Monday 26 May 2014

Further Exploration of Safe Withdrawal Rates (SWR) for UK Investors

If you’re like me and don’t have a Final Salary Pension waiting in the wings, rich parents (which might include an inheritance), intention to buy an annuity and don’t want to be raiding bins for food scraps in old age then the amount of wealth you accrue before calling yourself financially independent, allowing early retirement is a critical number that you really can’t afford to get wrong.  Retire with too little wealth and you could expend it all before parting from this fair land making life in old age very difficult.  Be too conservative and fall into the “one more year of work” syndrome and well all I can say is you’re a long time dead.  So we’re looking for a Goldilocks amount of assets.  Let’s try and figure out what that amount might be for a UK resident.

Given the seriousness of the topic I must give the following Wealth Warning before we move on.  I’m just an average person on a DIY Investment journey to Financial Independence and am certainly not a Financial Planner.  The content of this post is for educational purposes only and is not a recommendation of any type.

We've looked at Safe Withdrawal Rates previously.  In that post we focused on the 4% Rule or 4% Safe Withdrawal Rate (SWR) which in brief works on the principle that if in your first year of retirement you withdraw 4% of your portfolio, then yearly up rate your withdrawals (your “Gross Earnings” plus any investment expenses) by inflation, the end result will be that you won’t exhaust your portfolio in your lifetime.  If you dig a little deeper what it actually says is that using past market performance (which we of course we know does not necessarily predict future market results) for a 50:50 Stocks : Bonds portfolio then you have a 96% of not expending your portfolio in a 30 year period.

The 4% Rule also has two other potentially big flaws that I can see for UK investors:

  1. The Equities and Bonds used for the study were the US S&P500 for Equities and US High Grade Corporate Bonds for bonds.  I know as I am writing this as a UK Investor I only have about 5% of my total portfolio allocated to the S&P500 and I have nothing allocated to US Corporate Bonds.  I do however have 19% of my portfolio allocated to UK Equities and 22% allocated to UK Government Bonds (if I include my NS&I Index Linked Savings Certificates) and I'm probably light in UK assets compared to many in the UK.  Have past investment returns been the same for the UK?
  2. Over the time period in question the US consistently enjoyed among the highest inflation-adjusted returns and lowest volatilities for stocks, bonds, bills and inflation” when compared to other developed countries meaning a potential significant risk that 4% is too high a safe withdrawal rate.

So with these two questions hanging over us what might be an appropriate SWR for a UK investor to use if they were prepared to use history to help calculate that required wealth number?  Fortunately, Professor Wade Pfau  has been studying just this for a number of countries including the UK.  Table 1 contains Sustainable Withdrawal Rates Around the World (including the UK) with a Fixed Asset Allocation 50% Domestic Stocks and 50% Domestic Bonds and Table 2 contains Sustainable Withdrawal Rates Around the World (including the UK) with a Fixed Asset Allocation 50% Global Stocks and 50% Global Bonds.

Sustainable Withdrawal Rates (SWR) Around the World with a Fixed Asset Allocation 50% Domestic Stocks and 50% Domestic Bonds
Click to enlarge 

Sustainable Withdrawal Rates (SWR) Around the World with a Fixed Asset Allocation 50% Global Stocks and 50% Global Bonds
Click to enlarge

Unfortunately the news isn’t good.  Staying with only UK Stocks and Bonds in your portfolio and following the 4% Rule over a 30 year period would have resulted in you running out of assets 23.8% of the time.  To be 100% “safe” you have to drop to a SWR of 3.05%.  Switch to Global Stocks and Bonds and the news isn’t much better.  100% “safety” and your SWR is still only 3.26%.

Now I don’t want to scaremonger but it’s also important to note that this study did not consider investment fees and taxes.  They would have to also be paid out of your 3.05% or 3.26%.  This just further reinforces how important it is to minimise investment expenses and taxes.  Not to digress to far from topic but just imagine if your investment strategy used the Hargreaves Lansdown Wealth 150 Report as it’s basis where the majority of funds recommended seem to have a standard annual charge of around 0.75% (less a bit of HL “discount” plus a bit of other expenses).  Nearly 25% of your safe withdrawal could be going to keep the financial industry in their Yachts.  I don’t think it’s just the Ermine who isn’t rich enough to play these sorts of games.

So what’s my SWR going to be I hear you ask?  Previously I haven’t revealed this number but today I’ll give my thoughts with approximately 3 years left to run until Financial Independence.  I’m planning on starting with a SWR of 2.87%* (2.5% for me with 0.37% being my current annual investment expenses) and monitoring from there.  The more I can continue to learn to drive down my expenses the better my safety margin becomes.

So what does an SWR of 2.87% mean when it comes to how big the pot of gold at the end of the rainbow having to be.  Well, if I was Mr UK Average and earning £474 per week then I’d be requiring wealth of £985,920.  Let’s call it a million pounds shall we.  Now that is a lot of money which further reinforces why it’s so important to develop techniques to spend as little as possible to achieve the lifestyle you desire.

One final point.  To give me more SWR confidence of success I've been working towards gradually trying to manoeuvre my portfolio with additions like my HYP so that the interest and dividends spun of each year covers more than my SWR meaning I'm not drawing down my capital and ideally actually adding to it.  Then I only have to worry about inflation and financial Armageddon forcing me into garbage bins in old age.  As it happens looking at my portfolio today (excluding cash and NS&I Index Linked Savings Certificates wealth which will be used to buy the family home a few short years from now) it is yielding exactly 2.5% (allowing for work pensions which would be transferred to income producing assets with my SIPP upon leaving my current job) so a little more work to be done here if I am to create a small excess for reinvestment.

So what do you think?  To bearish or bullish?  If you’re living off your wealth what SWR did you settle on and is it working for you?

*Of course I reserve the right to change this percentage in either direction as I continue to learn going forwards.


  1. I don't think those tables help you much they are looking at a 30 year retirement probably starting at 55-60 with current life spans

    You are looking to retire about 45 which probably means about 40-45 years retired

    That longer period increases the risk of running out of money quite a lot

    Me, I'm still working despite having a few million saved

    1. Hi Anonymous

      Running my details through a life expectancy calculator and I'm presented with an average age of 87 meaning 42 years from my likely financial independence age so you're spot on. I agree that the longer period increases the risk of running out but the part I am also being very careful with is to watch I don't fall into the 1 more year trap.

      I'm very conscious that it takes all kinds and that's what I love about this site however if I had a few million pounds saved I'd definitely be calling myself financially independent. I must say congratulations. Would you care to share with others how you "made it" as the more perspectives presented, the more chance others can do their own research and succeed also?


    2. I started saving into ISAs and personal pensions as soon as I stated work and so did the mrs, putting the annual maximums in until about 5 years ago

      That was about 20 years ago

      We have our own small business too which really helps

      Put those together and you can keep your marginal tax rate below 20% pretty easily for profits up to nearly £200k a year

      Thats it really

      One reason why we keep working is because its a lot easier to make $$$ in the workforce continuously than leave it and have to start up again from scratch after a few years retired.....but thats just an opinion, maybe I'm just a rat on a wheel

    3. Thanks for sharing Anonymous. The continuation of work even though it seems like you "have enough" fascinates me. I'm going to start working on that now so that I'm ready when the time comes. That way continuation of work will be because I want to rather than think I need to.

  2. When I first stumbled across this early retirement malarky, I had learned about the SWR from people like mrmoneymustache who are very bullish on the 4% SWR so I thought that would be ok to.

    Now I've looked more into it and with being based in the UK, I am more inclined to go with 2.5% to 3% SWR to be on the safe side.

    It does mean that I need a hell of a lot more savings to fund this level of WR but like you, I am trying to cut my expenses down so I can save more now and need less to live on in the future.

    Thanks MFF

    1. Hi MFF

      I'm a big fan of MMM and read his site regularly. His charismatic style has certainly helped get the frugal message out to many which is impressive given the corporate advertising machine that he has to compete with in the modern day. If only I could get the message out to 10% of what he does I'd be ecstatic.

      That said, I agree that he is very bullish on the 4% rule. He's in the US so if he's in US equities/bonds he has history on his side to a point but in my humble opinion if he doesn't want to say it's history, only for 30 years and with a 96% success rate for message simplicity then he should be putting up a wealth warning of some sort. Particularly given how young he is as he could and would influence some. That said I guess advice really should be valued in direct proportion to that which you paid for it.

      Of course MMM doesn't have to worry about it as he hasn't yet retired. Instead he is in the enviable position of having his own website (I'd also love to have one of these) and construction businesses which are clearly doing very well. That is not said negatively. Good on him I say. He took a chance, left Megacorp and is doing something he loves.

      I'm very much with you on the expenses front. In my is it more important to earn more or spend less post I demonstrated just how important this was. This is because every pound saved is paid back 'twice' - it gets you one step closer to your goal but the goal also moves towards you at the same time.


    2. Note that if you move to a more aggressive portfolio, eg. 75% stocks and 25% bonds then your SWR increases to over 4%

  3. When I started down this path a few years back, I would have thought (had I researched it) that 4% was a bit conservative. Back then, I imagined I could just buy divi-paying shares and spend the income each year in the expectation that on average prices and divis would rise with income. The divi cuts of 2009/10 showed the folly behind the term "on average"!

    Now I regard 4% as irrelevant to early retirees today. Maybe OK for a Yank aged 65 before longevity issues kicked in. But a 40 year old today faces a much tougher challenge.

    For me, I'm working on 3.1%. And that's with the (admittedly minimal) backup of an old DB pension to bale me out in 20 years time if it all goes to rats. Portfolio is roughly split 70% HYP-ish UK equities, 20% fixed interest (nothing "interesting" - just fixed rate accounts with various banks and each under the FSCS limit), some gold (hedge against financial Armageddon) and cash (as a float and a hedge against divi-droughts). Broadly, I can take 80% of the income as "salary" and set aside the rest for rainy days.

    I've come to the conclusion that a financial strategy is only part of FI. The challenges and risks are so massive that you need an overarching philosophical strategy. You simply cannot hedge the risks of retiring at 40 unless you have a massive pot to start with. For starters, I'm betting on global peace and growth for, say, 50 years. Given the human race's propensity for scrapping, the planet's finite resources and environmental constraints, that ain't a good bet. The insight, of course, is that "just another year" shackled to a desk doesn't help either!

    The risk that gives me the willies, though, is tax. To reach FI, you need a million quid plus an unmortgaged home. In the eyes of the exchequer and the general population that makes you a rich bastard. It may not feel it as you frugally re-use your teabags and shop at Aldi but you are undoubtedly a filthy rich bastard. Ripe for squeezing.

    Currently, us early retirees and FI strivers get a good deal in the UK. I'm not a tax expert (yet) but, at a glance it looks pretty cushty. No wealth tax. A £10k tax allowance. No tax on divis until you hit nearly £40k. And potentially thousands of untaxed income from ISAs. A couple could be sitting on millions and taking an income of over £80k pa - yet paying practically no tax. How long is that going to last? 50 years? For most early retirees (of the saver-investor mould rather than the big inheritance or business founder type) a 20% tax will throw a major spanner in the works.

    1. Hi CountryBoy

      Many thanks for sharing what is clearly a well thought out strategy. Could I ask how you arrived at 3.1%?

      I agree with you on the tax front. It is ripe for the picking. I guess as a politician you'll come after whoever are the wealthiest minority idc.


    2. 3.1% is just what it is! If you take 80% of interest and dividend income and divide it by the total pot (including non-yielders such as cash and gold), the answer is 3.1%. If I've done the sums right! House is excluded from these calcs as I effectively consume the yield by living in it.

      I only came across the SWR concept (and therefore %) late in the game. I'd always worked on two levels of risk margin: firstly not spending all the income and secondly, maintaining a reserve pool of cash (or cash-like). I've just translated my real numbers into a "WR".

      I've not got the spreadsheet open now but IIRC, the equities section has a forecast yield of 4.35% and the average interest rate is 3.3%. As my long term fixes will be ending over the next few years, I may be squeezed a bit on that front.

    3. Thanks for clarifying and sharing CountryBoy.

  4. While I agree with your view that 4% isn't sufficiently conservative, I'm not sure a million quid is actually *necessary*. It all depends on the lifestyle you want to sustain. For me the answer is, indeed, circa £1m plus a home owned unencumbered. And this is where I'm at right now[1].

    However, this is not a 100% utilitarian life. Compared to Jakob at EarlyRetirementExtreme, I'm wallowing in frivolous luxury and decadence. Before I discovered financial independence as a goal, I picked up bad habits; too big a house, car ownership (and dependence to a degree) among others. My net unearned income (assuming next to no tax) would require a salary paying something like £35k gross. So it's not exactly skintville.

    I'm not sure what the minimum sustainable income (and, therefore, capital pot) would be in the UK. But I'll bet it's less than half a million. Possibly even £250k if you lived somewhere cheap.

    [1] But I'm still working. So the tax calcs are a bit of estimation as my earned income chucks all my unwrapped wonga under the scrutiny of HMRC. As to why I'm working - that probably takes shed loads of analysis. It's certainly not the money - we live off around 80% of our investment income. It's more likely to be the fact that my wife has recently started work and maybe I retain some atavistic sexist attitudes. Or, worryingly, maybe it's because I've become institutionalised and so programmed to work that I'll always find a reason to stay.

    1. Congratulations on the £1m + unencumbered home. I also know that this level of wealth would also buy my family and I a very nice life in indeed. Once you know sensible frugality I believe it would be quite easy to live a very happy, healthy and extravagant life on that.

      I found your "Or, worryingly, maybe it's because I've become institutionalised and so programmed to work that I'll always find a reason to stay" comment interesting. I also 'fear' something along these lines. Without giving to much away I spend a lot of my day assessing risk and when it comes to pulling the early retirement trigger there is always going to be some risk. Even if I had a £100m there is still the risk of a black swan event wiping me out. I'm hoping when I have enough I'll be able to pull the trigger. I'm starting to work on it now so that I'm prepared when the time comes.

      Would you care to share how you "won the lotto" for others to learn from?

    2. No lotto win. Same policies as you; earn more, save hard and invest well. Plus the leg that you don't mention: luck - which allowed the other three to happen.

      "Save hard" came first. I left school and found myself skint. I mean, really, really skint. Unemployed, nowhere to live type skint. Some people would call this "bad luck". In fact, it was the opposite. It gave me the frugal/survival habit that you never lose. And it forced me out of a fun series of jobs and into university which led to an actual career.

      "Earn more" came from the lucky move to university and leveraging a few connections I'd made in my pre-university days. I knew about computers, had an engineering qualification and knew people who really wanted to bring computers into their industry. I found myself being paid, to me, a lot of money (actually, it was and is "quite a lot" but not megabucks - sufficient to lose Child Benefit and, in very good years, my personal allowance)

      Actually, I'm not sure if I "invest well" - but I do invest and even cack-handed investing is better than not investing. But I had lucky timing. I grew up during the 80s privatisations so was of a generation that became "equities aware" relatively young. I started investing circa 1993 just because that's when I first had money. Ditto buying a house in 1995. Look at graphs of house and share prices with those dates in mind! Share before a house? Well, a planned purchase fell through so I spent my deposit on shares. My software development knowledge (knowing the difference and distance between aspirations and deliverables) kept me out of the worst exposure to dotcom horrors. And, I spent a long while working for a company that chucked shares at its employees. Nothing major and no dotcom flashiness - a FTSE350 business that grew and grew and grew and ran sharesave and exec bonus schemes continually.

      So that's my story. Did I mention luck?

    3. As above thanks for sharing. Great to see that the fundamentals can really take someone over the financial independence finish line. 7 years in I knew it would get me (and any lurking readers who are doing something similar after doing their own research) there but it's great to see someone who has lived a similar life having actually made the FI line.

      I don't see any luck in your strategy. Merely somebody who made there own luck by investing and then sitting back and letting the market do its thing. Congratulations.

  5. Thanks for the continued articles that continue to challenge my own assumptions. I have currently settled on 3.5%, but I do have the advantage of a DB pension as my main income. I have found the following papers useful in arriving at 3.5%.

  6. One factor that often seems missing from these calculations is a reducing need for income. I anticipate wanting a nice car, good holidays, regular restaurant visits etc at a retirement of 55, but not so much at 85.

    Just as the high:low risk ratios need to change as FI approaches, surely the withdrawal rate should too - higher to start with, tapering off with age ?

    1. I agree, and I intend to withdraw more in the first 10 years. Any decrease in withdrawal rate should be balanced by the state pension kicking in (big assumption). There are some useful calculators here that use a more realistic spending model over time>

    2. So what will you be doing at 85? My mother is in her mid-eighties, lives in a city and has pretty much the lifestyle and social life she had for the last 25 years. But the cost to her is creeping up. Cheap train travel to visit family, but taxis to the station because of the luggage. Finds she needs the help of a cleaner and a gardener to enable her to take pleasure in home and garden.

      She is not living with any chronic condition yet, just normal ageing, but the point will come.

      We all tend to assume we will live happy and healthy lives into the far distance, and then neatly drop off the perch when it all gets a bit difficult. The reality is most of us will live with various degrees of disability for a number of years. Money helps to manage that.

      So I think it is unwise to assume costs will fall. We will probably take fewer long-haul holidays, but we will need more assistance (technological or human) to remain independent.

  7. While the SWR studies are exemplars to consider, in practice their utility is limited since most people's retirement life will tend to exist in a number of phases for which different amounts of money will be needed.

    I retired at 55 three years ago. I have a good index-linked DB pension but it does not cover current expenses. My partner will work for another 5+ years probably. I have kids at university. I have a mortgage until 2021. I will get at least some state pension. I do have investments, currently still accumulating, but at a much slower rate than when I had surplus cash to throw at them.

    The only way to deal with such a complex scenario of incomes and expenditures, stopping and starting at various times, is to model it on a spreadsheet in terms of yearly cashflows and capital. I think this is safer than the SWR approach.

  8. How about aiming to wipe everything out including capital at the point of your life expectancy.

    .. Then with a cheap deferred Annuity purchased early on sit back and let the cash roll in to keep you going till you really do kick the can.

  9. Thanks for another interesting post
    I have read a few articles including MMM on how big a pot is needed for FI and what a sensible SWR is. However I am still a little puzzled on something which is probably quite basic ! - Unlike RIT I have no desire to leave a significant chunk of capital to Charity or other worthy causes when i finally depart, meaning I am happy to slowly burn through the capital in addition to the income that the portfolio generates.

    So in very simplistic terms I have calculated that the mrs and I would get by quite comfortably on an annual average income of circa 30k in real money. Assuming 1) we will both be exhausted 30 years from the point we start drawing down from our portfolio, and 2) Assuming that the portfolio simply generates enough income to keep pace with inflation the number we would need is 30k x 30(years) = 900k

    Accepting that this is a simplistic model, and all the usual unknowns - do those numbers work ? or have i missed something fundamental

    Appreciate any advice or thoughts

    Thanks guys

  10. Need to take inflation into account - which does not seem to be discussed much. Over a 20 or 30 year retirement, even a small annual increase makes a bit difference.

  11. An interesting thread of conversation here, which has tempted me in.

    My own portfolio is just shy of the magic £1m. A 5% rise in the markets would push it over that line and I have a very small modest house with no mortgage. So, yes I am a rich bugger by most people’s standards, but equally understand that it doesn’t seem like much when considering all the risks of retiring early. (I will be 50 later this year.)

    I have always highly regarded any books by William J Bernstein and his ‘The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk’, amongst others was an eye opener to me that taught me a lot about asset allocation that has helped me on my journey. (It might be too mathematical or technical for some, but as a geek, I loved it.) I forget which of his books recommended a SWR of 2%, backed up by statistics, but it feels right to my sensibilities and as a single person I could live comfortably on it in perpetuity I believe.

    Anyway, having worked with one employer for 20+ years and saved hard, it is difficult to make the jump, but I am getting psyched up for it. I don’t feel particularly institutionalised (maybe I am but don’t know it) it is more about finding a purpose and something to structure time. Being a rat on a wheel sure give structure to your time in spades.

    For me I am thinking about requesting going from a 5 day working week to 4 days as a step and maybe going back to further education. A gradual wind down may be less of a shock to my system. If they don’t let me then I may have to just jump of that cliff all in one go. It is too easy to think “one more year”, you are right about being a long time dead.

    These really are rich peoples’ problems though.

  12. One summer we ate lots of snails from the garden. If you give them lashings of garlic and butter they taste just like French snails - i.e. little bits of rubber flavoured with butter and garlic. See - it's possible to be frugal and have fun.

    And now a very brave deer has taken to entering our garden. I might buy a crossbow: my wife reckons she could cope with butchering Bambi.

    1. You could eat roadkill too if you wanted. Why pay for any food?

    2. Watcha mean "could"? We eat pheasant and deer from the verges. Doesn't everyone?

  13. The problem as I see it is that there is nothing remotely safe about the "Safe Withdrawal Rate". You can inform your judgement by looking at simulations based on bootstrapped historical returns but at the end of the day... it is a judgement call, nothing more and nothing less. I do very much agree with what's been said previously - FI is as much a psychological challenge as a financial one. You're not truly free until you've ticked the PI (psychologically independent?) box too.