Wednesday 27 February 2013

Debt – Instant Gratification vs Long Term Wealth Creation

The Free Dictionary defines debt as an “obligation or liability to pay or render something to someone else”.  In the context of Personal Finance I have a different definition of debt which is that it is a “decision to consume now without the necessary wealth to pay for that consumption.  Should interest be charged on that consumption and opportunity cost considered then the consumption now will likely be smaller than would have been possible should the wealth have first been created.”

If this was the official definition of debt it would then be obvious to people that by using debt you are likely getting less now than you could have had later in exchange for taking instant gratification today.  This therefore affects your opportunity to create wealth.  I do not believe that the majority of people appreciate this when they go into debt to buy something.  My definition also tells you this is for 2 reasons:

1.    Interest charges.  Buy it now without the means to pay for it up front and the end result is that each loan repayment being made to repay the debt is going to include a principle portion, which will eventually cover the original purchase price, plus an interest charge.  If you instead chose to save what would have been the regular repayment amount until you have saved up enough to pay cash then two phenomenon occur:
  • You will save the amount needed for the purchase faster than the equivalent loan will be repaid because what would have been the interest portion is adding to your savings. 
  • If you saved until what would have been the last loan repayment day then you will end up with more cash than the original purchase price, again because of the interest portion.
2.    Opportunity Cost.  This is rarely if ever discussed when people discuss debt but it should be considered as its effect can be considerable.  If you don’t make the purchase or defer the purchase then the money you would have used to fund the debt repayment can be invested to generate a return for you elsewhere.

It’s important to note that these statements are based on the assumption that the purchase does not rise in price at a rate higher than the interest charge.  If this was the case then you would also have to include the opportunity cost (including considering the risk of that other opportunity) of deploying the debt repayment s elsewhere.  If after this calculation the price was still rising at a faster rate then the debt may actually help with wealth creation while also giving instant gratification.

Sunday 24 February 2013

Has the UK Already Had Its House Price Crash?

Every month I run an analysis which looks at the Affordability and Value of UK Property.  This analysis uses the Nationwide House Price Index which measures the price of a standard house priced in Pound Sterling (£’s). 

In the current world we live there is one big problem with this Index and in fact all the other UK House Price Indices.  All of them are priced in Pound Sterling which is not a fixed peg in the ground for many reasons some of which include:
  • We live in a globalised world however only 0.9% of the World’s population use the £ as their currency;
  • The UK Government, Bank of England, Banks and many other vested interests have done everything in their power to keep asset prices in the UK high at the expense of just about everything else.  They’ve been relatively successful so far using methods such £375 billion of Quantitative Easing, 0.5% Official Bank Rates and the Funding for Lending Scheme.  This has allowed inflation to run a little at the expense of an official remit and led to negative real interest rates which among other things has resulted in Sterling falling in value against the currencies that 99.1% of the world use; and
  • The UK for all its problems is compared to the rest of the World a very attractive place to live and unlike a lot of countries actually has a Rule of Law.  It’s not perfect but as a person who has travelled the world for my work I ask where is.  This means a lot of people want to migrate and live here.

My first chart reminds us of the price of housing priced in Sterling.  If you’re a UK resident earning in Sterling, saving in Sterling and investing in Sterling this is what you’ll see.  Since the peak prices in nominal terms have fallen 12.8%.  Hardly a House Price Crash, more a small adjustment.

UK Housing Priced in Pound Sterling

Click to enlarge

What about Prices measured in the most widely held Reserve Currency, the US Dollar?  Measured in this currency we see UK house prices down 33.7%.

UK Housing Priced in US Dollars
Click to enlarge

Saturday 23 February 2013

UK Average Weekly Earnings – February 2013 Update

Over the past couple of weeks the mainstream media seem to finally have discovered that in real inflation adjusted terms average earnings are falling and that this is putting a squeeze on household finances.  They’re a little behind the curve given we’ve been talking about it here since April 2010 with the last regular update here.  This doesn’t really surprise me given that the Press today rarely published any investigative journalism instead choosing to publish whatever press release a political party or corporation is trying to push that day.  I guess it keeps running costs down but I digress...  Let’s not follow the same path and instead run some analysis to understand what is really going on.

Let’s firstly look at the nominal data. The Office for National Statistics reports that the Average Weekly Earnings for:
  • The Whole Economy including bonuses and allowing for seasonal adjustment is £472.  This is stagnant against last month and up £6 (1.3%) year on year.
  • The Private Sector earns less than the average Whole Economy at £468 per week.  Private Sector Earnings have also gone nowhere since last month and are also up £6 (1.3%) year on year.
  • The Public Sector earns more than the Private Sector at £489 per week and is also doing better when it comes to securing pay rises.  Month on month we see an increase of £1 (0.2%) and year on year an increase of £10 (2.1%).  Given that we are supposedly living in times of austerity, albeit a version where the government spends more than they did in the prior year, I’m amazed that the Public Sector is seeing year on year increases that are more than 50% higher than that of the Private Sector.

Unfortunately, while we were seeing those nominal annual increases of 1.3%, 1.3% and 2.1% respectively inflation according to the Retail Prices Index (RPI) was 3.1% during the same period.  This means that whether you are working in the Private or Public Sector it is likely you are taking a real terms pay cut. I know I am.  At my company’s last pay review I received a grand total increase of £0.  Meanwhile I know that essential items that I buy are increasing in price.  I’m continuing to learn frugal habits but I’m also sure that prices rising combined with stagnant earnings is putting pressure on my savings rate which at last check was only 55% of gross earnings against a target of 60%.  I’m working hard to find spending savings to get that back on track but given I’ve been at it since 2007 there is not a lot more to find. 

The long term erosion of spending power can be best seen with a couple of charts.  The first chart takes the RPI and Average Weekly Earnings and then converts them into an Index that starts in 2000 with a value of 100.  Whenever the gap between Earnings and the RPI is increasing earnings power is increasing.  The chart shows this stopped happening around 2008 meaning we have been seeing spending power erosion since then.  Today the spending power of the whole economy is back to levels last seen in May 2001.

Index of UK Whole Economy, Private Sector and Public Sector Average Weekly Earnings vs Retail Prices Index (RPI)

Click to enlarge

Wednesday 20 February 2013

Blogging for Money

Retirement Investing Today had humble 2009 beginnings when I began writing with a free domain.  Since then I believe the site has grown into a unique fact based data source covering both the general economy and personal finance ultimately aimed at helping you maximise your wealth creation and for those that choose the path early retirement.  I don’t say that because I’m arrogant but because the non-emotional fact based data tells me this is so.  This includes the site now having a Google PageRank of 3, a mozRank of 4.46, an Alexa ranking which puts the site in the top 12,500 sites read by people located in Great Britain according to Alexa and finally because readership continues to rise rapidly with visits up 32% in the last month alone.

Retirement Investing Today is also meeting the Objectives personally set which includes:
  1. Holding myself accountable.  By publishing my philosophy, strategy and progress measured against these I have to stay the course and can’t stray from the path.  This reduces the risk of my failing to achieve early retirement.
  2. Continuous learning about economics and personal finance.  To be able to publish unique up to date content regularly I am “forced” to continually data mine and expand my knowledge base.
  3. Share what I have learnt over the years, including my mistakes, so that you can conduct your own research and learn about unfamiliar topics which might affect your wealth creation.  The emails and comments I receive tell me this is occurring.
  4. The reciprocal of point 3 which is to gain information from you that force me to go off and do more research about a topic I clearly don’t know enough about.  I can definitely confirm that this is occurring.

To achieve the site you see and meet my objectives I typically invest 12 to 15 hours per week.  This covers data analysis, writing the posts, publishing the posts and keeping the site free from the continual spam attacks which you hopefully don’t see.  My daily commute plus day job currently then fills around 60 hours per week.  The two combined leave me with little time for further published content if I am to keep my current day job pace (which is necessary as it forms part of the Save Hard portion of my philosophy) and also allow some time to spend with my family.

Which brings me to the point of this post – Blogging for Money.  I already earn a very small amount of revenue which covers the costs of running the site but it’s not enough to give me a “salary” of any description.  It doesn’t cost you the reader anything but is achieved via:
  • Adsense.  If you click on any of the AdChoices in the right hand side bar I receive a small amount of revenue.
  • Amazon.  If you click on any of the links within The Books That Helped Me tab below the main site banner and then go on to buy something with Amazon I receive a small amount of revenue.
  • Sponsored Posts.  I post a very occasional Sponsored Post which has been written by a Freelance Writer working with an Agency.  Unlike most sites I clearly label these as a Sponsored Post so that you the reader know what you are looking at.

Saturday 16 February 2013

Why Using Your ISA Allowance Every Year Is So Important

We are now less than 2 months away from a new tax year in the UK.  With that new tax year comes a new ISA (Individual Savings Account) allowance.  The Investing Wisely portion of my Low Charge Strategy requires me to continually work at minimising the tax paid to HM Revenue & Customs  which is partly achieved by maximising my ISA contributions and coming as close to the full ISA allowance every year as possible. 

Before we review why maximising contributions and preferably using the full ISA allowance is so important let’s first review the basics of ISA’s:
  • An ISA is nothing more than a wrapper that surrounds purchased assets such as cash and shares.  Its primary purchase is to shield you from taxation.
  • There are two types of ISA.  The first is a Cash ISA where you can contribute up to £5,640 in the current 2012/13 financial year.  In the 2013/14 financial year the allowance will rise to £5,760.  The second is a Stocks and Shares (S&S) ISA into which you can contribute £11,280 less any contribution made into a Cash ISA this financial year.  In 2013/14 the S&S ISA allowance will rise to £11,520.
  • Contribute refers to the total amount of money you can pay into the accounts each year.  For example it is allowable to contribute £11,280 into a S&S ISA and then withdraw £3,000.  What isn’t allowed is to then add that £3,000 back into the ISA within the same tax year.
  • Current government policy is that the annual ISA subscription limit will be increased annually by the Consumer Prices Index (CPI). The increased limit will then be rounded to enable punters to make regular monthly payments in round terms. If the CPI is negative then limit will not be reduced but will be left unchanged.
  • Any savings in a Cash ISA can be converted to a S&S ISA but you can’t convert a S&S ISA into a Cash ISA.
  • You don’t pay any tax on interest received with a Cash ISA.
  • You don’t pay any tax on dividends received within a S&S ISA.  If you’re a 20% (basic rate) tax payer then in theory the ISA offers no advantage because 20% tax payers don’t pay tax on dividends.  If you’re a 40% (higher rate) or 45% (additional rate) tax payer then you get a big advantage because if you’re saving outside of an ISA your effective tax rate on dividends are 25% and 30.55% respectively after allowing for the dividend tax credit.  ISA’s therefore offer higher and additional rate tax payers a significant advantage however I also believe that basic rate taxpayers should also take advantage.  The reason is because you never know when you will be a higher rate taxpayer plus you also never know when government will start to apply tax to dividends received by basic rate taxpayers. 
  • You don’t pay Capital Gains Tax within a S&S ISA.  If you’re outside of the ISA wrapper then UK taxpayers receive an Annual Exempt Amount (£10,600 in 2012/13) however after this then you’re up for tax at 18% or 28% depending on your taxable income.  So ISA’s save basic rate, higher rate and additional rate taxpayer’s tax.  You may think that you can invest outside of an ISA and keep capital gains tax within your annual exempt amount by controlling when you sell but remember corporate events outside of your control like takeovers and share swaps can trigger capital gains tax events.  Within the ISA you have nothing to worry about.
  • A time advantage is that you don’t need to keep records for tax reasons and because you can ignore anything within an ISA for tax reasons then filling in your annual tax return is greatly simplified. 
  • It is a use it or lose it allowance.  So if you only contribute £10,000 to a S&S ISA this year then that’s it. You never get another chance to contribute that £1,280 of unused allowance.  It is lost forever. 

The last point is critical and shouldn’t be underestimated.  It is a mistake I have made and which is now impossible to rectify.  I was naive and for a number of years never even considered ISA’s.  Then when I did eventually understand a little about them I thought I’m just a basic rate taxpayer so they won’t help me.  Roll on a few years and hard work resulting in a few promotions plus bracket creep (inflation pushing income into higher tax brackets) has resulted in me becoming a higher rate taxpayer.  It’s a mistake that is now impossible to rectify because I can’t roll back the clock.  The vast majority of my savings will be used for my Early Retirement (some will be used to buy a home when value returns) meaning that I will possibly be paying for that mistake for the rest of my life.

Thursday 14 February 2013

Ignore Price Fluctuation - Focus on Yield

I’d like to again welcome back John Hulton.  John claims to not be a financial guru, stockbroker or financial journalist, but just an average bloke who has managed to find a way through the minefields of personal finance and develop a system that works for him and, which could be helpful for other people.  He has already retired from full time work which puts him at the end game of what this Site is about – Save Hard, Invest Wisely, Retire Early.  So while John is not a financial expert his approach has given him what many of us are chasing.  I hope you again enjoy his thoughts.

The FTSE 100 got off to a flying start in 2013, the best January rise since 1989!  The markets rose above 6,300, a price last seen prior to the start of the sovereign debt crisis in 2008.

How long this surge will continue nobody can know.  Is it a temporary spike or is it a sign that the economies around the world are starting to see signs of real recovery?  There will be much speculation in the media and on the discussion boards.

At one time, earlier in my investing career, I would probably have been thinking about selling some of the shares which had risen strongly.  I would be trying to second-guess the market - there is no justification for this rise - all the problems of systemic debt in the major industrialised countries have not suddenly disappeared - the markets will soon fall back towards 5,000 and I will keep my powder dry and pick up a few bargains later in the year.

I say ‘at one time’ but I’m sure there’s still a bit of me that thinks the same way now.  However, the emotional factors which underlie that process are basically twofold - fear and greed.  Fear the markets may suddenly swing down as quickly as they have risen and I will lose all the double digit gains on my portfolio - and the greed of selling high and buying low during the next downturn.  These two bedfellows are always present but need to be understood and neutralised if you wish to invest for the long term.

After many years as a private investor, I am gradually learning to regard these market swings and share price fluctuations with an attitude of mildly detached interest.  I really don’t get over-excited when markets rise and equally, I don’t become wracked with fear when markets are falling.  As an income investor, it will probably suit me when markets are in decline as it will throw up many more opportunities for a decent yield.

On a day to day basis, most investors will probably be following share prices because this is where all the action is.  Profits are made on the markets by buying at a low price and selling at a high price, right?  Wrong!  Over the longer term, up to 90% of the total return on your portfolio will be derived from dividends - growth of dividends and especially the reinvesting of dividends.

Tuesday 12 February 2013

The FTSE 100 Cyclically Adjusted PE Ratio (FTSE 100 CAPE or PE10) – February 2013 Update

This is the Retirement Investing Today monthly update for the FTSE 100 Cyclically Adjusted PE (FTSE 100 CAPE).  Last month’s update can be found here.

As always before we look at the CAPE let us first look at other key FTSE 100 metrics:
  • The FTSE 100 Price is currently 6,338 which is a gain of 5.2% on the 01 January 2013 Price of 6,027 and 9.5% above the 01 February 2012 Price of 5,791.
  • The FTSE 100 Dividend Yield is currently 3.47% which is down against the 01 January 2013 yield of 3.64%.
  • The FTSE 100 Price to Earnings (P/E) Ratio is currently 12.96.  
  • The Price and the P/E Ratio allows us to calculate the FTSE 100 As Reported Earnings (which are the last reported year’s earnings and are made up of the sum of the latest two half years earnings) as 489.  They are down 4.6% month on month and down 11.7% year on year.  The Earnings Yield is therefore 7.7%.

So we find ourselves in an interesting situation.  Nominal Earnings are falling and have been consistently since October 2011’s Earnings of 628 yet Prices are rising.

The first chart below provides a historic view of the Real (CPI adjusted) FTSE 100 Price and the Real FTSE 100 P/E.  Look at the trend line of the Real Price.  After you strip out the effects of inflation the perceived market value is doing not much more than oscillating above and below a flat line which we are now sitting on.  The second chart provides a historic view of the Real Earnings along with a rolling Real 10 Year Earnings Average for the FTSE 100.

Chart of the FTSE100 Cyclically Adjusted PE, FTSE100 PE and Real FTSE100
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Chart of the Real FTSE100 Earnings and Real FTSE100 Dividends
Click to enlarge

Sunday 10 February 2013

UK, US, Australian + the PIGS Government 10 Year Government Bond Yields – February 2012 update

10 Year UK, US and Australian Government Bond Yields 
Click to enlarge

 Click to enlarge

I haven’t published these datasets for 20 months now because as far as the UK is concerned it’s really been status quo.  The UK Government have continued to run a budget deficit that isn’t sustainable.  There isn’t any of the promised austerity because government spending is actually rising.  This combined has resulted in the UK National Debt reaching around £1.13 trillion today.  That’s £18,021 of Debt for every man, woman and child in the UK.  Less than half of the population work in the UK, 29.17 million people working against a population of 62.64 million, so comparing the debt to this group means a debt of £38,699 for every worker. 

Government forecasts project the debt continuing to grow quickly with it reaching £1.5 trillion by 2016.  Meanwhile in parallel the Bank of England has “bought” £375 billion (33%) of that debt through the Quantitative Easing (QE) programme.  This has had the effect of forcing UK bond yields down to historic lows when under the scenario described in the first paragraph yields should have risen which would have forced the government to take action rather than masking the problem.  Now it’s important to remember that for bonds already in circulation that as yields fall prices rise and that’s what we’ve been seeing happening for a number of years now.  It is however important to remember that the opposite can also happen.  Should that happen not only would the cost of borrowing for the Government rise but also other debts like mortgages would also rise.  That would reduce affordability and would in my opinion reduce house prices (and other asset prices) helping the value argument here.  Instead of asset price deflation we’re seeing just about every asset type either holding or increasing in nominal value including housing, shares and hard assets like gold which to me seems to be making the problem we have even worse.  

I’m therefore watching government debt yields closely and what its showing is that since August 2012 those yields have been rising despite the Bank of England announcing another £50 billion of QE in July 2012.  This is not showing in mortgage rates yet because the Treasury and Bank of England are distorting the market independently there with the Funding for Lending Scheme. 

Saturday 9 February 2013

UK Savings Account Interest Rates – February 2013 Update

The UK Treasury and Bank of England’s £80 billion (or £1,277 for every man, woman and child in the UK) Funding for Lending Scheme continues to hurt savers.  The banks currently have no need to borrow money from us savers when they can go directly to the Bank of England for a nice low rate of 0.25% per annum providing they meet a few T&C’s.

Money Saving Expert now tells us that if you are in the market for an easy access savings account you can get an interest rate of 2% AER with Derbyshire.  Forget to switch after 31 March 2014 to the next bank or building society offering the highest interest rate at that time and that becomes 0.5%.  Last month you could get 2.35% on accounts offering a bonus for a fixed period of time and back in June 2012 you could get 3.2% AER variable with Santander reducing to 0.5% after 12 months.  So in less than 12 months the best rates being paid have fallen by more than a third.

Choose to go for a no nonsense easy access savings account (always my preferred option) that available interest rate is also 2% today from Virgin.  Last month the best buy was 2.3% AER with West Bromwich Building Society.  Back in June 2012 the best rate was 2.75% AER variable with Aldermore.

I must note that I’ve left the Santander 123 current account out of the analysis even though it’s currently paying 3% AER.  I have no time for this sort of account.  To me it’s made deliberately complicated and I don’t believe the average punter would have a hope of calculating whether this account is the best for them.  It pays the 3% only on balances between £3,000 and £20,000, requires a minimum deposit of £500 per  month, takes a £2 per month fee (remember you’ll pay tax on the 3% but won’t be able to claim against the £2) plus in the circles I move I hear of the poor customer service that Santander offers.  I can’t help but feel somewhere in the small print I’m bound to lose out against a simple no nonsense account.  If somebody is having success with this account please do comment below as I’m sure many readers (I know I certainly would) would like to know if you are seeing success.

Wednesday 6 February 2013

Simplifying the Complex Pension Problem

 Ask anybody at a party or family gathering about personal Pensions, whether that be a now all to rare Defined Benefit Scheme or a Defined Contribution Scheme (such as a Stakeholder Pension, Group Personal Pension, the new National Employment Savings Trust or (NEST) Pension or the ultimate in DIY Pension Provision, a Self Invested Personal Pension (SIPP)) and it’s likely they’ll glaze over.  From my own experiences I feel this occurs for three main reasons – upbringing or culture, mistrust and lack of knowledge.  Let’s look at each of these in turn.

Upbringing or culture

The vast majority or people learn from a young age to spend and save what’s left.  That philosophy is then continually reinforced through a never ending bombardment of advertising which not only encourages us to spend what we earn today but also that it’s ok to spend what you haven’t yet earned today.  It’s a fairly old post now but if only people were taught to pay themselves first.  I’m the first to admit that I fell for it until I was 35 years of age.  The problem is who has an incentive to educate people about this?  The Government / Bank of England don’t, particularly now, as we’re in a spiral where they need us savers to spend.  They are actually trying to do the opposite and educate us to spend by doing all they can to erode our savings through forcing negative real interest rates upon us.  The Corporations of the world certainly don’t want you to gain this knowledge as you wouldn’t be then contributing to revenue today.  The only logical place I can see it coming from is family, friends or in very limited cases somebody stumbling across a site like this and believing what I write.  Unfortunately though it’s a spiral because if family and friends don’t know about it how can they pass that knowledge across.


The simple mention of two words – Equitable Life – is a good place to start.  This however is actually a symptom not the cause of the Mistrust because most Pensions don’t actually operate like this.  The actual cause is the vast majority of the Financial Services sector (which includes the FSA) who fail to educate with the full story but instead only present the side that helps them.  People are in my opinion right to go in to a Pensions transaction sceptical and mistrusting.  Let’s look at a simple example.  The website of most Pension provider’s will probably say something like the government is trying to help us save for our retirement.  If you’re a basic rate tax payer then for every £8 you invest the government will top up your pension with a further £2.  They’ll probably then go on to say if you’re a higher rate taxpayer you may be able to claim even further tax relief.  The bit they always seem to forget to inform us about is that Pensions, excluding the 25% Tax Free Lump Sum (TFLS), are actually just a tax deferral scheme.  You aren’t taxed on the way in but you are taxed on the way out.  If you’re a 40% taxpayer and plan to be a 20% taxpayer in Retirement or if your employer makes a contribution if you do then it’s probably worth it but what about the person who’s a 20% tax payer now, will be a 20% tax payer in retirement and doesn’t take advantage of the TFLS (after all it’s not compulsory and would require some knowledge to understand).  Is it worth it for him or should he just save in an ISA?.

I also feel they seem to make Pension products sound deliberately complicated to ensure that you use them instead of going DIY.  This then also enables them to maximise how much they skim for themselves without you immediately noticing.  How many people out there have and are paying large expenses today and will then find in 30 years that their Pension has delivered nothing like what they thought it would.  It’s short term thinking and self defeating but unfortunately a lot of human nature is based around greed.  Take a fair fee for helping somebody, which I actually believe some providers are doing today, then in 30 years that somebody has seen some success and so they make a recommendation to their children.  Next minute the snowball is rolling and everyone wants a pension.

Monday 4 February 2013

The S&P 500 Cyclically Adjusted PE (aka S&P 500 or Shiller PE10 or CAPE) – February 2013 Update

The US stock market has seen some large gains since New Year’s Eve. As I write this post the mid market price for the S&P500 is down 0.9% on the day at 1,499.8 but still up 5.2% in little over a month. Similarly, the Dow Jones is down 0.8% at 13,903.5 but is up 6.1% since the market close on the 31 December 2012. It’s therefore appropriate to run the standard Retirement Investing Today monthly update for the S&P500 Cyclically Adjusted PE (S&P 500 CAPE). Let’s see if the market is just exuberant or starting to head towards Irrational Exuberance.  Last month’s update can be found here.

As usual before we look at the CAPE let us first look at other key S&P 500 metrics:
  • The S&P 500 Price is currently 1,500 which is a rise of 1.3% on last month’s average close of 1,480 and 13.3% above this time last year’s monthly Price of 1,324.
  • The S&P 500 Dividend Yield is currently 2.1%.
  • The S&P As Reported Earnings (using a combination of actual and estimated earnings) are currently $88.85 for an Earnings Yield of 5.9%.
  • The S&P 500 P/E Ratio is currently 16.9 which is up from last month’s 16.8.

The first chart below provides a historic view of the Real (inflation adjusted) S&P 500 Price and the S&P 500 P/E.  The second chart below provides a historic view of the Real (after inflation) Earnings and Real (after inflation) Dividends for the S&P 500.

Chart of the S&P500 Cyclically Adjusted PE, S&P500 PE and Real S&P500
Click to enlarge

Chart of Real S&P500 Earnings and Real S&P500 Dividends
Click to enlarge

As always let us now turn our attention to the metric that this post is interested in which is the Shiller PE10.  This is also shown in the first chart which dates back to 1881 and is effectively an S&P 500 cyclically adjusted PE or CAPE for short.  This method is used and was made famous by Professor Robert Shiller.  It is simply the ratio of Real (ie after inflation) S&P 500 Monthly Prices to 10 Year Real (ie after inflation) Average Earnings. 

Saturday 2 February 2013

Calculating that Important Retirement Number

For anybody planning on a retirement, whether that’s Early Retirement Extreme, Early Retirement or a Typical Retirement not dependent on the whim of Government, based on a passive income stream generated provided by a portfolio which includes assets such as Equities and Bonds, then the amount of assets you need to accrue before pushing the retirement (financial independence) button is possibly the most important number that will be ever considered in your lifetime. 

Given the seriousness of the topic I must give the following Wealth Warning before we move on.  I’m just an average person on a DIY Investment journey to Financial Independence and am certainly not a Financial Planner.  The content of this post is for educational purposes only and is not a recommendation of any type.

For this post I am going to use a fictitious Average Joe who is in a similar position to me and is planning for Retirement.  This means he:
  • doesn’t intend to purchase an annuity but instead intends to only use Income Drawdown to Generate Gross Earnings (Earnings before Tax) from the portfolio;
  • doesn’t have the benefit of a Defined Benefit Pension or other income streams.  Therefore all of his Gross Earnings must come from the interest, dividends and capital growth of his portfolio;
  • doesn’t have rich parents who are going to leave him an inheritance; and
  • wants to maintain the same standard of living throughout retirement so will increase his Gross Earnings in line with inflation every year.

The actual calculation of the Retirement Number (how big a portfolio is required to retire) is actually very trivial and depends on only two numbers.  It’s getting those two numbers that is the difficult bit and where all the risk is.  The first number is what Gross Earnings do you want in retirement and the second number is what Initial Withdrawal Rate do you intend to start with.  The maths is simply Retirement Number = Gross Earnings / Initial Withdrawal Rate.

Let’s look at both of those numbers in detail.

What Gross Earnings do you want in retirement?

This is just a matter of sitting down and thinking about what expenditures you intend to have in retirement that will give you the standard of living you desire.  Here is a short inconclusive list of possible considerations:
  • You’re no longer saving for retirement so don’t need that portion of your current salary;
  • You’re possibly no longer working so may not need to be paying for transport to and from work plus other costs such as work clothes;
  • You’re hopefully tax efficiently invested in wrappers like ISA’s meaning you need a lower Gross Earnings than Gross Salary to give the same amount of money in your hand each month.
  • If you’re in the UK then the assets in your portfolio are taxed in a more friendly way than your current Salary meaning you also need lower Gross Earnings; and
  • You possibly own your home by now meaning you won’t be making those current mortgage payments. 

I calculated my retirement Gross Earnings back when I was in my mid thirties and first started on my journey towards financial independence.  Every year I have then up rated this amount by inflation to ensure my standard of living will be maintained as the pound is devalued.  When I hit retirement I intend to continue with this strategy.

On Retirement Investing Today I never reveal my Gross Earnings target because it’s just irrelevant.  Everybody has different needs, wants, risk tolerance and portfolio type meaning we all have a different Gross Earnings requirement.  To enable us to run an example let’s assume that our Average Joe requires Gross Earnings of £25,000 when measured in today’s £’s. 

An Essential Guide to Offshore Investments*

As more and more people are deciding to either live a life of perpetual transience or retire to warmer climes, offshore investments are becoming increasingly popular. As well as taking advantage of some significant tax savings, investors are often keen to select just one investment opportunity instead of having their capital tied up in several different locations around the world. However, a little knowledge about how different offshore funds work will mean the logistical and financial obstacles that hinder many British expats can be removed.

What Does This Type of Investment Involve?

The modern offshore fund involves geographically portable products that offer consumers statutory protection and a wide range of investment choices. Contrary to popular belief, they are not based in shady, semi-legal rogue states, but they are based in established financial centres such as the Isle of Man, Ireland and Luxembourg. This gives consumers the peace of mind in knowing that their funds are protected by law-abiding and stable governments.

The Various Offshore Products

If a person wishes to invest a lump sum, they may do so with the help of an offshore investment bond. A bond can be used as the 'packaging' for a comprehensive range of investments, including open-ended investment companies and unit trusts. As these bonds are based offshore, they give consumers much more choice. Investment funds that are available include guaranteed return funds, managed future funds, stock market-linked funds and government bonds. Exactly which opportunities are best for the individual should be discussed with an experienced financial adviser, but the decisions will depend on factors such as the person's attitude towards risk, age and time-frames.

A detailed consultation with a financial adviser will ensure that investors know exactly much money needs to be injected into a fund every month. A person's disposable income will generally dictate exactly what the offshore investment will be composed of. Most of these products can now be managed closely online, so issues of time-difference and language are no longer obstacles to a lucrative investment.