Is it the 3% rule in Australia?

[jaysee]

Between CGT, franking credits, currency risk, home bias, superannuation and any number of other factors, I'm trying to figure out what percentage of liquid investments would be reliable in terms of growth and draw-down rate, for those of us who primarily reside in Australia and have our funds domiciled in Australia.

Putting superannuation aside for a moment (as it's not really my money until I turn 65)...

Suppose my money was invested in some cheap index fund, e.g. Vanguard High Growth Index Fund.

Would it be safe to assume a 3% compounding growth rate, after all taxes, fees and inflation?

And would it be safe to also assume a 3% safe withdrawal rate, where the principle holds its value over 30+ years if I keep taking out 3% every year?

If I could arrive at a reasonably confident Australian version of the American "4% rule", this would certainly make planning and budgeting that much easier.

Any thoughts?

[deborah]

The studies which posit the 4% rule and have been extended to other countries, show a 3.8% "rule" for Australia because of some terrible years around 1965 (or thereabouts). The problem with all the studies is that we have a completely different financial system now than we did before the Hawke/Keating years. It's like basing a future orange harvest on preceding apple harvests.

[Gremlin]

FWIW, I'm quite comfortable running my numbers using 4%.  Having said that, I know I have plenty of room where I could trim my budget if necessary.  There's a trade-off at either end.  Running a lower number (say 3%) gives inherent safety in your financial projections, but comes at the cost of trading away some of the best remaining years of your life.  Time is a finite and, in my opinion, an incredibly undervalued resource.

[Ozlady]

I do not follow the 4% rule at all; mine is a 0% rule as i do  not intend to touch my nest egg to pass to the next generation.....

I will live off 100% from passive income that i throw off from my net rents, dividends , fixed deposit interest etc.

My rule is : do not kill the goose ...eat the eggs instead (or is that the hen??!!) -i am confused sometimes:)

[deborah]

I do not follow the 4% rule at all; mine is a 0% rule as i do  not intend to touch my nest egg to pass to the next generation.....

I will live off 100% from passive income that i throw off from my net rents, dividends , fixed deposit interest etc.

My rule is : do not kill the goose ...eat the eggs instead (or is that the hen??!!) -i am confused sometimes:)

The withdrawal rate doesn’t include the income generated by the stash. In a simple example, you have a stash of $1m. The 4% rule says that you withdraw $40,000 (plus inflation) a year from that stash. It is generating rents, dividends... which are expected to be more than 4%, so you usually don’t need to sell any of your investments. In good years, you have a lot left over from the income from the investments and you invest that as well. However, occasionally, you don’t have a renter, or the share market tanks, or your other investments have a bad year, and you will need to sell some of your investments.

The 4% rule says that there will be enough good years that the bad years don’t matter - you will still have enough to see you through, including inflation. There is no way you can have a 0% withdrawal rate if you are actually using your stash.

[HomewardBound]

This might be of interest:


Taken from an 8 part series pulled together by Ordinary Dollar https://ordinarydollar.com/safe-withdrawal-rates-for-aussies-part-8-summary-so-far/.

Personally, I've gone for a 2.5% + Investment Expenses = 2.75% WR and also have quite a bit of fat in that to trim back in the lean years if necessary.  Similar to Ozlady this means I'll actually be spending a bit less than nominal dividends as I FIRE.  I'll also go into FIRE with 3 years of 'fixed' spending in cash.  Hopefully that means in the lean years, when dividends fall, I'll not end up having to sell down any equities.

[itchyfeet]

I’m not quite FIRE’d but am will start with a withdrawal rate above 4% excluding my home. If you assume the home can be drawn on down the line then it’s below 4%.

We have plenty of flexibility to trim spending if need be, expect to spend less as we age (less travel and entertainment expenses) and expect to pick up some small amounts of income along the way.

I have tried to put my stash into buckets
1. Home - (could sell down to an apartment at 50% of cost later if need be)
2. Base stash - 4.25% drawdown
3. Travel stash - 5.5% drawdown (knowing that some years we will spend hardly anything)

[jaysee]

This might be of interest:


Taken from an 8 part series pulled together by Ordinary Dollar https://ordinarydollar.com/safe-withdrawal-rates-for-aussies-part-8-summary-so-far/.

Personally, I've gone for a 2.5% + Investment Expenses = 2.75% WR and also have quite a bit of fat in that to trim back in the lean years if necessary.  Similar to Ozlady this means I'll actually be spending a bit less than nominal dividends as I FIRE.  I'll also go into FIRE with 3 years of 'fixed' spending in cash.  Hopefully that means in the lean years, when dividends fall, I'll not end up having to sell down any equities.

Quite a detailed chart, thanks for sharing. Going by that chart, 2.75% seems way conservative, so if you can make do on that amount, you should be well more than set!

I think I'm going to go for 3.5% for now, until I find compelling evidence for being more/less conservative. Keeping in mind that I want to continue doing paid work of one kind or another right up till old age.

[daverobev]

The 4% rule is before expenses.

So the Americans have to pay for their healthcare from that 4%, for example. Tax on dividends, pension withdrawals, etc. You have to factor all that.

IIRC even MERs on ETFs are not included in the 4%? I forget.

[itchyfeet]

I believe the 4% SWR was determined after allowing 1% for management fees on the stock/bond portfolio.

This is part of the reason some argue the 4%
Is too conservative.

Firstly it was actually ~4.25% in the original study and secondly, today you can pay a lot less than 1% in fees.

[happy]

I use 4%, but I am 60. If I were younger I would use a lower number...if I retired in my thirties I’d want 3%.

[habanero]

This series is good:
https://earlyretirementnow.com/safe-withdrawal-rate-series/

One might agree or disagree with his conclusions but it's an impressive body or work and the author challenges quite a few of the common assumptions behind retiring early. Not only the 4% rule itself but also how much flexibility in expenses or income can help you etc (a lot less than people think) and a lot of other stuff. It's a long read, but worth the time to read through the series.

[jaysee]

This series is good:
https://earlyretirementnow.com/safe-withdrawal-rate-series/

Thanks habaneroNorway, that's exactly the kind of resource I was looking for. I'll check it out.

[jaysee]

After giving this a lot of thought and pondering... what strikes me is that any kind of investment comes with the downside risk of losing the entire investment.

I can't see any real exception to this rule. If you own stocks, the stock market might tank at the wrong time (for you). If you own bonds or cash, inflation might hit at the wrong time (for you). If you own land or a house, some natural disaster might happen or you might fall behind in your mortgage payments or tax payments, or get hit with massive renovation/repair costs.

Given that there's no such thing as a risk-free, downside-free investment, it seems like investing needs to be thought of as an opportunity rather than as a guarantee. I can't rely on investments, but I might as well invest because the up-side is so high.

What I'm now starting to consider is semi-retiring rather than fully retiring.

I'll find some work that's not too mentally taxing, keeps me up & about, active and social and pays well enough that I can save half my income or more. I'll get used to living very frugally and basically just work 6 months on, 6 months off.

Though cash isn't a good investment, I think holding enough cash for 6 months living expenses is a reasonable risk to take. It seems unlikely that there would be sharp inflation over a 6 month period. If there is, I guess I'll just keep working for the full year.

The investments will, meanwhile, go up or down depending on the state of the economy. But they'll always be there as a fall-back, in case I need to take longer than 6 months off or pay for medical expenses or deal with any other kind of emergency.

I guess this is kind of already what FIRE advocates. No one seems to be saying that you should do nothing after retiring. Rather, you should still do some kind of work - paid work if possible. Keep some kind of non-investment income rolling in. But keep your investments in growth assets and keep your living costs down, so that you can gain maximum benefit from your investments.

You're more free from money if your job choices are dictated by health, fun and purpose. Freedom from money doesn't mean being able to survive without working. It just means that you have an opportunity to do work that's fun and low-stress, because you don't have to support a massive income in order to support extravagant and unnecessary spending.

[Bloop Bloop]

I think if you aim to own a few moderately priced properties in good areas with good rental demand, and get house insurance and landlord's insurance, you are about as protected as you can be. There will always be families that can't afford to buy at a given time. They will be your passive income.

[mjr]

Whether it's stocks (diversified), real estate or cash, you're pretty unlikely to "lose the entire investment".   Just not going to happen.

Sure, they have the risk of going throug a big downturn, but that's a hell of a lot different to losing it all.  Other than inflation's affect on cash, they'll recover.

Just do the best you can with asset allocation to avoid having to liquidate during the downturn.

[alsoknownasDean]

Whether it's stocks (diversified), real estate or cash, you're pretty unlikely to "lose the entire investment".   Just not going to happen.

Sure, they have the risk of going throug a big downturn, but that's a hell of a lot different to losing it all.  Other than inflation's affect on cash, they'll recover.

Just do the best you can with asset allocation to avoid having to liquidate during the downturn.

This.

Of course leverage can complicate the situation and bring the real risk of losing 100% or more of the original investment. If someone buys a house in a mining town for $500,000 with a $400,000 interest-only mortgage, and the house is worth $200,000 in five years after the mine closes, then they're going to be in trouble.

If all three of the major stock indices, real estate and cash are worthless overnight, we'd have much bigger issues than the value of our investments. Individual companies can and do fail, but every company on the ASX200 or S&P500 failing overnight? That's probably a 'bunker, tinned food and ammunition' situation.

[Metalcat]

After giving this a lot of thought and pondering... what strikes me is that any kind of investment comes with the downside risk of losing the entire investment.

I can't see any real exception to this rule. If you own stocks, the stock market might tank at the wrong time (for you). If you own bonds or cash, inflation might hit at the wrong time (for you). If you own land or a house, some natural disaster might happen or you might fall behind in your mortgage payments or tax payments, or get hit with massive renovation/repair costs.

Given that there's no such thing as a risk-free, downside-free investment, it seems like investing needs to be thought of as an opportunity rather than as a guarantee. I can't rely on investments, but I might as well invest because the up-side is so high.

What I'm now starting to consider is semi-retiring rather than fully retiring.

I'll find some work that's not too mentally taxing, keeps me up & about, active and social and pays well enough that I can save half my income or more. I'll get used to living very frugally and basically just work 6 months on, 6 months off.

Though cash isn't a good investment, I think holding enough cash for 6 months living expenses is a reasonable risk to take. It seems unlikely that there would be sharp inflation over a 6 month period. If there is, I guess I'll just keep working for the full year.

The investments will, meanwhile, go up or down depending on the state of the economy. But they'll always be there as a fall-back, in case I need to take longer than 6 months off or pay for medical expenses or deal with any other kind of emergency.

I guess this is kind of already what FIRE advocates. No one seems to be saying that you should do nothing after retiring. Rather, you should still do some kind of work - paid work if possible. Keep some kind of non-investment income rolling in. But keep your investments in growth assets and keep your living costs down, so that you can gain maximum benefit from your investments.

You're more free from money if your job choices are dictated by health, fun and purpose. Freedom from money doesn't mean being able to survive without working. It just means that you have an opportunity to do work that's fun and low-stress, because you don't have to support a massive income in order to support extravagant and unnecessary spending.

Continuing to work isn't a fundamentally better approach, it's just another form of diversification of income streams.

If you want to be diversified in that way, then cool, do that. If you don't, then don't. Plenty of people don't work at all in retirement and it works out just fine for them.

By all means, if you want to diversify into employment income in retirement, then there's no reason not to, but don't do it based on an illogical fear of your investments dropping to $0.

That said, you can't know how much employment you can do or will want to do in retirement. So while employment income is a great source of security and flexibility in retirement, it's also a terrible factor to count on for security. So your plan should already be diversified and secure enough regardless. Employment income should just be gravy.

That means, you have to be able to have reasonable faith in whatever investment strategy you settle on.

[habanero]

You can view work as an inflation-linked bond paying X dollars per month, where X is the after-tax take-home pay from work and assuming wage growth is roughly equal to the inflation rate.

This bond, however, has some features a regular bond doesn't have:
- you can "buy" it for no money if you want (by starting working). You have to pay in time units as yo go, however.
- if you "sell" it (aka stop working) you don't receive any cash from the sale. But you get your future time units back.

The only special thing with job income vs other income streams is that you can turn the cashflow on and off and scale it pretty much at will within your time constraints and it has very low correlation to any markets (assuming you can always find some job). You invest time, not money. In return you get more money but less time. 

[Alchemisst]

The studies which posit the 4% rule and have been extended to other countries, show a 3.8% "rule" for Australia because of some terrible years around 1965 (or thereabouts). The problem with all the studies is that we have a completely different financial system now than we did before the Hawke/Keating years. It's like basing a future orange harvest on preceding apple harvests.

Is/ was this study this assuming you are investing in Australia? Or a world index fund?

[mjr]

The Australian stock market

[Alchemisst]

The Australian stock market

I don't know who would be heavily invested in the ASX when it's such a tiny portion of world market anyway.

[mjr]

Lots of people.  See Peter Thornhill for example.

I don't know why people think that the ASX being "a tiny part" somehow infers that this means that you miss out on potential gains.  Concentration risk for sure.  But the ASX has had great gains over its life and rewarded those who invested in it.

[marty998]

Lots of people.  See Peter Thornhill for example.

I don't know why people think that the ASX being "a tiny part" somehow infers that this means that you miss out on potential gains.  Concentration risk for sure.  But the ASX has had great gains over its life and rewarded those who invested in it.

Agree. Also, it's not like all the companies are invested only in Australia. The Big Banks give you NZ exposure. A whole stack of companies give you exposure to the US, China, Europe, Asia.....

The only sector we don't have much of is tech.

[itchyfeet]

Agree completely.

Having worked in developing economies for many years now I can tell you that it becomes pretty obvious why Australia is a rich country. It’s not just mineral wealth.

Having a broad exposure to a lot of shitty, corrupt economies is not necessarily better than having a narrow exposure to a more efficiently run country.

I have significant international exposure in my portfolio, but have no qualms in having a home country bias when my home country is Australia.

[Alchemisst]

Home bias is discussed in this Vanguard article

https://web.archive.org/web/20150912062007/https://pressroom.vanguard.com/content/nonindexed/6.26.2012_The_Role_of_Home_Bias.pdf