Living off your investments is the ultimate goal of financial independence (FI) and the trickiest part to get right. This phase is known as decumulation and it’s the part of the journey I’m about to embark on.

My objective is simple:

• Drawdown enough income so that Mrs Accumulator and I can live without needing to work.
• Maintain a decent quality of life.
• Not run out of money before we die.

The key is to allow plenty of margin for error.

Our decumulation plan needs to cope with volatile market conditions, flawed assumptions, and the fifth law of thermodynamics: Grit happens.

What I’ll present – over three detailed articles – is our genuine, all-our-skin-in-the-game plan to meet this challenge.

This is no longer theoretical for me and Mrs A..

It’s the rest of our life.

My plan rests on the best practical research I’ve found over many years, fitted to our personal situation.

It’s resistant to the main threats that bedevil many decumulation strategies:

• A long life – also known as longevity risk.
• Inflation risk.
• Living off volatile assets – sequence of returns risk.

I’ve built in multiple safety features. But I know there are no guarantees.

Decumulation: time to get personal

My plan’s core components will be relevant to other decumulators, FIRE-ees, and near-retirees, regardless of our different circumstances.

Customisation is critical though, so here’s a list of our particulars:

• Time horizon: 45 years
• Chance we both live another 45 years: 8%
• Decumulation method: annual withdrawals based on a sustainable withdrawal rate (SWR) from a portfolio of volatile assets such as equities and bonds.
• Capital preservation required: No
• Legacy required: No
• Back-up sources of income: State Pensions due in approximately 18 years. Small Defined Benefit (DB) pension for Mrs A in the future. Ability to work if required, or as desired.
• Inheritance: No

I’ve decided not to share our personal numbers. This plan scales regardless of wealth or income. I’ve left clues all over the Internet, anyway.

It may be helpful to know that we got here on relatively modest five-figure salaries and plan to live on less than the annual median household income.

That’s quite tight, which is why the plan is bold in some respects.

I’d love to take a ‘safety-first’ retirement approach. To rely more heavily on less volatile instruments such as defined benefit pensions, annuities, and index-linked government bonds.

Sadly, that route is unaffordable for us. But it’s definitely worth investigating if you have greater means.

My final, overriding, set-up point: my job has been fairly all-consuming for more than two decades. I’d like to live a fuller life now.

That entails risk.

That’s life though, so I’ll try to offset the risk via:

• Multiple back-up plans
• Awareness of the failure points
• Conservative assumptions
• Not believing this is fire-and-forget

Living life now means not waiting until we can live off the dividends or fund a conservative 3% SWR.

But a naive 4% SWR is too risky, in my view.

So how can I use more sophisticated decumulation techniques to deploy our wealth more effectively, without turning retirement into a decades-long tightrope act?

The first step is understanding what an acceptable failure rate is.

Failure is negotiable

Standard SWR studies define failure too narrowly.

If the simulated portfolio’s wealth hits zero before the end of its time horizon then it’s a fail.

But we humans can run out of life before we run out of money. If I flatline before my wealth does then… success!

Well, sure. Kinda. Sorta.

The point is that SWR failure rates are less risky when you factor in your own mortality.

If Mrs A and I have a 10% chance of both being alive in 45 years, and our portfolio has a 10% chance of giving up the ghost in that time (at our chosen SWR) then our actual failure rate is:

0.1 x 0.1 x 100 = 1% chance of running out of money and both of us being alive to worry about it.

That’s a 99% success rate! Always look on the bright side of death.

I’m assuming here that the portfolio will more easily support one person than two.

That matters, because there’s a 49% chance that at least one of us will be around in 45 years.

One person won’t be able to live half as cheaply as two, but the portfolio will definitely last longer if it isn’t financing my chocolate habit.

The upshot is I’m comfortable picking a higher SWR – based on a 10% failure rate – when it’s twinned with a reasonable life expectancy for both of us.

Remember, we only stand an 8% chance of both being around in 45 years, so I’m still choosing an optimistic life expectancy. There’s a 2% chance we’re both here in 50 years time.

Also, SWR sims don’t account for humans noticing when the bank balance is draining at an alarming rate.

In real life people put the spending brakes on years before their portfolio sparks out. (More on this later.)

• We’ve written before on life expectancy for couples.
• Try running your numbers on a life expectancy calculator.

Next!

Decumulation diversification

SWR research is generally based on single-country portfolios split fifty-fifty between equities and conventional government bonds.

In a nutshell, US-based historical studies may be too optimistic. But non-US studies don’t account for the contemporary advantages of global diversification.

Research into asset-class diversification generally shows a modest uptick in SWR.

As a UK investor I’m not going to bank on history repeating the stellar US asset returns of the past century.

But I’m happy that a diversified global portfolio could replicate historical developed world returns. Those were scarred by two world wars, after all.

Here’s my de-accumulation asset allocation:

Growth – 60%

• 20% World equities
• 15% World multi-factor (Size, Value, Quality, Momentum)
• 10% UK equities
• 10% Emerging Market equities
• 5% REITS

(Note: there’s approximately 2% more UK exposure in the World funds.)

Defensive – 40%

• 15% UK gilts (long, intermediate, and short durations)
• 15% World index-linked government bonds (Hedged to £, short duration)
• 5% cash (currently it’s 10%)
• 5% gold (I don’t own this yet)

Most of my holdings are in cheap index trackers, though I will use active funds when I don’t have a good passive investing alternative.

I won’t use high-yield funds because I think that a total return strategy beats an income investing strategy.

Decumulation portfolio rationale

Here’s a short (ish) explanation of my decumulation portfolio choices. Happy to debate any of it in the comments after.

Growth

The expected returns of our equity holdings should provide the real returns we need to sustain our income over the decades. A strong equity allocation along with our State Pensions is our best protection against longevity risk.

It’s that or troughing out on deep-fried Mars Bars and cigarettes for the next 30 years. YOLO!

Adding a multi-factor holding to my equity split increases diversification at the price of higher fees, mitigated by the hope of slightly higher returns. This is debatable, optional, and may well be a slim hope.

Threats

The volatility of equity returns exposes us to sequence of returns risk. That is the chance that a poor run of market conditions sends our portfolio into a death spiral we can’t escape.

Another threat is high inflation whittling away the value of our defensive assets over the long-term.

Defence

Our defensive assets reduce our sequence of returns risk – as well as the stress of watching our main income source collapse during a market crash.

Conventional government bonds are likely to outperform other assets during a steep market decline.

Short duration bonds and cash guard against rising interest rates but they are much less effective than longer bonds when equities bomb.

(Cash sometimes outperforms bonds, especially in inflationary scenarios. It’s also easier to get change from a tenner than a 10-year gilt at Tesco.)

Index-linked government bonds are best against runaway inflation. Equities do badly in these scenarios. Equity inflation protection asserts itself in the medium to long-term, but linkers can pay your bills today.

We’ll hold linkers and conventional bonds in a 50:50 ratio.

Structural problems with the UK’s index-linked gilt market explain why I use developed world linkers.

For conventional bonds, choose a global government bond fund or total global bond market fund if you prefer. Just make sure it’s hedged to the £ (to eliminate currency risk) and that it’s overwhelmingly concentrated in high-quality bonds.

Match your bond fund’s duration to your time horizon to reduce interest rate risk.

Gold is a wild card that can perform when nothing else works. It’s typically uncorrelated to other assets and, in recent years, has spiked when people think the financial system is circling the drain.

I see gold as a one-shot wonder. It’s a shotgun blast in the face of some crisis occurring during the first 10-15 years of decumulation.

That early period is when we’re most exposed to sequence of returns risk. After that gold will be discarded like an empty weapon because its long-term returns are poor.

Triple threat

Does the age of negative interest rates, QE, and government bazookas mean we’re in for secular stagnation, rampant inflation, or stagflation on steroids?

Your guess is as good as the next clairvoyant. I’ll hedge my bets with that mix of equities, linkers, and gold.

In times past, I’d probably have been 50:50 split across bonds:equities on the eve of decumulation. Now I won’t go below 60% equities. I believe I can tolerate the extra risk.

If I couldn’t handle this large (ish) equity allocation, I’d need a bigger portfolio to sustain the same income. I believe high equity valuations and low to negative bond yields heighten the risk of anaemic returns over the next 10 to 15 years.

A diversified portfolio in itself is only worth a small SWR raise, so I’ll also use a dynamic asset allocation strategy to try to squeeze a bit more juice out of my pot. This means my equity allocation could hit 100% if the market stays down for years.

Before I check out

In my next post I’ll explain how I plan to employ dynamic allocation – and dynamic withdrawals – to finesse my plans. Subscribe to make sure you see it.

Take it steady,

The Accumulator (though not for much longer)

What caught my eye this week.

I sold a six-figure shareholding last week for a phenomenal capital gain – over 1,000%.

For historical reasons the shares were held outside of an ISA. This means I’ve got a big capital gains tax bill coming, despite years of defusing.

The sheer size and hence risk of this single position – and the awkwardness of trading it outside an ISA – meant something had to be done. Rumours that Rishi Sunak might raise capital gains tax rates tipped me over the edge.

Like most taxpayers I remind myself I support an accessible health service and a welfare safety net. My sister is a nurse.

Thank you NHS.

But not to the tune of a mooted 45%!

To stash or not to stash the cash

The lessons of this investment – and of getting rid of it – will be fodder for a future post. As will be my specific findings from what happened next.

Which was deciding what to do with it.

Remember, I’m running a big interest-only mortgage, which through one lens is borrowing to invest. So somewhat risky.

Euphoria abounds in the stock market today – and elsewhere. Bitcoin just breached $56,000. Bulletin boards are blowing up hedge funds. Growth stocks seem unstoppable.

Even with nominal yields on government bonds sneakily rising, real yields remain very low and confidently predicting an imminent bust is folly. But it hardly seems imprudent to take some money off the table.

The trouble is where to put it?

I knew, of course, that rates were very low. I sort of assumed if I dug around I’d eek out something decent across multiple savings accounts.

But no, not to the extent it’s worth the hassle.

Long story short, Premium Bonds seem about as good a place as any for the maximum I can put in them.

I will keep a further chunk in cash, despite inflation eroding its value. I’ve felt too light on cash ever since I bought my flat, and I love Jamie Dimon’s description1 of having a fortress balance sheet. It’s time to rebuild my walls.

Otherwise, I’m thinking I might actually throw a few pennies at that big interest-only mortgage that half of you hate so much!

I’d presumed I’d run my mortgage full tilt for a decade, at least. But it is looking like some of my expected investment gains have probably been front-loaded.

What’s more, my bank’s rates have already floated off the floor. I have two years left of my very low five-year fixed rate to run. Given the odd way I got this mortgage, the end of this term could be a non-trivial event.

It’s still tempting to stash the cash rather than lock it away forever by paying down some of my mortgage. Even at a cost of lower returns from savings. The set aside cash could cover several years of monthly mortgage payments in a pinch. Sunk into the mortgage, it only reduces monthly payments by less than £100.

Also it’s entirely possible I’ll never be able to get a mortgage of this size again. Not without buckling down and ramping up my earnings, and even that hasn’t helped in the past. (I’m self-employed, one way or another.)

On the other hand, repaying debt charged at 2% looks sweet in a world that barely pays you for lending it cash and expects every share to go to the moon.

Lucky bastard

I’m aware this problem is plucked from the box marked Nice Problems To Have. Despite vast State support, many people and businesses have been hit hard by the pandemic – including several unlisted companies I’ve invested in.

How they’d love to have the headache of where to stash thousands of pounds in cash.

All I can say is I planted the seed of this windfall many years ago, when times were good and most people were spending freely. Now my investment has matured and blossomed. We all have to manage our own finances as best we can, whatever is going on in the world.

Luck won’t always go my way. That’s why I – like you – save and invest for the future. I fully expect to be hit by future tax rises, too, to pay for furlough and other breaks I didn’t get a penny of (but nonetheless supported).

But that’s more article fodder, I guess. Another dividend from reshuffling my assets!

Where would you stash the cash – or would you just save it for the mother-of-all post-lockdown parties? Let us know in the comments below.

Otherwise have a great weekend.

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1. Possibly pinched from Warren Buffett. [↩]

What caught my eye this week.

Perhaps if it was known as the Bengen rule, William Bengen would be more insufferable.

But judging by his appearance on the Rational Reminder podcast this week, the inventor of the (in)famous 4% rule (of thumb) is a delightful human being.

You’ll remember Bengen was the first to put statistical guardrails around how much a US retiree could spend from their savings to avoid running out of money.

The approach seems as obvious as the merits of index funds nowadays. But it was a breakthrough back then, when retirees managing their own assets all but used a Ouija board to tackle the problem.

Of course the 4% rule is subject to much debate. People say it won’t work at this time of paltry returns from fixed income. Bengen has warned his sums weren’t looking at early retirement or non-US investors.

Most interestingly of all, in a low-inflation world Bengen now believes US retirees can take out 5% a year with confidence.

Don’t get cross with me! Go listen to the podcast.

You should also check out the various withdrawal rate posts by my co-blogger The Accumulator.

More to spend

There was a further positive spin on retirement income from Christine Benz at Morningstar this week.

She makes the point that those retiring on today’s potentially lower withdrawal rates have almost certainly got much larger pots to draw on, too, thanks to the long bull market.

As a result, their actual spending budgets may not be much different:

To use a simple, admittedly arbitrary example, let’s say an investor retired in early 2011 with a $1 million 60% equity/40% bond portfolio.

If she were using the 4% withdrawal guideline–$40,000 initially with that amount inflation-adjusted by 3% annually–she’d have pulled about $460,000 from her portfolio over the past decade.

Meanwhile, let’s say someone who was 55 and had a $500,000 60/40 portfolio back in 2011 is ready to retire today. Thanks to market appreciation and assuming that she hadn’t been engaging in regular rebalancing, her portfolio is now worth about $1.4 million.

Even if she has to take a lower starting withdrawal of 3%, her larger balance means that her first-year withdrawal is about $41,722. Her first-decade withdrawals, assuming 3% initially with 3% annual inflation adjustments thereafter, would be about $478,000, roughly in line with the 2011 retiree’s.

It’s not quite apples to oranges, but it’s a worthwhile contribution to the discussion.

Bengen himself says in the podcast that precision is a bit moot. Any sensible investor will readjust if things go badly wrong. Like many advisors, he says his biggest challenge was to get retirees to spend their money, not it running out.

I believe there are many ways to skin this cat.

For example I’m still presuming I’ll convert to income producing assets if I ever decide to live off my wodge, much to the annoyance of some Monevator regulars.1

Other readers are working off 3% withdrawal rates, or even lower. Perhaps they don’t want to be left behind by lifestyle inflation in the general population. Or they may be skeptical about valuations in the market, and fear a crash.

My view is thinking sensibly about this problem gets you 95% of the way there. After that, adapt as you go.

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1. Yes, you need more money to start with. Yes, you’ll probably die with lots of cash left unspent. No, income-investing is not a superior strategy to total market investor from a returns perspective. No, I wouldn’t be owning individual shares in individual dodgy failing UK companies and expecting them to pay me through a forty-year retirement. Et cetera. [↩]