So look I get that no-one needs another piece debating the 4% rule. (I did write a piece doing exactly this last summer though, showing that the last decade of low rates had “broken” the 4% rule – in the UK, similar conclusions would hold in the US).
The follow-up to that piece was surprising- we got a lot of interest in the work, and a good deal of pushback (much of which focused on the fact that 4% rule had never worked in the UK in the first place). Unlike the original research on this we used actuarial longevity models to vary the retirement lifespan as well as investment returns.
There are quite a few important moving parts here – when you retire, the withdrawal rate, your asset allocation, charges and whether you increase spending with inflation. So what we did was create this little free online tool that lets users play with all thee variables themselves to see how sustainable different strategies are in retirement. Try for yourself!
But from extensive playing with the tool I actually got to a weird conclusion: at high equity allocations and very low charges you can give the 4% rule a decent shot at working from surprisingly young ages – like 40 or 45. The example below assumes 100% equities and 0.2% p.a. charges (probably the absolute lowest feasible level of total charges assuming passive investment and a low cost platform). You can see that we give the 4% rule a 2 in 3 shot at working with this set-up (33% chance of running out of money). That’s with a strict spending rule that always increases withdrawals every year come what may, in practice if you could be more flexible, your chances of making it work would be higher.
That means that if you could afford to live on what the PLSA define as a “moderate” retirement living standard for a single person (£20,000 per year) you’d need around £500,000 saved – a vast amount of money for sure, and usually limited to the realms of very high earners and those with a windfall, but achievable with a combination of the very high savings rates on relatively normal salaries discussed on early-retirement forums such as MrMoneyMoustache or in the FIRE movement. To hit the PLSA’s comfortable living standard as one half of a couple, you’d need around £600,000 each. I set up a neat tactyc web tool to quickly see what sort of savings rates and returns could lead to accumulating these sorts of amounts.
This modelling assumes real returns on equities of c4.3%p.a. in the future. It does show how much uncertainty there is in all this though – as the picture above shows the fund on average lasts for c73 years at that withdrawal rate but the range of ourcomes is huge – you could be sitting on millions after a few years or could run out of money entirely in a couple of decades. If you hit the “play simulations” button in our tool you’ll get a sense of the variability of different paths. So, great for modelling, perhaps not so helpful in the real world.
It also shows how vital charges are over such long periods. Increasing investment charges to c1.5% p.a. , a fairly normal level, reduces the median fund life by over 30 years, and knocks in a big hole in any chance you had of making that early retirement work on the 4% rule.
It also gives us a window into inflation. In the example above removing the inflation link to the amounts withdrawn increases the average fund life by 30 years and halves the chance of running out of money. But also the purchasing power of that income will halve over 30 years. For someone considering a very early retirement, this really really matters.
Real Investment Returns
Looking at inflation also make it very clear that it’s real (ie, over and above inflation) investment returns that matter. A few years ago (in 2010 say in the UK) investment in government bonds gave healthy real returns of around 2% p.a. almost risk-free. That is no longer the case which creates the greatest “portfolio puzzle” which I dive into in more detail here. Today you need a decent amount in equities just to stand still after inflation and fees.
But conditions changed in the past, they will probably change in the future as well. If we “roll back” investment assumptions to 2010 levels where we pegged equities at an expected real return of 7%p.a. (close the long-term historical averages) suddenly the 4% rule looks eminently do-able with an almost 90% chance of working from age 45. In fact, with that level of returns and charges you could make a 5% or even 6% withdrawal rate work, meaning that you’d need a savings multiple of 20x or 17x your living expenses to retire early (equivalent to £350k or £400k of savings to meet the moderate retirement living standards).
In practice few people will be retiring in their 40’s, and one thing this does show is just how much of a rollercoaster ride you’d face in trying to do so. In real life you don’t get to live the average of 10,000 model runs. However it does point us to the right questions to be asking for anyone looking to live off an asset portfolio more generally:
- Inflation. Over the decades inflation adds up hugely. With 3% inflation over 30 years the same amount of money will lose over half its purchasing power. Any long-term plan has to factor inflation into account
- Asset allocation: in today’s world real returns come from equities not bonds, you’ll want a substantial allocation to equities even if this involves more investment risk. It’s also good advice to go global, and include emerging markets as you want the best shot at getting high returns. In today’s world you can easily make such allocations passively at very low charge levels
- Charges. These matter hugely over the decades. Good advice is probably worth paying for, but be laser-focused on every charge which comes out of your assets (platform, asset management and advice)
- Return expectations. No-one knows what these are for sure. We can use history as a guide, and many institutions today make their assumptions public. No-one knows for sure though, and these are a key variable
- The power of compounding. Yes, we all know this important. But it is really important. Under reasonable assumptions HALF of your total pension pot could accumulate between age 60 and 70, which highlights just how important the retirement timing decision is
- Flexibility. If you are able to have flexibility in your withdrawals you can make your situation much more sustainable compared to a situation where you need to withdraw an increasing amount of money each year come what may
- Benchmark milestones. By investigating how much money you could feasibly retire on from younger ages this gives us milestones to aim for in our investing journey. We have shown that having 20-25x your salary (or more accurately of your expenses) saved more or less equates to “financial freedom” at most ages. So having 10-12x your salary is halfway there, a good benchmark. My tactyc web tool gave the following milestones at different ages in terms of savings as a multiple of salary. These were based on 20% savings rate and returns of 5% and 7% annually.
Test the tool for yourself here. Or just check out these cool videos showing some of the sims –
And now do 2% charges …
Read our piece on the 4% rule here.