfair, sow discord or cause distress. Instead, something that reflects our lives and lived values.

Something that looks to the future.

The final chapter

Neither The Mr nor I are qualified to give legal advice. But we have seen several wills that have proven distressing.

The Mr: One relative left a will that seemed to be saying they didn’t much care what happened after they died. That was hurtful for their children.

One tip when writing that first will is to set aside time to consider what you’d want to happen to your belongings should you die in the next week, month, or year.

Use the time to consider what end of life treatment you’d undergo, and whether to consent to being an organ donor. (Among the rash of recently published medical memoirs, there’s an excellent account that guides readers through the sorts of decisions they will need to make, somewhere towards the end: 33 Meditations on Death by David Jarrett.)

You would do well too to adopt the medical maxim: first, do no harm.

More tips for when you write a will

1. Last words

Your will is likely to be your final communication with family and others who knew you. Try to avoid it leaving an unpleasant aftertaste.

Think about the tone and language adopted. Whilst some technical terms are required, there’s nothing to stop you adopting a warm tone or plain English where possible. Even if the will says exactly what has been anticipated, it’s unsettling to read an overly-formal, fussy legal document when the deceased was an untidy, fun-loving friend.

If you don’t want to deviate from standard wording, here’s a suggestion: write a letter of farewell.

Write short positive letters to children or significant others that recall good times spent together and thoughts for their future. Try to be magnanimous. Most kids (even middle-aged ones) want reassurance in the wake of death.

Keep these letters with your will. Update them as and when needed.

2. Transparency

One of the advantages of planning your legacy earlier rather than later is that time is on your side. You are not making decisions under the duress of a terminal illness. Your thinking is not impaired by dementia and other age-related diseases.

Use the opportunity of drafting your will to discuss its implications with anyone who might reasonably expect to be a beneficiary.

Transparency is easier in straightforward situations. When The Mr & I updated our wills in 2018, we showed our kids the documents. It sounds a bit ghoulish, but they were reassured that we’d named guardians in the event of both of us dying, understood that we intended to leave bequests to charity and, most importantly as far as they were concerned, that there was adequate provision for re-homing any family pets (not named).

But what if your situation is complicated?

Perhaps you consider your adult step-children to be more deserving than your own children? Or you’ve decided to leave everything to your oldest son because he has a disabled child? Or your relatives are all sufficiently well-off and there are better causes you’d prefer to help?

If you want to do something off the beaten track, communicate and start to manage expectations. You may discover that things are not as you supposed or that your relatives approve of your chosen charities.

In these situations, seek legal advice in drawing up your will. Any one of the scenarios sketched above could lead to a contested will and, according to a recent Financial Times report, inheritance disputes are on the rise.

Don’t risk your legacy festering into a family rift.

3. Stuff matters

I wish my mother had known about a Letter of Wishes. At my mother’s funeral, a number of her relatives asked me for a meaningful memento. A few roamed around the house until my father put a stop to it.

A Letter of Wishes does not have the legal force of a will. At its simplest, if you think Auntie Jean should have that vase then note it down. The publication Which? has clear advice on drawing up a Letter of Wishes

Another alternative is a Living Will. This distributes cherished items to relatives, friends, or organisations who could use them while you are alive.

When an elderly relative of The Mr – let’s call her Doris – downsized, she asked children, grandchildren, nephews, and nieces what items of hers they would like. There was astonishingly little overlap.

Everyone got at least one thing they actually wanted and Doris herself got to see many of her things appreciated in new homes.

Just do it: write a will!

Despite dealing with death, your will is a living document. It needs drafting and, once drafted, needs revisiting.

There are costs to consider. There are free templates online and some will writing services are very inexpensive. However, for most of us it’s worth a few hundred pounds to get it drawn up by a qualified, regulated solicitor.

The Law Society recommends using someone carrying its ‘Wills & Inheritance Quality’ accreditation. A solicitor will generally also deal with storing the will with the government’s HM Courts and Tribunals Service, which is a handy backup in case it goes missing or there is a dispute about the final version.

The Mr: They can also help with inheritance tax planning, but that’s a subject for another post, written by someone with the right expertise.

Last words: plan for death so that you can get on with the business of living.

See all The Mr & Mrs’ articles in their dedicated archive.