Saturday, 22 November 2014

It’s All About Living Well Below Your Means

I've mentioned previously in passing that as I build the wealth necessary to reach Early Financial Independence I'm noticing that the major wealth contributor for me has actually been the Saving Hard portion of my strategy rather than the Investing Wisely.

Let’s firstly quickly remind ourselves of what each portion contains.  Saving Hard is the methods used to acquire Capital for investment.  For me that is a full time professional career with Megacorp where I’m continually working to Earn More, as well as continually working on methods to spend less, while achieving the standard of living my family desires.  The spending less is typically called Living Below Your Means or LBYM in the financial independence blogosphere.  Investing Wisely is the methods used to maximise return on that Capital.  For me it includes low investment expenses, tax minimisation, modern portfolio theory, tweaking of asset allocations based on market valuations and even my HYP.

The below chart separates the wealth I've personally built each year from both Saving Hard and Investing Wisely.  Every year except 2012 more wealth has been built from Saving Hard.  It even includes the last couple of years where significant monthly savings are given to my better half so that Financial Independence day is synchronised.  So as I alluded to at the start of this post for somebody like myself who’s trying to become Financially Independent in 10 years or so Saving Hard is essential.

Year on year change in wealth
Click to enlarge

So Saving Hard is important.  Let’s look at each element in turn.  When it comes to Earning More I've been fortunate, having been able to increase earnings by 128% since 2007, however I can also say it has come at a price.  I am also very aware that in the modern continually globalising economic climate where average earnings in the UK are increasing at a less than inflation 1.3% this is currently not easy and importantly is not 100% in our control.  I'm going to ignore Earning More for the rest of this post for these reasons.

Sunday, 16 November 2014

14 Years of HYP

Having recently celebrated a birthday I've increased the ‘annual salary’ that I’ll need my wealth to provide by the current rate of inflation.  This is a strategy requirement and something I've done every year since I started on my Retirement Investing Today journey back in 2007.  Interestingly it’s pushed the ‘annual salary’ required upwards by 26% nicely highlighting the damage inflation can do to you if you fail to consider it.  Even with this change my financial position spreadsheet, which is updated weekly, still tells me I have less than 2 years to go before financial independence (FI) beckons.  It gets closer every day.

My portfolio is also largely based around Modern Portfolio Theory (MPT) with 86% of all current assets being index trackers, cash or NS&I Index Linked Savings Certificates.  I've mentioned it previously but this approach is walking me into a conflict I'm not so happy with and one I want to ideally fix before FI.  I therefore have less than 2 years to sort it out.

I'm calling myself Financially Independent (and may even Retire Early) when the ‘annual salary’ I require equals 2.5% of my total wealth.  The conflict is that ideally I don’t want to have the psychological problem of having to sell down assets to live.  Instead after buying a home for my family I’d like enough dividends spinning off to cover my spending plus a little bit extra that I can use to build a safety buffer during the good times to help smooth out the future guaranteed economic downturns.  I’d therefore like my annual dividends to be about 3% of portfolio value on FI day.

Saturday, 1 November 2014

10 Habits to Become a Millionaire

Anton is a 27 year old dollar millionaire – at least in net wealth terms.  While he seems to have made about two thirds of that wealth through the US equivalent of leveraged Buy to Let property investment it’s still a pretty impressive feat.  Building that type of wealth in such a short time is not a lot different to what I’m trying to achieve, that is financial independence giving the option of early retirement in less than 10 years.  His 10 Habits That Made me a Millionaire post this week therefore intrigued me.  Let’s look at these 10 habits in turn and compare notes.

1. Setting Detailed and Actionable Goals

I have a proverbial shopping list of financial goals that I've set and then track myself against.  They cover everything from weekly targets for fuel economy on my monster commute and grocery shopping spend targets through to longer term goals including the amount of wealth I require for financial independence including timescales to get there.  I even go one step further and publically score myself against some of these goals at regular intervals.

2. Religiously Tracking My Net Worth

If you’re chasing financial independence then the buck stops at Net Worth.  I have recorded the values of every one of my investments which I then sum to give net worth every week since 2007.  I've never missed a week.  From that history I can then build charts like that below which track my progress to Financial Independence.  It also enables me to easily measure progress against my goals.

RIT Path Trodden to Financial Independence
Click to enlarge     

3. Having the Discipline to Save 60% of My Income

He doesn't say whether this is Gross or Net Income but for a long time I was saving 60% of the more difficult Gross.  I've had to recently relax that to 55% only because a recent healthy pay rise has pushed me well into Higher Rate Tax where including National Insurance I'm losing 42% which makes it impossible to save 60% of Gross.  With that in mind I'm declaring a pass against this habit.

Saturday, 25 October 2014

Practice Makes Perfect

2007 was the year I started to Save Hard and Invest Wisely for Early Retirement. While today this is a mature strategy (with some 364 posts on this site reflecting that) back then I was an amateur who was reading continuously and running so many Excel simulations that I’m sure at one point I saw smoke rising from my computer.  As it was a year of transition and my financial record keeping was quite sketchy it’s quite difficult for me to say exactly when I started really following the strategy.  I do know that 2008 was the year where the strategy that you see today really matured and I also know that the 5th anniversary of RetirementInvestingToday.com will occur next month.  What however I don’t know is when I really “officially” started living most of the principles that are today mature.

What I do know is that by August 2007 I was already saving large chunks of money while spending little however throughout that month I was also still talking to Independent Financial Advisor’s, IFA’s, who at the time I thought were the secret to success but today firmly believe are not (at least for me, they may be for some).  I also know that it took me until the end of November 2007 to finally sell some funds that were charging me up to 1.78% in fund expenses per annum.  So the “real” Retirement Investing Today anniversary is probably somewhere between September and November.  Given we’re between those 2 dates today I’m going to call October 2007 the date when my journey really began.

October 2014 therefore represents the 7 year anniversary of my journey to financial independence and optional Early Retirement.  The question then becomes has 7 years of practice made perfect?  Well to answer that question I’ve just spent a couple of hours sorting through sketchy old records (this bit wasn’t by choice but rather my better half ‘encouraging’ me to participate in a very late spring clean) which really do make for interesting reading.

Sunday, 19 October 2014

Valuing the UK Stock Market (FTSE 100) - October 2014

Over the past couple of weeks the mainstream media have been getting all excited about recent share price falls.  As a group of people who are paid to write stuff I guess you could easily get excited by a graph like this:

3 Month Chart of the FTSE 100 Price
Click to enlarge, Source: Yahoo Finance

Eyeball this short term chart and of course they’re right.  Over the past 6 or so weeks there is no denying the FTSE100 has fallen 8% or so.  Personally, as a long term investor with a mechanical investment strategy I ignore it all and simply think that markets go up and they go down.  This is more the view I’m interested in looking at:

Chart of the FTSE 100 Price since 1984
Click to enlarge, Source: Yahoo Finance

On this scale the recent pull back is a bit of noise that means nothing more than my next share purchase is likely to be made at a better valuation than it was going to be.  Providing of course that earnings hold up.  Given I’ve now mentioned the valuation word as investors let’s today spend some time valuing the FTSE 100 over the longer term rather than wasting our time on short term price movement discussions.

Firstly let’s normalise the data by:

  • Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
  • Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

The normalised dataset shows that Friday’s FTSE 100 Price is actually still 32% below the Real high of 9,339 seen in October 2000.  We’re also now 23% below the last Real cycle high of 8,171 seen in June 2007.  We are therefore a long way from previous highs.

Chart of the Real FTSE100 Price
Click to enlarge