This week we talked about the Trinity study – where the 4% rule came from. Looked at the maths behind the 4% rule and why it works.

We introduced a new term “sequence of returns risk” and explained how to protect yourself against it. This included a lot of talk about bonds.

We also talked about doing things future you will be grateful for. You can’t know the whole path before you start. Get going now and start doing things every single day that future you will thank you for.

Katie and I retired 33 years before the normal retirement age.

How could we be confident that we wouldn’t run out of money and it would work perfectly for that length of time? How can you even be confident at normal retirement age that you won’t run out of money, that things won’t go badly, that the stock market won’t crash?

You cannot know with 100% certainty, that doesn’t exist, but if we understand the maths, we can have confidence that things will work out well. The maths will give you confidence that enough is enough and you can actually put your feet up and do whatever you want to do afterwards.

This stuff is quite complex so take your time, rewatch as many times as you need, take it in stages, watch us super slow and sounding funny. Whatever you need to help you process this information. Working on your finances is a journey that can take some time to go through!

Breathe, pause and start where you are.

Don’t carry on regardless. Stop watching the investing weeks. Work on your mindset. Go back and re-watch the relevant weeks where you need to progress and take action. There is no problem with going back over the weeks. Build your foundations first and then progress from there.

People on the course are from a whole range of ages, from less than 21 to 80 and over. All very different situations, needs and desires. We cannot cover all scenarios, but we can give you the tools you need to work it out for yourselves. We want to empower everyone (including you!) to be able to make choices and take action with their own financial futures. Our aim is that you take the information we give you and apply it to your situation.

Remember, anything is possible – the extraordinary belongs to those who create it….

On to the 4% rule! How you know enough is enough

The 4% rule came from a guy called William P. Bengen in 1994. He was reading a retirement study called the Trinity study from two professors and he noticed that if you withdraw 4% of your portfolio a year you have a 96% success rate! He thought 96% was pretty good and decided to come up with what we now know as the 4% rule.

The Trinity study looked at a 30 year retirement period, different withdrawal rates and whether you will run out of money before you die!

• Retirement period: this just means the length of time from when you retire (stop earning) to when you die. They assumed this would be 30 years on average
• Withdrawal rates: this means how much you take (withdraw) from your retirement pot each year.

The reason for doing all this work was so that you could trust that your money won’t run out in retirement! All this is explained in The maths behind retirement. People wanted to know with certainty that if they retired with XXX invested then they would still have enough to live even at 90+ years old.

Looking at all the different scenarios, William Bengen, a retirement advisor saw that you have a 96% chance of not running out of money with a 4% withdrawal rate. That was what he then started advising his clients to spend from their portfolio each year.

It seemed to work really well and not only did people not run out of money in most instances but they were wildly successful having more money to spend later in life. Since that point William has been on record saying that this could quite easily be a 5% withdrawal rate and with some flexibility you probably won’t run out of money.

Katie and I retired with £1,000,000 invested. At a 4% withdrawal rate than meant we could live off £40,000 a year inflation adjusted for the rest of our lives.

The Trinity study was all about inflation-adjusted spending. But what the heck does that mean? Well, let’s talk about pizza to help understand this! You know Alan loves Pizza.

Every year pizza gets more expensive? Have you noticed that when you were younger you could go to Pizza Hut for £5 eat all you can Pizza? Not any more!

The price of pizza, and everything, goes up every single year. Knowing that you will need more money in 20 years’ time to buy the same number of pizzas as they will cost more.

If you aren’t invested, this feels painful. Inflation makes it feel like things are getting way more expensive.

If your money isn’t invested then it isn’t growing as fast as the price of things you buy. The same money today buys far less pizza than 10 years ago.

The 4% rule is based on your retirement expenses at the time of retirement and then inflation-adjusted for each year of retirement. This means you can buy the same amount of pizzas/groceries/stuff every year.

So, if you’re invested, the price still goes up, but your money grows alongside or even faster than the prices are going up and you can live off 4% of your pot forever inflation-adjusted.

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In the green slide to the right you will see that if you retire on £40k a year in year 1. Then by year 2 you will need £41k to buy the same amount of stuff, inflation and everything getting more expensive. By year 5 you need £45k to buy the same amount of stuff. By year 15 you need £59k a year to buy the same amount of stuff.

If you don’t want to be significantly poorer because of inflation as you age you need your money invested. This is why having inflation adjusted spending is so critical and an important part of the 4% rule.

You will always have the same buying power. You will always be able to buy the same amount of pizza forever. Which is great because we LOVE pizza!

In retirement you can withdraw 4% of your portfolio each year, increasing for inflation and you have a 96% chance of not running out of money! yay

We talked a lot about bonds. What they are, what they are not and why we’re even talking about them.

You can lend the government or a company money and they guarantee a return on your lending as an agreed percentage of interest over a certain period of time. You can then cash in the bond at the end of the term and get your money back. The difference between bonds versus stocks and shares is that with a bond you do not own the company, you just lend it money, with stocks and shares you own a small part of the company.

This is a hypothetical image of you lending money to a company and them giving you a bond (yes they used to be pieces of paper!) in return saying what they will repay you over time.

1. A secret agent, but we are all trying to save the world, one way or another….

2. Premium Bonds (UK) – these are also you lending the government money but you don’t have any guarantee of getting anything back apart from what you have lent them in the first place. Instead, you go into a monthly draw for a number of cash prizes (tax free) which you can take as cash or automatically buy more premium bonds. You can cash in some or all of your premium bonds at any time and get your money back. We have some of our emergency fund in premium bonds.

3. Part Owner ship in a company – with bonds you do not own anything, you lend money. With stocks and shares you own a small part of the company, our strategy of global broad based index fund investing means you own a little of a lot of companies for diversification

In our opinion when you are earning you do not need bonds. Using bonds is related to retirement and approaching retirement.

As you add more bonds to your portfolio the overall growth growth on your portfolio lowers (bonds roughly only just keep up with inflation).

Katie created an incredible chart to show the impact of bonds on your pot. The chart maps what would happen if you invested 10 grand in different stock/bond ratios based on real market data for the last 15 years.

Bonds balance volatility and are one way of reducing sequence of returns risk. As you approach retirement you have less time to recover from a market downturn. Bonds protect you from having to sell off shares in a down market.

You do not need bonds at all if you are in your earning years. This is purely as you approach retirement and in retirement. Bonds are one way of reducing sequence of returns risk.

SoRR is the risk that the order of returns, market increases/decreases, that you get goes against you in the early years of retirement and then you run out of money before you die. This is not ideal as you don’t want to be having to go back to work at 85 as you have run out of money!

If you retire as the market crashes and you’re forced to sell when the market crashes you are more likely to run out of money in the future. This is only for big crashes.

Aside: BE AWARE that the media is full of scaremongering. Big crashes are uncommon, but do happen. Small crashes are incredibly common. Good news is not a seller, so the media do everything they can to scare you with “bad news” and even small crashes are hyped as a crisis. There’s never news about the market going up, that the market has done well. It doesn’t sell, it’s boring! So don’t buy in to the hype, ignore it and just chill, let your index funds do what they do and maybe buy some shares at a cheaper price

The best way to bring this risk to life is to think about if you had tried to retire just before the financial crisis in 2008. Imagine you had just retired in late 2007. You were super proud and looking forward to spending time with the grand kids. You retired with a £1M portfolio.

By March 2009 your portfolio has halved to £500,000. How would you be feeling? I would be pretty scared too! If you sell your shares at this point you are selling double the number of shares you had at the peak to get the same amount of money to live on.

This is sequence of return risk. Your shares would run out a lot quicker if this happened to you. And it did happen to people in 2008.

There is always another big crash coming, just no one knows when or how long it will last. This is what the whole course has been preparing you for!

SoRR is a very small risk, but it can have a huge impact, so it’s important to understand it and be prepared. Bonds are one way of avoiding it, but there are other ways.

Bonds are a double edged sword. The more bonds you have, you decrease volatility and in turn decrease your SoRR.

More bonds also decrease growth which increases the risk that you will run out of money in the long run.

The chart to right with the arrows shows the interplay of risks as you increase bonds.

Is it really so bad to just stay 100% in stocks and call it a day?

No, but there is a risk. To avoid SoRR you could flex spending, delay retirement, phase retirement, have a cash cushion, use bonds or a combination of those.

Bonds are just one way or protecting yourself from SoRR.

You get to chose how you deal with SoRR. Just have a plan and be prepared to implement it if you are unfortunate enough to retire into a global financial crisis!

Here are some of the other ways you can protect yourself against SoRR:

1. Flexible Spending: if the market goes south then you tighten your belt. Practically what does this mean. If you are used to spending £40k a year but it is a bad year in the market then you reduce your spending. Cancel Netflix, reduce holidays etc. and spend less until the market recovers. Katie and I always marvel at how little it can cost to live in Thailand or Argentina. If the market crashes and we need to we will just move there for a year and spend less till the market covers. Flexibility of spending is an incredibly powerful leaver you can use to protect yourself against SoRR
2. Delayed Retirement: in the 2008 example if you were about to retire in 2008 and you saw the market collapse then you could delay retirement for a year, live off your salary and wait for the market to recover. Not ideal if you hate your job but it will protect you against SoRR. If you see the market crash by 50% don’t just retire into it and spend willy nilly. That is how it all goes wrong.
3. Phased Retirement: You could slowly reduce your days at work over time. Let’s say you reduced your days working from 5 to 3 to start with. Then down to 2 days a week and so on. This means you have some income in the first 3-5 years of retirement and if the market crashes you aren’t forced to sell shares when the market is down. This protects you from SoRR and if you love your job you might actually enjoy a couple of days a week to keep your hand in the game!
4. Cash Cushion: This is where you build up a stock pile of cash that you have at hand for the first few years of retirement. You spend this cash instead of selling stocks and shares and if the market does crash you are protected as you have cash to fall back on. The problem with this strategy is that cash is a devaluing asset. Every year your cash cushion buys you less as inflation erodes it.
5. Bonds: In the years running up to retirement you switch from buying stocks and shares and you buy bonds instead. You work to get to a balance of 5% cash, 20% bonds and 75% shares. Then if the market crashes in the early years you sell off the bonds and live off those and leave the stocks and shares to recover!

All of these strategies are designed to stop you from having to sell of shares in the early years if the market crashes. SoRR is only really a risk in the first 5 years of retirement. Any one of these strategies can keep you safe in the occasion of a BIG market crash like 2008.

We are NOT talking about a 10% crash. The 4% rule has a safety margin build into it that protects you from all but the biggest of crashes. With these strategies you can increase your chances of not running out of money to as close to 100% as humanly possible.

You buy bonds just like you buy index funds. There are many different options to choose from. We think the same approach for index funds works well for bonds too, i.e. global, broad based, funds.

Like index funds there are income and accumulation funds. Bonds pay out interest rather than dividends, either as cash in the income funds, or reinvest in the accumulation funds.

The account structure is the same as for index funds. If you’re not sure about this, or need a reminder go back to week 8. The important things for index funds are the same for bonds. Choose tax efficient accounts first.

One of our favourite finance books ever is the Simple Path to Wealth by JL Collins. The strategy he recommends for retirement is to switch from 100% shares when you are working to a split of 5% cash, 20% bonds and 75% shares in retirement.

This then allows you to do what is called rebalancing each year and also protects you from SoRR. Just to be clear Katie and I never switched to bonds as we still had some income from my business that made us feel safe to remain 100% in stocks and shares. Adding bonds to your portfolio is one way of mitigating SoRR and allows you to rebalance each year.

The split will change over time. Wait, what?!?! Why?

Because of growth – as stocks grow, or as your bonds grow your split will change, the difference in growth (or fall) will mean your stocks and bonds are at a different percentages of the overall value of your portfolio. You then need to rebalance to get back to your chosen split.

Rebalancing is something you do once a year, it’s not a constant rebalancing. Pick a date, maybe your birthday or a random day in June and designate that as your rebalancing day

The slides below should jog your memory from the course. The basic principle behind rebalancing is that it forces you to sell something when it is highly valued and buy the other asset class when it is lower.

The examples. Imagine you retired a year ago with a £1M portfolio and you had the classic split of 80/20. So you would have had £800,000 in shares and £200,000 in bonds.

Over the year stocks have grown a lot but bonds not so much! Now you have £1,126,000 in shares and £206,000 in bonds. This means you have 82% in shares “too much” and 18% in bonds “too little”.

How do we fix this. We sell off some of the shares and put it into bonds restoring our balance of 80/20.

If you introduce bonds to your portfolio then rebalancing is a fabulous strategy that forces you to sell off the asset that has grown the most and switch to the one that hasn’t.

If the opposite had happened and stocks and shares had crashed you would sell off some of your bonds and rebalance into stocks and shares. This means you would be buying stocks and shares when they are down and selling bonds when they are up.

Just have a clear and simple rule that you do it on x day each year and use it as a tool to protect yourself from SoRR.

These are the different leavers you can pull to increase your chances of success in retirement:

1. Flexible spending: if the market goes down then flex your spending and don’t just willy nilly spend into oblivion. This also means that if you are past SoRR (5 years or so) then you can increase your spending if your portfolio does really well!
2. Flexible earning: could you earn ten grand in the year that the market was down? Could you work in a coffee shop, build something, create something or get a contract for a few months? If you do this then you can reduce the amount you have to withdraw in the down years. If you are not adverse to doing a little bit of fun work for pocket money then this leaver can drastically improve your chances of success. Some of you will never want to work again and that is ok, just use the other leavers!
3. Flexible withdrawal rate: this is where you flex how much you withdraw from you portfolio. In the down years you take a little less and then with time and compounding you might be able to take a little bit more! Just be cognisant of major crashes and flex a little bit when they happen
4. Cash Cushion: have some cash to ride out any down markets
5. Bonds: you can increase bonds as you close in on retirement and then reduce them again as you pass the SoRR period of 5 years.
6. Increase the % of stocks and shares: Interestingly the higher the percentage of stocks and shares you have in your portfolio, your growth engine, the higher chances of success you have. Katie and I have focused more on this strategy to protect us through that first period knowing we can fall back on flexible spending, flexible earning or other tools if we need to. Want to know why this is, scroll back up to the chart that shows the possible returns with different splits between stocks and shares and bonds. The more stocks and shares you have the higher your returns will be over time reducing the chance of running out of money

These are all tools or leavers you can pull if you need to. They are a back up plan. Katie and I have not had to pull any of these leavers in our first 5 years of retirement. In fact it has been the opposite as our portfolio has double from £1M to £2M and we are working to increase spending.

This next section is going to blow your mind. I couldn’t believe it when I worked out the numbers and maths!

Compounding continuously confuses the human brain. At the beginning you are confused as it doesn’t feel like compounding is doing anything and at the end you are even more confused as you wonder how did this work so well!

Imagine you retire with a 1M portfolio. You are going to be retired for 30 years in total. You will increase your spending each year in line with inflation (inflation adjusted) which is used 3% to model.

How much will you spend over that 30 year period?

The answer is you would have spend 1,902,800 in total! Nearly 2M. you would have retired with 1M and spend nearly 2M in retirement. So how much would you have left at the end of that 30 year retirement period?

Traditional maths would say I retired with 1M and spend 2M so there for I would have -1M and be in debt?

This doesn’t take into account compounding and growth.

The average person would have £10,075,000 even after spending all that money! isn’t that crazy?

The chances are that you will end up SUPER wealthy over the long run if you keep your money invested because of the power of compounding.

Just let that sink in for a minute. Your chances of running out of money are very small but your chances of ending up with a huge amount of money are very high.

We spend so much time preparing for the tiny possibility that we will run out money we forget to think about the far greater risk that they will end up with a huge amount of money that we have to work out what to do with.

Worried you can’t save the figure you need to retire? You don’t have to do the work. That’s what compounding does for you.

The human brain can’t compute exponential numbers! Compounding is hard to fathom. Watch this video to help you get your head around how compounding does the work for you.

This is the first part of week 4 which explains compounding in more depth.

🎉 Future-Proofing – Week 9 Quiz

1. Read How much does it take to retire
2. Consider your asset allocation. Are you working? If so check you are in stocks and shares! Are you close to retirement? Consider if you want to introduce bonds. Are you in retirement? Have you checked what investments you have an optimised them?
3. Focus on the basics. The fundamentals of personal finance and simple (not easy). Focus on keeping your spending down, increasing your earnings and creating a giant gap. Then take this gap and get it working for you. Please check to make sure you are nailing the fundamentals
4. Schedule in your monthly finance meeting. if you aren’t doing your monthly finance meeting then get it scheduled, make it fun and start working on a bright future for yourself!

Community is so important. Surround yourself with people that are working towards a similar goal to you and you’ll be amazed what you can learn from each other. For those of you in the UK I wrote this article for you about the FIRE movement in the UK. There are good people out there who want to support you and help you! And obviously there are the amazing people in the Rebel Finance School Group as well! If the people closest to you aren’t supporting you as much as you would like on this journey then find people who will.

The Donegans are cheering you on!

We have a last section of content for you, including Katie’s amazing retirement calculator and starting to think about what you want life in retirement to look like. We’ll also have a celebration and culmination of all that we’ve been talking about for the last 9 weeks. Can you believe it’s been 9 weeks?! One more week y’all! Looking forward to it already!

Plus we have a HUGE HUGE HUGE special guest star coming next week to chat to you all and hang out. One of my favourite people in the world!

If you have emailed us and we haven’t replied, we’re not ignoring you! We have been inundated with emails asking for help. Sorry. We are working as hard as we can but there is only so much of us to go round!​

If you have sent in a question to us using the question form, please check the Q&A Thursday sessions. We have tried to answer all the questions that have been sent in. If your question hasn’t been answered, or you have further questions please get in touch.

Remember, the best place to get a response is to reach out in the Facebook group with any questions you have or if you get stuck. Don’t let confusion be an excuse for not progressing with this stuff. We are here to support you!

At the end of week 9 we did a ceremony to thank the incredible Rebel Ninjas who have helped us to run the course throughout the last 9 weeks and into the final week next week. They have tirelessly answered questions, helped us migrate the website, write articles, build tools, Q&A prep, managed Zoom and YouTube comments. They are our Knights, Lords and Ladies of the Sacred Order of the Rebel Pineapple.

They are amazing. If you get a chance send them a thank you note, find them on the Facebook group and give them a thank you note. This course would not have been what it is without them! THANK YOU

It is so difficult for our brains to comprehend compounding and how things till turn out over time. Run the numbers, check with the retirement calculators and trust the maths. We have to make the best decisions we can and charge into the future positively.

Thanks for enjoying the week 9 notes. Leave us a comment below and make our day!

Love, Peace and Pineapples

Katie and Alan