Category Archives: Financial Independence

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.

 

Berkshire Hathaway Shareholders Meeting 2020 – Top tips from Warren Buffett

The latest annual 2020 Berkshire Hathaway Shareholders meeting (AGM) held on 2 May in Omaha was as insightful as ever. Warren Buffett was on top form, dispensing timeless advice to investors, new and pros alike. Charlie Munger, Buffett’s partner was not present at this year’s meeting due to logistics difficulties brought by the ongoing Coronavirus epidemic. Instead, Buffett was flanked by Greg Abel, one of his deputies. Unlike previous years, the thousands of attendees were absent and the virtual meeting as streamed by Yahoo Finance. Here are key takeaways.

Market volatility

Dow Jones Industrial Average Chart

Dow Jones Industrial Average

Stock market prices can be very volatile for a whole range of reasons. This is something that investors should expect and huge price drops are to be expected once in a while. Buffett referred to the Dow Jones Industrial index’s long term performance. The price dropped by more than 50% in the 1930s, following the roaring twenties.

Full recovery only occurred after 1950, although dividends were collected in the meantime. Therefore, it is important for investors to have the psychological temperement in order to go through market drops and were possible buy more stocks at reduced prices.

Buffett gave the example of owning a farm. You would have purchased it at a value based on its projected investment return. However, A neighbour with a similar farm may offer to sell to you at a price which varies wildly from day to day. This is how the stock market behaves and does not mean that you should act on these prices.

Plant seeds now

Responding to a question about why Berkshire Hathaway invests huge capital in its energy businesses, Buffett and Abel outlined that these are long term, planned investments analogous to planting seeds. As investors, we can use this to plan for the future by making the right investments as soon as possible without focusing on an immediate return. Returns may not be epic, but will become substantial over a long time.

Index fund investing

To avoid disaster, investing in index funds offers wide diversification of industries within the economy. This is particularly important now in the time of the Coronavirus. Different sectors’ performance will vary as evidenced by a contrast in fortunes of Technology companies and the airline/ travel industry.

Berkshire has sold all of its holdings in four major airlines at a loss due to bleak prospects in the sector. Buffett alluded that the initial purchases were a mistake and that the world has now changed due t the virus. Such losses can be inflicted on individual investors too if the are into buying single stocks and day trading, rather than diversifying across the whole market.

Be prepared according to goals

Buffett revealed that Berkshire now holds over $130 Billion in cash/ equivelants. This seems like a huge figure but must be taken in the context that Berkshire’s overall market cap is nearly $400 Billion.

A large cash pile enables the company to protect investors and part of it may be used to make a large ‘Elephant’ size business acquisition when valuations permit. This opportunity has not appeared to Buffett during the recent chaos on the markets.

On a personal investor level, one can develop micro portfolios, which ensure that you are better placed to meet your goals if the market crashes. For example, if saving for a real estate property, one can have a dedicated fund with less than 40% stocks, and be 100% stocks if they have a longer term goal such as early retirement.

Appreciate key workers

Buffett and Abel also made known their appreciation of key workers in the current COVID-19 crisis. It is disheartening that people born in the right place at the right time or who can do things such as arbitrage bonds become more successful than those who do truly important work such as teachers, nurses delivery and transport workers. We really on such workers in times of crisis and rarely fully appreciate them in normal times.

It will be interesting how the next few months play out for investors. Diversification will be as important as ever as the World emerges to different ways of doing things.

The full 2020 Berkshire Hathaway Shareholders meeting can be streamed on Yahoo Finance here.