Category Archives: Finance basics

The 4% Safe Withdrawal Rate for retirement savings – A Reflection

The 4% rule of thumb; this is what got me convinced about the concept of Financial Independence. I am taking some time to reflect on this rule after a few years to better understand how it shapes an investor’s journey.

The 4% Rule

According to the 4% rule, one can withdraw a maximum of this amount from their portfolio (consisting of stocks and bonds) each year and never run out of money. Therefore having a portfolio of which 4% can cover your annual expenses means that you are Financially Independant (FI).

This amount or Safe Withdrawal Rate (SWR) was determined by examining historical stock market returns. A lot of investors have no idea how much to safely withdraw from their portfolio, fearing that they will deplete it, so the 4% SWR is definitely a good starting point.

What does this mean in practice? As an example; if the investor has monthly expenses of £1,000 or £12,000 annually, we need to work out 25 times the yearly amount to determine the value of their required portfolio size – £300,000. A portfolio of £1 million would provide an income of £40,000. By saving and investing at least 50% of their income such a portfolio is attainable in a relatively short period.

Historical Withdrawal Rates – Impact on Portfolio Value

Portfolio success rates: 1926 to 1995

The table above from the Retirement Savings: Choosing a Withdrawal Rate That Is Sustainable Journal, outlines success rates of portfolios with different stock/bond allocations over payout periods of up to 30 years. The data is for the period from 1926 to 1995. I do not expect results to be very different today and data from more recent periods shows even better results.

A quick glance shows that a Withdrawal Rate of 4% largely covers most individual scenarios with high levels of safety. 3% appears to be bombproof! 5% and 6% seem doable for the highly risk averse investors, and consequently means that they would need a relatively small portfolio.

Terminal value of a $1,000 dollar portfolio: 1926 to 1995

It is interesting to know how much your portfolio could be worth after a range of withdrawal time frames. An illustration is shown here. Generally, the portfolio will be worth a lot more on average, and the longer the period the larger the value. A striking example for the 75% Stocks/25% Bonds portfolio over 25 Years. A sixfold increase while withdrawing 4%!

Investor Progress

In my own personal situation, as of today i have achieved 62.37% FI in about 8 years with an average savings rate of 53.38%, while targeting a proportion of larger than 80% in stocks within my portfolio. It has been a bumpy ride, with markets ups and downs, but with stocks near all time highs things are looking positive.

My current Withdrawal Rate is 6.46% which is well short of the 4% I would be comfortable with. However, looking at the 6%/7% columns above makes me feel in a very good spot right now. Of course, lifestyle inflation can drastically alter these figures for the worse overnight, while Geographic Arbitrage can improve things.

A reflection of the progress and historical data shows that it is imperative to invest aggressively early on and stay the course until a safe level is reached. The aim is to buy stocks as often as possible, particularly when prices are low, while avoiding market timing.

 

How Patience and Consistency Can Make You Rich

Man and Clock

Eight and a half years! That is how long I have been on the journey to Financial Independence. The first couple of years were not very effective as I did not have the knowledge and targets to aim for to make the most of it. It can be frustrating at times but I have come to realise that patience and consistency are key to achieving substantial wealth.

At the start point in mid 2012, I effectively had negative net worth as I had blown all my life savings on a BMW. From a distance you would think that the car was an “asset” since it supposedly represents status, wealth and getting ahead in life. However, it turned out to be merely a mode of transport and a liability; worthless since its value depreciated heavily overtime, not to mention countless trips to the garage before eventually getting written off. As a replacement I got back to my senses and acquired a less costly Japanese make vehicle which seems to be the right decision.

55% rule

Fast forward to today, I am nearly 60% financially independent, with a net worth into six figures and growing, no liabilities and trying to avoid ruinous financial decisions as much as possible. Buying the BMW would barely make a dent now but it would still be unwise. It is amazing how a single decision can have a huge impact for years to come.

Central to the strategy is applying the 55% Rule. This is a personal rule where I aim to save an average of 55% of my net income every month. Preferably this amount is invested in low-cost index funds.

Once you aim for the 55% you can manage your life around this, considering optimising things like housing, transportation and food. I use 55% as I estimated that this is what is needed to achieve a base level of Financial Independence in a reasonable period of around 10 years. 

Patience and Consistency

Once you are comfortable with the 55% rule two virtues are required – patience and consistency.

Without patience you will not be disciplined enough to go through with plans and may end up being a victim of lifestyle inflation. Wealth building takes a hockey stick shape over the long term. After a long period of quiescence a sudden sharp increase in wealth is to be expected. This is also often observed in business where success occurs just as those involved are considering quitting. Never underestimate the impact of Compound Interest.

A good tip is to avoid checking your investment portfolio or progress too frequently. A watched pot never boils. A quarterly or annual check in should be enough.

Once you get that out of the way aim for saving and investing a decent amount on a regular basis. With consistency you can more easily make up for any lost opportunities and rectify problems automatically. As an example, working out several times a week while targeting different areas of the body is more likely to achieve results than doing it on and off every few months.

Systems vs goals

Having a good system in place is better than just having goals. James Clear explains this very comprehensively here. If you are goal oriented, once a milestone is achieved you may suddenly stop all the good work you have been doing rather than achieving greater things, especially considering that you would already have place yourself on a platform to achieve greater things.

A goal oriented individual will only be happy momentarily when goal is achieved. But what happens next? Is it not more satisfying to witness your systems and processes working as they should, leading you towards multiple levels of achievement, improvement, refinement and continual progression. Furthermore, systems can yield various good results, rather than the one that you initially envisioned.

Don’t fear the future

On a final note; you should not fear the future or pretend that it does not exist.

Time does not stop moving so you should never stop planning and putting the correct measures in place. I did the opposite when I first started working in the corporate world by completely ignoring my workplace pension during most of my twenties.

I thought that retirement was so very far away so decided to live for the moment. Now I regret this after estimating how much more the pension pot would be worth had I just signed up then. Fortunately now I look forward to making more than average pension contributions while taking advantage of top ups by the employer and government.

So rather than burying your head in the sand, it is useful to always plan for the long term, typically 5 to 10 years ahead since this time will come along anyway. Often sooner than you think!

Useful Resources

     

 

Key metrics to track for Personal Investors

It is important to track certain key metrics when working towards Financial Independence. Different types of metrics can be tracked including investment performance, personal goals and even macro-economic ones. Having an eye on key metrics is particularly useful in times such as today with ongoing events of civil unrest over social injustice, Coronavirus, trade wars and an uncertain economic outlook.

In this post I will outline the key metrics I have been tracking over the years. Without these, investing would feel like driving blind.

Stocks proportion rule

Historically stocks have been the best performing asset class for investors with a typical portfolio which also includes cash and bonds. It makes sense to maintain a minimum proportion of stocks in order to capture returns of the market in line with your personal risk level.

I prefer to set this level to 80%; this ensures that as long as I have this amount of stocks I do not have to worry about what is in the remaining 20%.

Stock proportion rule

Stock proportion rule

Other assets/ liabilities such as cars or real estate can also be included in this comparison.

Asset Liquidity Breakdown

Financial liquidity is the ease with which an asset, or security, can be converted into ready cash without affecting its market price. Knowing how much of your portfolio is liquid is critical; a lot of people claim to be wealthy because the house they live in appears to be worth a lot.

However, the house is highly illiquid, requires maintenance, has many fees and taxes attached, has a price of ultimately what the other party is willing to pay, and is just somewhere to live. If the person has very few or no other assets, or has negative equity they are a long way from financial independence.

Liquidity Breakdown

Liquidity Breakdown

Property such as real estate, business assets and pensions which are to be accessed after many years are regarded as illiquid. Liquid assets can be stocks, shares and bonds in an investment portfolio held in an ISA (Individual Savings Account) and cash. Usually, such assets can be converted within a matter of days for use towards Financial Independence purposes.

You can also further breakdown the liquid portion to specific asset classes. This way, you can identify if the liquid assets are geared appropriately for desired long term returns by determining if the portfolio is too aggressive or conservative.

Liquid - asset classes

Liquid – asset classes

Financial Independence Goals

Tracking the overall goal towards Financial Independence is another important metric. The chart below shows how I do this.

Financial Independence - Goal tracker

Financial Independence – Goal tracker

The black line is the ultimate portfolio size to enable Financial Independence at 25 times  annual expenses. The red line shows historic progress. Current portfolio size is shown by the dotted line – once this crosses the black line the goal is achieved.

Achieving 75% (green line) of the goal is also a big milestone as one can easily find other ways to make additional income required or they can become more comfortable to transition to a different type of working such as self-employment.

The dashed grey line shows the current portfolio size plus property. If this crosses the grey line it shows that if the property is converted to the portfolio the goal can be achieved early.

Data and update frequency

To visualise these key metrics and others I regularly enter relevant data into a Google Sheets spreadsheet and have created charts which are updated automatically. This does not have to be an onerous process and only needs a few minutes of updating every month.

So far it has been incredibly helpful in keeping an eye on progress and providing much needed motivation. Definitely something for every series investor to consider.

 

Investing wisely during lockdown

Coronavirus investing

Lockdown will be a new experience for most if not all investors. Based in the UK, I have pretty much been housebound for over a week, apart from the occasional trip to the shop or for a walk. Fortunately, I am able to work from home so my productivity has not been impacted much. As the Coronavirus continues to wreak havoc across the World with increased intensity, here are my top tips for the Intelligent Investor.

Polish up you CV and Skills

It is no secret that, across the board, all types of companies, big and small, have been affected by the Coronavirus and are looking into different ways of mitigation. This may impact employees through reduced hours or pay, forced leave or redundancies.

In such times it is very wise for the employee to be prepared for the worst by getting their CV up to date, improving or learning new skills and have a Plan B. It may not be easy though as hiring may be scaled back or stopped in certain sectors.

Have a Low Information Diet

The worst thing about being stuck at home is that you will probably end up watching/ reading a lot of the news which ends up making you even more depressed. For investors, too much bad financial news may cause one to act irrationally.

Personally, I know a few people who were happy when the bull market was raging recently but are now either rushing to sell or hoping to stop investing when previous valuations are restored. Selling now will crystallize your losses forever. Instead, it is best to not check your portfolio frequently, stay the course and hold firm.

When I did my regular quarterly update my portfolio is down 18.33% so the net worth chart below looks bumpy. It may look like an entire year’s progress has been wiped out but it is a a good time to buy. My progress to Financial Independence has been scaled back but I will keep investing.

Net worth chart snapshot (to Q1 2020)

Net worth chart snapshot (to Q1 2020)

Keep buying stocks consistently

It is undeniable that Coronavirus is unlike anything investors have ever experienced. Even Warren Buffett said he had never seen such an event in his lifetime. The virus has touched every aspect of life from the housing market to visiting family. Unbelievable; even last month who would have ever thought that you would be never be able to move house or go to the local park.

The one thing to do now is to be consistent at buying stocks, preferably low cost index funds. This may be an opportunity of a lifetime for investors with a long term view, particularly if stock prices remain low for a prolonged period. When things recover, those who have been piling into the markets will reap the rewards.

Look out for the silver lining

It is also important to have a positive outlook. Not all bad things have to end up that way. If we get through this situation then there may be other opportunities to be had. You just have to be in the right place at the right time so it is worth thinking about any potential benefits in future.

A number of great businesses were born during scary recessions of the past including General Electric, Microsoft, IBM, Disney and FedEx. Necessity is the Mother of Invention.

You may be finally finding out in shock that your job or business can go at any moment. It is best to have some resilience. A level of Financial Independence can also help mitigate any financial hits.

Relevant posts:

Investing lessons from Warren Buffett’s letter to Berkshire Shareholders 2019 amid Coronavirus market panic 

Why I am Optimistic about future investment returns 

How to react to a Bear Market and invest wisely

Why volatility is an investor’s best friend and top insights from Warren Buffett’s 2017 letter 

Standoff and stocks selloff – Should Investors be worried