Retirement Withdrawal Rates vs Probability of Success

The 4% Rule gets bandied around pretty loosely (I sometime think dangerously so) in the personal finance (PF) world these days and on some of the forums people seem to believe in it almost religiously.  What I’m not sure about is if these same people have actually read the T&C’s of the 4% Rule.

Within the T&C’s there are a couple of pertinent points relevant to this post.  Firstly, it is based on US historic data which doesn’t seem to hold for the UK, a global portfolio or for many other countries for that matter and of course history is not necessarily a predictor of the future.  The other point about it is that it gives you a 96% chance of success historically.

Having debated/discussed PF topics and specifically FIRE topics with many of you over the years I’m finally (I can be a bit slow and a bit stubborn at times) starting to realise that I’m a fairly conservative creature and that I also like to go to a level of detail that probably few others would have the patience for.  These traits lead me to selecting FIRE withdrawal rates after expenses of 2.5% that hopefully will give me a 100% chance of success at planned spending even though I know I have the ability in my plans to cut back on discretionary spending in severe bear markets.

Brexit vs FIRE to the Med

So the UK has voted, Article 50 of the 2009 Lisbon Treaty will soon be invoked and over the next couple of years we’ll negotiate (hopefully sensibly) our way out of the European Union.  Of course I have no idea what those negotiations are going to result in but I also don’t really want to hang around and wait.  After all I’m trying to become financially independent in less than 6 months from here and retire early to the Med in less than 12 months.

It therefore seems worthwhile to get my initial thoughts down on paper which can then be modified as I learn what is happening and being negotiated.

Wealth to FIRE

Post referendum there was plenty of economic doom and gloom around however there was also plenty of exuberance in the days prior.  Priced in £’s my portfolio actually ended the week 1.9% higher than my position at the end of last week and priced in Euro’s I’m down 1.2%.  Hardly FIRE destroying leaving me very much still on for financial independence in less than 6 months.

Click to enlarge, My path trodden to financial independence

As a person positioned as a UK investor right now I’m also stress testing my portfolio against a £ to Euro exchange rate of 1.123.  It’s currently 1.2307 so this is still also looking good.

Getting in the door

One of the founding principles of the European Union was the free movement of its people across its countries borders.  The RIT family were planning on taking advantage of this to enable the move to the Med.  I would say there is a definite risk now, that with us Brexiting, this right will be taken away for UK passport holders not already resident in their new EU country.

My Early Retirement Financial Strategy and Portfolio

With FIRE now on the doorstep it’s time to finalise what my early retirement drawdown strategy and portfolio is going to look like.

Firstly, let’s look at the strategy and portfolio that has put me where I am today.  I first published it in detail in 2009 and then polished it slightly in 2012.  In brief it was about building significant wealth (at least for me) in quick time.  Quick time was less than 10 years which meant I needed to be accruing wealth in relation to My Number at just a little less than 1% per month.  A very aggressive target when I look at it that way in hindsight but one which provided Mr Market behaves for just a few more months looks real.

By living frugally while focusing on earning more I believed I could Save Hard.  To date my Savings Rate has averaged around 52% of Gross Earnings so that has played out.  This then advantaged me when it came to investing as I didn’t have to take great investment risk giving me an increased probability of success.  I called it Investing Wisely.  As it turns out since starting my annualised investment return has been 5.9% which is 3.3% after inflation.

When I came out I stated that at the point of Early Retirement I wanted wealth of £1 million (it was actually £1,011,000).  Today my trusty Excel spreadsheet is telling me that once I hit £1,023,000 I’m good to retire.  At this point it’s then no longer about building wealth but instead the simple problem of ensuring I outlive my wealth which will be drawn on as I’ll have no other earnings.  I suspect it may require a slightly different strategy and investment portfolio to that which I have today.  That said the principles of tax efficiency, low expenses and a diversified investment portfolio, with a key decision of what Bond to Equity Allocation Percentage at its core, I intend to keep.

Given the seriousness of this topic it’s about now that I have to pop in a wealth warning:  History is not a predictor of the future, this is not financial advice, I’m not a financial planner and I’m just an average person who’s made investment mistakes on a DIY Investment journey to Financial Independence.  The post is also just for educational purposes only and is not a recommendation of any type.  Ok let’s move on...

My current estimates, based on my forecast FIRE date, suggest I’ll actually overshoot my FIRE wealth Number with circa £1,117,000.  A Mediterranean life will then mean a life priced in Euro’s.  The average exchange rate with the £ since the Euro’s inception has been 1.3742.  I’m not going to bank on that.  Instead, I’m going to use the worst average year since inception, which was 2009, with its rate of 1.123.  That gives me EUR1,254,000 of wealth to buy a home with and live from for the rest of my life.  I’m going to assume a 40 year retirement period.

Valuing the Housing of England and Wales at County Level – Year 4

In my view (and unfortunately) house prices in this great country are driven by Affordability, which is one’s ability to service debt at current interest rates, and not by Value.  This is one reason why I’ve never bought a home, and now don’t intend to buy, choosing instead to move overseas.  So when/if salaries increase, the price of debt decreases and/or the government provides ‘help’ we can expect house prices to rise.  Let me demonstrate with one simple example showing how just one of these affects prices – average house prices vs average employee earnings:

Click to enlarge, Average house prices vs average employee earnings (in England and Wales at County level)

For me, clearly mistakenly, I’ve always been more focused on Value.  With this in mind every year at around this time I preparing a house Valuation metric that goes beyond that generally presented by the mainstream media by getting more granular and trying to Value housing at County level.  For completeness last year’s efforts can be seen here and you can track back to previous years from there.

My definition of Value is simply how many years of gross earnings (median and average) are required to buy an average house.  This is a simple average Price to Earnings Ratio (P/E) and is not unlike how some might value a company share.

For House Prices I am using average house prices as published by the Land Registry. This is calculated by using:

• The Land Registry House Price Index (HPI) dataset.  This index uses repeat sales regression (RSR) on houses which have been sold more than once to calculate an increase or decrease.  As it analyses each house and compares the latest buying price to the previous buying price it is by definition mix adjusting its data also.  It uses all residential property transactions made in England and Wales since January 1995 so covers buyers using both cash and mortgages.
• Average prices are then calculated by taking Geometric Mean Prices (as opposed to an arithmetic mean), to reduce the influence of individual values, from April 2000 and adjusting these prices in accordance with the Index changes.  They are seasonally adjusted. I am using the latest published data which comes from March 2016.  

The Valuation analysis is arranged according to the Regions and County’s defined by the Land Registry and is shown in the Table below.  Unlike the mainstream media I am calling high house prices bad (unsurprisingly the County with the highest house price is London at £534,785 and is shown in dark red) and low house prices good (the County with the lowest house price is Blaenau Gwent at £69,384 and is dark green) with all other prices shaded between red and green depending on house price.

I think I can, I think I can, I think I can FIRE in 6 months

Life is really busy.  No, that’s not right, let me try again.  Work is consuming me.  I’m pressured, stressed, exhausted and for the first time in my life that I can remember have so much workload that I’m failing to achieve what I’m setting out to do.  If I was a normal 43 year old working away to my current State Pension Age of 67 then I really would have to be doing something about it as it is just not sustainable long term.  Looking at my progress to Financial Independence tracker is however going to make me do something else instead.

Click to enlarge, My path trodden towards financial independence

Today, I have wealth of £938,000.  This is also my net worth as I have £0 in debt.  With a FIRE (financially independent and retired early) target of £1,000,000 and provided Mr/Mrs Market behaves him/herself I should be able to close that gap in 6 months according to my Excel spreadsheet.  That is not far away and now requires me to do some things over the coming months.

1. Pick an early retirement date

Into the melting pot for this decision goes:

• the weather.  Not much point moving in the middle of winter.
• tax efficiency.  As I’ll have the opportunity to work for only part of the year it seems to make sense to earn enough in a tax year to take me up to the start of the 40% higher rate income tax rate to maximise my FIRE wealth for a given work effort.
• work projects.  I do have some longer term projects at work that I would like to finish.  I know I don’t have to but for me at least I feel it is the right thing to do both for myself and those who work around me.
• assured shorthold tenancy (AST).  As a renter I have a tenancy period that I need to comply with.  There is no point paying rent on a flat that is empty.  

Working through each of these in turn and it looks like I’ll actually resign in late winter/early spring 2017 with a plan to be in The Med in late spring/early summer 2017.  So at this stage it looks like I will be overshooting what is physically possible financially and I’m ok with that.  I’ll only be 44 years of age after all.  It’s not like I’m planning to do One More Year (OMY) or anything like that...

2. Ensure my portfolio is right for distribution and not accumulation

When I built my investment strategy it was all about the accumulation of wealth.  That book is now fast coming to a close and I’m about to start a new book called Starting out in the Retirement Distribution phase.  My investment portfolio today looks like this: