The 4% retirement rule - does it apply to the UK too?

[blizeH]

Hi all,

I've been interested in early retirement for quite some time now, starting off by getting advice from sites like Moneysavingexpert before moving onto r/personalfinance, r/frugal, early retirement extreme and of course MMM.

I think I'm quite lucky in that I'm naturally quite good with living a relatively frugal lifestyle, however there is still room for improvement, and recently, after reading an article on this very site in fact, I finally made the decision to sell my car (which I loved!) and start cycling into work - I genuinely feel a lot better for it; the environmental, health, and cash benefits are all very nice!

This has made a very big difference to our monthly outgoings (as well as putting a nice amount into our investments as a one off boost) and as a result due to our very low living costs, we're around half way to getting to the 4% rule at the age of 28, and 23 respectively.

My only concern is just how viable is the 4% rule in the UK? I know there are things that cost a lot more here, but I guess to balance that out we don't have to pay for healthcare costs so it does seem like a fair guide.

My only worry is that it's almost impossible to predict what will happen in the future, but I cannot see any big purchases being necessary - the only thing that may be required is a bigger house at some point, we have a house that would be great for raising a family, but my girlfriend has recently quit her job to start her own business and she needs at least one, maybe even two rooms dedicated to that. But I guess if the business goes well enough that we need to upscale, then her profits should be able to help cover that :)

Would be very grateful for any suggestions or advice - are we really half way on our journey to financial independence?

[boogiewoogie]

Hey blizeh,

You're ahead of the curve if you've already started at such a young age, but I believe the 4% rule should work in the UK. I've finished reading Smarter Investing by Tim Hall which is a UK book which had a bit towards the end about the 4% rule. 3% might be better if you can achieve that. By the way, another good website for UK investment/savings is monevator.com

I guess the point of FI is to be able to be able to make big decisions like starting a business without having to worry about failure. Also, if you need to buy a larger property, your high levels of savings would make it a lot easier to do,  although you should always do the maths to see what the impact will be on your investments. 
However, I try not to think too much about where we are in our journey to FI and just concentrate on enjoying the frugal stress free life.

Cheers
BW

[blizeH]

Thank you very much for the reply, Smarter Investing is a book I've heard so many good things about that I feel I owe it to myself to check it out :) My problem with finance books is that I buy them with good intentions and rarely read them thoroughly, but maybe I should make an exception with this. I love monevator though and read it regularly! 3% may be a slightly more realistic target for me, plus then it offers up some sort of safety net rather than the slightly more optimistic 4%.

And yeah, good point about FI - in many ways that's exactly what my girlfriend is doing now, but she has far more talent, motivation and drive than me so I figure she's better off doing that (I genuinely believe her business will be a big success) and hopefully in 10 or so years time I can join her (I'm a software developer, but would love to make my own games)

Good points about a frugal life being stress free though, it's weird but I feel so much happier after selling my car - it's almost liberating in a strange kind of way.

[lizfish]

Hi Blizeh,

Hello to another fellow Brit. There are so few of us I feel like I need to say hi to each one individually! I'd have thought the 4% still stands because the related x25 rule is based on your costs, whatever they are. So you live on £20k a year? You save £500k and withdraw 4% of that. Less costs, less stash. The beauty is in the simplicity. I assume you've seen this post, but if not here it is again:

http://www.mrmoneymustache.com/2012/01/13/the-shockingly-simple-math-behind-early-retirement/

That's not to say it's easy but as boogiewoogie says, you've made a fabulous start at quite a young age. (jealous? moi?) Also the rule does not take into account any state pension you might receive in later life nor the fact you might choose to do *some* paid work during retirement/FI. Both of these are considered by MMM excellent safety margins along with the fact that most of us don't cut our expenses right to the bone therefore allowing us to cut expenses further and withdraw less if we need to.

I also love moneysavingexpert. I tend not to use a some of the advice because I just don't buy that much but I love the way he explains things to people in plain english. Understanding financial stuff is so key to taking control of your finances. Plus I never fail to compare insurance/breakdown/energy every year.

I'm curious, given that we in the UK can't touch our pensions until 55 (or couldn't at least until the budget announcement), do you have any pensions savings and do you count them in your stash?

[nosyparker]

helloo fellow brits!
the pension age of 55 interests me too, what are your plans for that?
i am self-employed so pretty flexible anyway and my partner enjoys his job so we're not necessarily looking to retire before 55. my thoughts at the moment are to get pensions to a good level (utilise matching from his work) plus pay off mortgage asap now while we're young (mid 20s) and then once they're looking healthy, save money elsewhere (i.e. isa) for any bridging years there may be between finishing full-time employment and being able to access pension.

[warfreak2]

My only concern is just how viable is the 4% rule in the UK? I know there are things that cost a lot more here, but I guess to balance that out we don't have to pay for healthcare costs so it does seem like a fair guide.

The 4% rule refers to how much it's safe to annually withdraw from your investments, as a proportion of your initial investment, adjusted for inflation. If expenses are higher in the UK, then your investments must be proportionally higher so that 4% of them = your annual expenses, but it's still 4%.

That 4% is determined by what you invest in - it was established by an academic study ("the Trinity study") which found that a portfolio of 75% stocks, 25% bonds had a 100% success rate over all 30-year periods between 1926 and 1997. This is investing in index funds:

The stock returns in the analysis are total monthly returns to the Standard & Poor's 500 Index. Corporate bond returns are total monthly returns calculated from the Salomon Brothers Long-Term High-Grade Corporate Bond Index and Standard & Poor's monthly high-grade corporate composite yield date.

I.e., if you start with £1MM, you can withdraw £40,000 the first year and then an inflation-adjusted £40,000 every subsequent year, and very likely have a successful retirement. It doesn't make a difference whether you spend that £40,000 on healthcare or the TV license.

[blizeH]

Hi! :)

Thanks for the info, our outgoings are actually close to half that but I would like to allow a little extra (maybe £2k p/a) for holidays and eating out. Thanks for linking the MMM article, I actually read it last night which is what inspired me to write this post :)

I am not allowing for state or my work pension in my calculations, I guess I should, but since I can't touch them for another 30+ years I figured I'd just work with what I have for now, though maybe I'm being overly conservative. And yeah, MSE is a fantastic site :) It's very clearly laid out like you said, and has no doubt saved me a fortune over the past 10 or so years.

[Squirrel away]

WOW! I just wanted to say you are doing very well for your age.:)

[wesley]

Hello UK people,

I am currently living and working in the UK, the 4% rule will definitely work provided your underlying investments are sound, but at such a young age a slow transition to part time work might be worth your while (keeps that 'stach growing for a buffer).

Also to the posts that have discussed the pension after age 55, IMO this will change, it will head towards 57 within a decade and creep from there, that being said there may be scope to withdraw earlier but face penalties for early access...

This change will need to happen to balance the pension, there is definitley an overhaul in the works for the whole pension industry (having recently allowed more freedom in terms of what you can do with your pension, there will be further changes in the coming years)

Just something to consider

[blizeH]

@nosy - hello! Sounds like a really good plan, I think even if you enjoy your job it's worth planning for early retirement just because it gives you such a nice cushion. I've recently changed jobs (not by choice) and whilst it's okay I was much happier in my old role. That's a part of what has pushed me to really want to start cutting my expenses like with the car. Good luck!

@war - thank you for the explanation, sounds like if we stick to the 4% rule we should be fine, but I will be liberal when I do my annual costings just to ensure I haven't miscalculated anything. I've spent a lot of time researching stocks etc and have been very lucky so far (investing in Tesla, SolarCity, Google, Disney etc) but I think for me personally in the future just using Vanguard exclusively is going to be my best option.

@Londoner38 - Thanks! :) It's partly down to starting at a very young age and also living with my parents until I was 24, which helped me get together the funds needed for a house etc, so I owe a lot to them too.

@wesley - Thank you! I was actually considering starting a new thread about the possibility of going to part time work too. I'm in a weird position where despite not really loving my job, it is super convenient (10 minute bike ride away) and has a lot of perks - I'm just worried that if I go part time, I will end up having to find a job with a long commute, doing something I really hate. I don't like going outside of my comfort zone much :) I agree with you about the pension age too, and I think as you said it will continue to creep up. More incentive to keep cutting costs, and keep saving!

[Ayanka]

Please note that as someone mentioned earlier the Trinity study did count it for only 30 years. If you retirement will last longer than that, you can't use the 4%swr and just think you are good. If you don't count in the reinforcements and they will get you through the rest than no problem, but keep it in mind. I would research the 4% rule and look up Jacob (ERE) before you start counting on it.

[FIREman2036]

One other thing to note with the UK is that i believe you need to pay NI for 20 years before you qualify for state pension. If you are so young and close to ER you should check out how you can make sure you still qualify when you hit 67 (probably nearer 80 by then). You may be able to make extra payments which would be worth it in the long run for that guaranteed income. 

Its something i have been thinking about as a Brit living abroad and thus not currently paying NI. 

[pom]

There have been some studies outside of the USA on the 4% rule. Look at table 3.2 on this web page:

http://wpfau.blogspot.fr/2012/05/may-i-add-part-vi-to-retirement.html

If you look a the link for his article, you will have further table that says that for the UK, the SWR is 3.77% with an allocation of about 85% stock, 15% bonds.

Canada has the highest SWR: 4.42%
Lowest is Japan: 0.47%

[blizeH]

Thank you all for the replies, this will hopefully be for a longer retirement than just 30 years so I may need to re-do the calculations then! Good point about NI too... I'm currently over half way there (been paying it for 12 years I think) and realistically I won't be retired before I hit 20 years of NI contributions, but it's definitely worth considering anyway, thanks :)

[warfreak2]

You are allowed to make voluntary NI contributions - if you do retire before you've paid in for 20 years, you can just keep paying in for a few more years anyway, and it's likely profitable to do so.

[blizeH]

Thank you, if that did happen I would definitely pay the contributions I think, especially since if I do retire before then, it will likely be very close to 20 years anyway :)

[skyrefuge]

Wow, I'm disappointed that it took 12 posts before pom finally posted the correct answer:

No, the 4% SWR does not apply to the UK!

The 4% "rule" was generated by studying the historical returns of the United States stock and bond markets, and combining them with the US inflation rate over the same periods.

If the stock/bond markets and inflation rates of other countries are used, the SWR range varies quite a bit (and it's important to note that the US number is at the very top of that range). The UK number is in the ballpark of the US number, but it's still definitely lower.

Now, an SWR number is a purely historical thing, and going forward, it's entirely possible that US investments allow a withdrawal rate lower than 4%, and UK investments will allow a withdrawal rate above 4%. It's also now easier to invest in markets that are not tied to your own country. But it's difficult to avoid the inflation rate of the country in which you're living.

In general, I would say that something close to the 4% rule will end up being valid for the UK, but I think it's critically important for people to understand where the 4% "rule" comes from, and why it is not directly applicable to different countries.

Again, Japan's SWR is 0.26%!

[the fixer]

More on this specifically targeted at UK investors: http://monevator.com/world-stock-markets-data/

[warfreak2]

Again, Japan's SWR is 0.26%!

This sounds suspicious to me. Japan's inflation rate has been famously low for quite a while; that should mean it's safer to withdraw more, because much less is "lost" to inflation. I guess they're assuming that you'd invest in very slowly-growing Japanese stocks (rather than the S&P 500). Either that or the exchange rate risk is much higher than I would have thought.

[skyrefuge]

Again, Japan's SWR is 0.26%!

This sounds suspicious to me. Japan's inflation rate has been famously low for quite a while; that should mean it's safer to withdraw more, because much less is "lost" to inflation. I guess they're assuming that you'd invest in very slowly-growing Japanese stocks (rather than the S&P 500). Either that or the exchange rate risk is much higher than I would have thought.

Remember, SWR is a backward-looking thing, not a forward-looking projection.

In these studies, the Safe Withdrawal Rate is the rate that would have worked even in the worst possible year to retire over the historical period studied. It's not an average, or an estimate, it's a reflection of the worst that actually happened. In Japan, that "worst year to retire" was 1937, and if you withdrew more than 0.26% of your portfolio per year, you would have run out of money in less than 30 years. If you retired in any other year besides that "worst year", you would have safely been able to withdraw more than that headline SWR number.

Apparently getting a couple of nuclear bombs dropped on your country ain't so good for stock/bond returns.

The predictive element of SWR research comes from the idea that "if X% was the worst result over the past 100 years, I shouldn't expect anything worse than that going forward." If you don't expect Japan to get involved in any World Wars going forward, then you could maybe rightfully expect a higher SWR.

[matchewed]

We do have to caveat some of the research. First of all the asset allocations are assuming a rigidity that wouldn't be recommended for an actual 30 year time frame.

I also believe that the asset allocation is also specific to that country. That is there is an assumption that someone in Japan is solely investing in Japanese stocks and bonds based off of Dimson, Marsh, and Staunton (DMS) dataset. I'm not exactly sure how this data set is broken down or the assumptions behind it.

That isn't to say that anybody is wrong here but to say that the 4% rule fails in the UK because a paper said so is off base a bit given the assumptions the paper has.

[train_writer]

As a fellow European, I think there are big differences in approaching retirement.
Options of working part time, amount of paid days off, cutting costs on transport etc are easier in most of Europe than in the US.  For example: I have a job which does not allow to make big steps in salary, but receive 10 flexible weeks per year of paid vacation! And I am allowed to take an additional max. of 3 months per 2 years sabbatical, unpaid but with a few other benefits.

About the 4 %, I would, but that is a personal risk, include an 'end date' on your stash, like age 80, by which date you have consumed 90% of your initial stash. (so not only using the returns)

Example:
- A 25k annual withdrawal would mean needing a 500 k stash BUT
- let us say you want to retire age 50. than you are safe with a 370 k stash, assuming you could break into an additional pension if necessary at age 60 and will receive social pension at age 70 (let's assume the age will go up quite a bit..).

Anyways, it seems you don't need all this considerations as you are well on your way to ER!

[wesley]

Again, Japan's SWR is 0.26%!

have to point this out:

Thats based on the cash rate and cash/safe bond returns.
IF you or anyone on these forums lived in Japan they would be investing in overseas index funds and withdrawing dividends only, or 4% per year...

So I don't this is relevent, also to anyone who suggests that the SWR in the UK is lower than the US, this is easily overcome by investing in a US index fund. This is very simplistic I know but I doubt anyones stach and subsequent withdrawl rate is solely relying on one income stream.

[beltim]

Again, Japan's SWR is 0.26%!

have to point this out:

Thats based on the cash rate and cash/safe bond returns.
IF you or anyone on these forums lived in Japan they would be investing in overseas index funds and withdrawing dividends only, or 4% per year...

So I don't this is relevent, also to anyone who suggests that the SWR in the UK is lower than the US, this is easily overcome by investing in a US index fund. This is very simplistic I know but I doubt anyones stach and subsequent withdrawl rate is solely relying on one income stream.

Actually, that rate is based on a 50/50 mix of stocks and bonds. It is interesting to note that a 4% withdrawal rate failed in Japan in just 38% of historical scenarios. 

And it's dangerous to say "just invest overseas" without consideration of exchange rates, differential rates of inflation or taxes, and other country to country differences. 

[warfreak2]

So I don't this is relevent, also to anyone who suggests that the SWR in the UK is lower than the US, this is easily overcome by investing in a US index fund.

The 4% rule is after inflation, and at least inflation is different between the USA and the UK. Also, since US stocks/bonds are priced in dollars, you'd be almost totally exposed to exchange rate risk. It makes sense that you wouldn't get quite the same level of safety at a 4% withdrawal rate.

Also, the UK taxes dividends by 10% silently, so you would have to go back and calculate how much you're paying for this tax, and include it as part of your "withdrawal".

[wesley]

HI Beltim and Warfreak,

Before responding again, is anyone actually from Japan and needs to figure out there SWR?

Anyone?

You are both right, and I guess if you were in Japan you may weigh more heavily into Asia-Pacific and get into an Aust index which outperformed both the US and UK over the last century, anyway I'm sure a Japanese mustachian would have a range of investsments and if investing in overseas indexs would have a mix of hedged and unhedged.

From memory (and this is going back about 2 years) you could buy in outer Tokyo for between 100-300k USD and expect a yield of 6-8% but the holding costs were high and could chop this down to 4%, the apartment management/service charges will kill you over time - they seemed high compared to other countries