Safe Withdrawal Rate (SWR) Thoughts

Many of us in the Early Financial Independence, Early Retirement, community are chasing an amount of wealth which when achieved will allow us to as a minimum call ourselves financially independent and as a maximum allow us to head into full early retirement.  To calculate that target wealth number it’s likely (I know I have) we've ascertained how much we intend to spend per annum and then divided that number by a Safe Withdrawal Rate (SWR) we’re happy with.

The 4% Rule is a SWR that is bandied about freely as a rule of thumb.  Personally it’s too bullish for me and so as I type this I'm planning on an SWR of 2.5% plus 0.25% to allow for investment expenses for a total withdrawal rate of 2.75%.

When we choose a SWR we’re likely trying to calculate the maximum real inflation adjusted annual income we can take while ensuring we don’t run out of wealth before we run out of life.  In doing so what we are really doing is trying to protect ourselves from worst case sequence of returns risk.  In trying to protect ourselves from this sequence of returns risk (and assuming history repeats which we all know is not guaranteed) we actually end up with a scenario where in the vast majority of cases we end up with a lot more wealth than we started with at check out time.

Let me demonstrate with an example.  To do this I'm going to teleport myself to the US and use the excellent cFIREsim calculator as we’re pretty starved of decent free tools here in the UK.  I'm going to assume I retire with one million dollars ($1 Million), give myself a 60% US Equities : 40% US Bonds asset allocation, spend at an inflation adjusted $25,000 per annum (a 2.5% SWR), assume annual expenses of 0.25% and assume I need that level of spending for 40 years.  The output of that simulation is shown below:

Click to enlarge, cFIREsim output

How about those falling iron ore prices – Adding Rio Tinto to my High Dividend Yield Portfolio

While those around me at work are talking about the holidays, fashion and gadgets they have bought with their bonuses I've kept fairly quiet as I have chosen to save 100% (after HMRC has of course taken 40% Higher Rate Tax and 2% National Insurance) of mine.  So having saved all of it where have I invested it wisely?  I've gone for 4 main areas and I’ll cover 3 of them today, saving the fourth for a separate post.

The first deployment was sending 35% of the bonus to my better half to keep both of our financial independence end dates synchronised.

With only 18 months or so to go until Financial Independence I also want to make sure that I have positioned my financial life to also give myself the option of Early Retirement.  From where I am today this means I need to do two things:

• I am currently renting in London but want to give myself the option of buying a home in whichever country my family chooses.  I therefore need cash for this and lots of it.  My second deployment was therefore sending 33% of the bonus to my savings account and RateSetter P2P account (plus a little to my Stocks and Shares ISA which is yet to be invested so is currently cash but ensures I've at least used all of my 2014/15 £15,000 Allowance).
• I don’t like the idea of having to sell down assets to eat in Early Retirement and would much prefer to be simply spending dividends/interest with a little left over to invest.  After I net off the cash I've saved for a home my investments are currently yielding 2.1% and I’m planning on drawing down at 2.5% after investment expenses.  I therefore need to find ways to improve my dividend yield and fast.  My High Yield Portfolio (HYP) is one way I have been trying to do this.  My third deployment was therefore 15% of the bonus into Rio Tinto (Ticker: RIO).  So why Rio Tinto?

The price of the FTSE100 is today near record nominal highs (the real high is something different altogether but that’s for another day). In comparison the price of Rio Tinto is almost half of previous highs:

Click to enlarge, Price History of Rio Tinto (Source: Yahoo Finance)

To FIRE Fast we must know what we really Value

I think we've had enough about what I eat for breakfast and what I want to be when I grow up for now.  Let’s get back to what this blog is all about – an unrelenting focus on Saving Hard and Investing Wisely to enable Early Retirement in my case.  Your end game could of course be different.

I work hard for the money that I earn.  Given how much effort I've put into acquiring it the least I can then do is now put a bit of effort into retaining as much of it as possible.  Why?  Well, now that I have some money in my pocket I'm up against millions of people and corporations trying to extract as much of that money from me as possible.  It’s nothing personal but just the way it is.  Importantly, it’s also not just the big purchases.  I’ve found that sweating the small stuff is possibly more important because leakages here often have very little impact on your health and wellbeing.

So why at this stage do I want the minimum extracted from me while still living the life I want to live?  For me it’s not emotional and is simply by learning how to spend less I can save more which is then an enabler to help me FIRE faster (Financial Independence Retire Early).  Seven and a half years into my journey I'm at the point where this is probably the most important lesson I have learnt thus far.  Sure earning more helps but that just helps accelerate you to the goal posts and minimising investment expenses/taxes also helps but I’ve found savings have had a bigger impact on my wealth creation so far as the short time I have given myself to accrue the assets to FIRE don’t get much time to compound.  Spend less and two things occur which is why it is a critical element – it both moves you more quickly towards the goal posts but also moves the goal posts towards you.

Am I Making a Mistake?

Security of employment is not what it was once.  Changes including globalisation, technology, automation and lean (lean is basically doing more with less through the elimination of waste), amongst others, have sent it well on its way.  We see lack of security of employment manifest itself in many ways with one of the more recent ones making headlines in the mainstream media being zero hours contracts.

The problem with this change is that without security of employment there is always the risk of starving to death (maybe an extreme example given the UK’s welfare state status, but certainly not in some countries and hopefully you get my drift).  According to Maslow’s Hierarchy of Needs inability to correct for this deficiency need (or d-need) then prevents one from ever reaching Self-Actualisation which is essentially the realisation of your full potential.

Click to enlarge, Source: www.convene.com

Personally, in my current career I’m also under no illusion of having any sort of security of employment.  I know that my current security is linked to nothing more than my last performance review or (not and) nobody anywhere else in the world being able to offer the equivalent service for a lower cost.  Part of this is within my control, but mistakes do happen, and part of this is outside my control.

With time I’ve come to realise that my solution to this problem in the short term has been to keep my skills current (the 1% inspiration) and then work hard (the 99% inspiration).  So far this is working with a recent notification that I’ll be receiving a salary increase of 4% and a bonus that exceeds my notional amount in recognition of my performance last year.  I never thought too much of this work hard approach, including was it too extreme, but when readers last week made comments like;

“I appreciate this is the path you've chosen, and for well thought out reasons, but your hours of work sound awful“;

and;

“Holy s**t - good job you have an escape plan as that is a brutal life you currently have carved out for yourself - 16 hour days!  You must be tough as nails!”;

it really did make me take a step back and think.

My Non-Financial Life

This blog is focused on charting my progress to Financial Independence and optional Early Retirement.  By having to continually to write about it I am forced to stay the course because I’m continually held accountable.  You the reader get to see my journey, warts and all, which also includes most of the financial research I do behind the scenes.  It stays very unemotional and fact based as that’s what personal finance in my opinion should be.

Behind all this though is a living breathing human being and also my family who are personally affected daily by what I publish here.  I rarely write about this side for a few reasons:

• At this time my anonymity is important.  I don’t think this will always be the case but right now it’s probably not a good idea if my boss knows I might retire in 18 months at 43 years of age;
• This is a personal finance site and not mumsnet;
• Even though I'm a STEM graduate it’s the financial side including all the planning that I've found the most difficult.  Executing on it including finding ways to Earn More, Spend Less by Living Well Below Your Means, Spend Less by effectively opting out of consumerism or even Spend Less by sweating the small stuff I haven’t found difficult at all; and
• Finally but importantly while achieving Financial Independence by 43 is pretty exciting stuff knowing that I eat Weetabix (I don’t BTW because I wouldn't buy a more costly brand when equivalent lower cost alternatives are available) for breakfast probably isn't.

All of that said it is of course relevant for anyone considering, but not currently on, a similar journey to my own.  Some 7 and a bit years on it’s now just the life my family and I live but thinking back our personal lives have changed a lot.  This was reinforced this weekwith a reader making the following comment:

“Have you previously posted on what you get up to in your daily life? I have a lot of respect for what you're achieving and would enjoy hearing how you enjoy daily living while being frugal. When last did you go on holiday? What do you do for entertainment? Etc. Does that make sense? Just trying to get a feel for the types of adjustments I'd have to make.”

So without further ado let me give some insights into how I live my personal life.