This is one of the biggest questions that we are asked as a company and is one of the most important for every client we look after. Whether you are currently retired and want to know what to draw from your capital now or whether you are still working and want to know what to aim for at retirement, it comes down to the same thing, what is a safe rate of withdrawal from my capital.
For years advisers have been using a broad rule of thumb that 4% per annum was a sustainable rate of withdrawal (20 years ago, when I started out, it was often 5% but that had more to do with tax deferred bond withdrawals rates). This rate was set as a fixed amount at retirement and rarely reviewed. The outcome was too much capital when you died for those that lived through good investment periods and not enough for those that lived through bad.
More recently advisers have been using cashflow tools to forecast the future of clients’ capital and therefore start to answer the questions of when to retirement, how much you save and how much to draw in retirement. Most of these tools though, use an single assumption about flatline future growth rates (for example 4% per annum) and so suffer from the issue that the only ‘knowable’ thing about the cashflow is that it is wrong as soon as it is produced.
And then there is Abraham Okusanya the Übermensch of advice and funniest man in financial services (a narrow field admittedly). With his company Timeline, Abraham has produced some cashflow software which shows clients’ future financial needs but as they relate to the investment conditions of the last 100 years in a beautifully simple and graphically rich way.
Timeline recently blogged the origin story of the 4% rule and then went on to test its efficiacy using the same historic investment data to see how likely it is to still hold true. The results are fascinating and anyone saving for retirement or in retirement (so everyone) should take a look at the results because they give a really clear indication of how sustainable retirement will be for anyone not relying on fixed pension incomes.
The most surprising result is that the original research didn’t take into account investment fees. Timeline have done this with their research and assumed a 1% per annum total cost of investing. This is perhaps where the assumptions come a little adrift from reality. Whilst it is true that some of our clients are paying less than 1% per annum they are in a tiny minority of all the clients we meet. In the worst case scenarios we have found clients with in-house DFM solutions can be paying 3% per annum and this would make a huge difference to Timeline’s projections.
Fortunately there has been a move towards greater cost transparency from the start of this calendar year and for the first time some clients are seeing their true cost of investing. All the attention from advisers so far has been towards how to generate stable returns to keep clients spending capital safely in retirement but hopefully this might start to shift towards a focus on how the whole investment profession can spend less of the clients’ capital on themselves.