Saturday, 10 January 2015

2014 In Review

Retirement Investing Today charts my financial journey to hopefully Early Financial Independence with Early Retirement then being an option at any time thereafter.  This is not a model or a demonstration journey.  It is my real DIY financial life warts and all.  Get it right and it’s smiles all round.  Get it wrong and I have a long compulsory work life ahead of me followed by a derisory State Pension thereafter.

The headline numbers are that in 2014 net wealth has increased by 13.2% and spending has decreased by 5.1% allowing me to move significantly closer to Early Financial Independence.  In line with my Plan, Do, Check, Act (PDCA) approach let’s now Check in detail by focusing on the three key focus areas that I believe are essential to get over the Financial Independence line - Save Hard, Invest Wisely and Retire Early.

SAVE HARD

Saving Hard is simply defined as Gross Earnings (ie before taxes) plus Employee Pension Contributions minus Spending minus Taxes.  Earn more and one is winning.  Spend less or pay less taxes and you’re also winning.  Savings Rate is then Savings divided by Gross Earnings plus Employee Pension Contributions.  To make it a little more conservative Taxes include any taxes on investments but Earnings include no investment returns.  This encourages me to continually look for the most tax efficient investment methods.

On the Gross Earnings front it’s been a great year with total earnings having increased by 37.7%.  Spending on the other hand has decreased by 5.1% by continuing to challenge all spending.  My one fail is that taxes are up a long way.  This is caused by the earnings increase but also more investment taxes as the portfolio continues to grow and is now significant.  The end result is the chart below which shows an average 2014 Savings Rate of 48.1% against a target of 55%.  The majority of the big gap was all caused by my good friend HM Revenue & Customs making a pigs ear of my taxes in years gone by and then chasing me for it at the start of this year.  By the back half of this year that Savings Rate had recovered to 52.8%.

RIT Savings Rate
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Saving Hard score: Conceded Pass.  Savings contributed 7.8% of my net wealth increase.  I’m also earning more and spending less but my big problem is taxes which I’m struggling to control.  Any extra £ that I now make is taxed at the Higher Rate of 40% plus 2% National Insurance plus as my non-tax efficient investments grow in size I’m being taxed on these as well.  I could solve some of this by increasing personal pension contributions but I don’t want to go there for 3 reasons:

  • They’re very open to tinkering by government which includes extending the age at which you can access them.  That’s not conducive to Early Retirement.
  • I’m already making big pension contributions.  2014 saw 71% of Savings put into them.
  • I may need a big cash or cash like pile to be able to buy (not mortgage) my family home in the not too distant future.

INVEST WISELY

Investment returns for 2014 were 5.4%.  Very little excitement in this area with my investing strategy continuing to be followed.  The only tweaks I’ve consciously started to recently make is to increase cash like holdings giving the option of a family home purchase and to start thinking about how to increase portfolio dividends from my current 2.3% to 3%.  The 3% number comes from a decision to drawdown at 2.5% after expenses which then leaves a little for reinvestment also.  Psychologically I feel this would result in a more relaxed Early Retirement than one where you are selling assets off continually to eat.

My current asset allocations are:

RIT Asset Allocations
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My investment types are laid out within a number of posts within this site but briefly these are currently:

  • Cash is Savings Accounts and Peer 2 Peer lending.  I have personally chosen RateSetter as my preferred P2P provider;
  • Bonds are UK Index Linked Gilts and NS&I Index Linked Savings Certificates (which unfortunately have not been on sale for some time);
  • Property is 49% UK Commercial Property and 51% European Property in the form of the iShares European Property Yield UCITS ETF (IPRP);
  • Commodity is physical Gold held via an ETC;
  • International Equity is 36% European Trackers, 41% US Trackers, 22% Japan Trackers with a splash of Others;
  • Emerging Markets are just Emerging Market Trackers;
  • Australian Equities are also simple Australian Equity Trackers.  In hindsight this represents a bit of a mistake which I’m trying to clean up with time.  If you read some of my early posts the original plan was a family Retirement to Australia.  This is no longer the case however the Australian funds I bought are not Distributing Funds meaning should I sell them any gains would be taxed as Income.  I'm therefore slowing decreasing this allocation by not buying any more and by reinvesting dividends elsewhere; and finally
  • UK Equity which is currently 31% HYP with the remainder being FTSE All Share Trackers.

I continue to invest as tax efficiently as possible with my tax efficient holdings now consisting of:

  • 45.2% held within Pension Wrappers with the majority being within a Youinvest SIPP
  • 13.7% held within the no longer available NS&I Index Linked Savings Certificates (ILSC’s)
  • 10.4% held within a TD Trading ISA.

Tax efficiency score: Pass.  2 years ago I was 69.1% tax efficiently invested.  This is now 69.3% in an environment without NS&I Index Linked Certificates.  I’d like more efficiency here because it is definitely affecting my Savings Rate badly now but I am struggling to find any more methods.

Investment expenses also continue to be driven down.  In 2014 I've taken these from 0.36% to 0.31%.  It might not sound much but every little bit helps, 0.05% is £250 on a wealth pot of £500,000 and I'm very conscious of how many small amounts add up to big amounts with time.

Minimise expenses score: Pass.  An improvement and I also know very clearly where the large expenses are coming from:

  • I’m still choosing to salary sacrifice large amounts into the “expensive” insurance company pension fund offered by my employer.  This enables me to take advantage of an employer contribution match up to a certain point plus my employer also contributes a portion of the employers NI saved.  For me it means I end up with more wealth even after the higher fees.  As soon as I get the chance it will of course be transferred into my Youinvest SIPP where I can buy similar products for far less expenses.
  • I refuse to expose myself to unnecessary taxes in the hunt for expense minimisation.  For me it’s all about minimising expenses and taxes not expenses or taxes.  As I mentioned above this mainly means I’ll reduce my Australian Equities exposure with time.  Some of these have expenses of up to 0.99%.

If I'm Investing Wisely I should be able to beat, or at least match if I was 100% Index Tracking, which IMHO is an admirable pursuit, an Index Benchmark.  My benchmarks are continually challenged by readers but at least for now my Benchmark here remains a simple UK Equity and Bond Portfolio aligned in percentage terms with the building blocks of my own portfolio which is then rebalanced once every year.  Today that benchmark allocation is 67% UK Equities and 33% UK Bonds. The 2 indices I use to replicate that benchmark are the FTSE 100 Total Return (Capital & Income) Index which this year returned 0.7% and the iBoxx® Sterling Liquid Corporate Long-Dated Bond Total Return (Capital & Income) Index which has returned 13.4%.  The annual return of my benchmark is therefore 4.9%.  My 5.4% annualised return is favourable against this.

Investment return score: Pass.  I’ve beaten my Benchmark.  I'm particularly happy with this given my Benchmark doesn't carry any costs where my portfolio sees expenses including fund and wrapper expenses, investment spreads, trading commissions, withholding tax on some investments and deducted at source tax on savings interest.

In the scheme of a lifetime of investing 1 year is an insignificant time period.  My strategy is all about time in the market and not timing the market so let’s zoom out and look at my performance since I started down this DIY road.  This also still looks good with the chart below tracking the performance of my portfolio against my Benchmark and inflation (RPI).  Note that the chart assumes a starting sum of £10,000 which is not my portfolio balance at that time but is instead simply a nominal chosen sum to demonstrate performance.  As always I never reveal my portfolio values in £ terms as it’s irrelevant to readers as we all have different earnings, investments, risk profiles, savings rates and target retirement amounts.

RIT Portfolio Performance vs Benchmark vs Inflation
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Since the end of 2007 the benchmark continues to beat inflation with Inflation growing at a Compound Annual Growth Rate (CAGR) of 2.9% compared with the benchmark at 4.8%.  In contrast my portfolio has increased at a CAGR of 6.4%.  In real inflation adjusted terms that’s now 3.5%.  My whole investment strategy since 2007 has been to generate a Real Return of 4% over the long term and I remain below that plan.  Will it improve?  Who knows what Mr Market is going to throw up so only time will tell.

Long term investment return score: Conceded Pass.  Not at my long term real return target of 4% but better than my benchmark.

RETIRE EARLY

Combining Saving Hard and Investing Wisely should eventually give Early Financial Independence and the option of Retiring Early.  When I started this site in November 2009 I stated that my aim was to retire (which at the time I defined as work becoming optional) in less than 7 years.  I am a little over 5 years into that journey and assuming I can continue to save at expected rates while achieving a real return of 4% I forecast that financial independence will arrive in about 2 years at the grand old age of 44 years.  That will be very close to 7 years from waking up to what the game was all about to goal achieved.  It will also mean financial independence in less than 10 years from when I went DIY in 2007.

As I mentioned in this posts introduction total wealth has increased 13.2% over the year while spending has decreased.  Two charts demonstrate the effect of this.

Firstly, if I stopped work today my earnings would have to come from drawing down from my investment wealth.  The chart below shows on a month by month basis what that drawdown rate (so that’s Spending divided by Total Wealth) would be.  My target of 2.5% is shown and importantly while the monthly actuals are pretty noisy that trend line is decreasing nicely towards 2.5%.

RIT Withdrawal Rate
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Secondly, I look at it in terms of how much wealth I currently have compared to how much I need to accrue (so that’s Spending divided by 2.5%) to be able to drawdown at a rate of 2.5%.  As I write this post I have now accrued 76.7% of the wealth I need for Financial Independence.  You can see my progress to financial independence and optional early retirement in the chart below.

RIT Path Trodden Towards Financial Independence
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Retiring early score: Pass.  Still on target for 7 years from blog start up and less than 10 years from going DIY.  I’ve moved a lot closer to retirement in 12 months.

A reasonable 2014 with no Fails and progress to retirement continuing nicely.  How was your 2014 financially?  Are you happy with your achievements?

As always please do your own research.

11 comments:

  1. Well done with another solid years saving/investing and another big step towards FI. Investment return of 5.4% is exactly the same as mine but with a large % of trackers, I suspect a lot less effort - just goes to show, there are many ways up the mountain....

    Be interested to see how the house situation evolves.

    Good luck with the coming year.

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    1. Thanks for the wishes John and good luck yourself. As you say we're doing it quite differently. Some years I'm ahead, some years you're ahead yet on the average we're pretty close. Just goes to show that it's not about perfect but rather starting with something sensible, then sticking with it rather than continually chopping and changing.

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  2. Three Points :

    1. Tax is deducted at source on pension payments
    2. Aiming to increase equity portfolio yield from 2.3% to 3.0% will be no easy matter
    3. are you using up both your wife's and your CGT allowance annually ?

    1. It seems very likely that you will be a higher rate tax-payer once you start drawing on some of your pensions. Tax is deducted at source - tax thresholds and rates are
    likely to change over time - and that change is most likely be towards higher tax rates.
    Keeping as much of your portfolio in tax free instruments is therefore going to be increasingly important- using you and your wife's full ISA allowances and hanging on to your IL Savings Certs - even though RPI is so low currently- as you say they are effectively irreplaceable.

    2. Another way of achieving an increase in equity yield is to take a more aggressive ( and therefore risky ) approach to your equity portfolio- increasing exposure to growth stocks rather than HY. To state the obvious a £100K portfolio yielding 3% produces the same overrall income as a £ 200K portfolio yielding 1.5%. OK - that is an extreme example - but I think your hope of increasing yields from 2.3% to 3.0% is also quite extreme - unless your aim is to achieve this switch over a 5-7 year period.

    3. I am sure that you are using up your annual CGT allowance -investors may not realise how quickly significant gains can build up- to the extent that it can hamper being able to sell the stocks when you want to . CGT is a pain to calculate - maybe this is why investors try to ignore it !

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    1. Thanks as always for the very thoughtful reply stringvest.

      Taking each in turn:

      1. If I retire at the point of FI then my better half and I will be basic rate taxpayers. Of course as you allude a basic rate taxpayer today could be higher rate tomorrow through government intervention. If I work past FI for a long period then I also could become a higher rate payer. Both of us are using 100% of our ISA limits every year. Depending on when I buy a home I may cash in the ILSC's. Certainly if I move overseas in 2 years, settle for a year in rental and then decide to buy I'm going to be cashing them in. I'll need to do that to keep a 'balanced' investment portfolio.

      2. I agree this is a challenge and also it's not one that is crucial to success. I just feel it would be psychologically advantageous. My strategy has never required me to chase high yield or high total return for success because of my very high savings rates. I only want 4% real pa during the building phase and only intend to draw down at 2.5%. I'm earning my wealth rather than relying heavily on my capital to be earning it. This is mostly because of the very short period over which I'm working meaning compound interest only has a limited effect. In this situation I'm very conscious of Buffet's comment "Rule No.1: Never lose money. Rule No.2: Never forget rule No.1." I have the HYP which is starting to help and I'm also looking at starting to buy more income funds like Vanguard's FTSE All-World High Dividend Yield UCITS ETF. If I can make it to 2.5% then I'm covered from an income perspective but it would be nice psychologically to also be reinvesting some divi's back into continued wealth building. Your growth stock example doesn't quite get me there as that's effectively where I am today. The total return amount of money per year is not the problem but the psychological need to sell down capital to eat is.

      3. A really important point which I certainly take advantage of when appropriate.

      Cheers
      RIT

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  3. This is very good returns. Congratulations RIT.

    One question to you and readers - anyone is planning to make adjustments in equity portfolios to address potential risk of deflation?
    K.

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    1. Hi K

      I can confirm that I am thinking about altering my portfolio a little although I'm also reticent as what I'm already doing seems to be working. The portfolio is now significant enough that I'm considering some further diversification in the form of targeted UK and global mid and small cap allocations. I haven't pulled the trigger yet and it's not for deflation reasons but simply additional diversification over what I already have.

      Are you making any plans?

      Cheers
      RIT

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    2. I am concerned about deflation and low stock returned in developed economies. I suspect that housing bubble can be popped not by inflation but by deflation when the actual debt in real term acquired by people will be growing with lowering wages and negative inflation. Think Japan in 90's.

      Ultimately the problem is huge pile of debt, and while it can be served by low interest rates, it nevertheless prevents any raise of central banks. ECB will try QE by buying debt and injecting liquidity into the economy but I am doubt that it will be successful as this is too late for this. Deflation is already here. Did you notice how cheap groceries are now? Ski trip France got cheaper by 50%!

      The question is how long it would last - the longer we have it, the more difficult it would take to get back. So, i did my re-balancing with selling some extra US stock which went up last year into high quality corp bond funds and some emerging markets.

      K.

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    3. Thanks for your thoughts. Your adjustment almost sounds like rebalancing :-) On a more serious note did you already have any Corp Bond Funds? They're not something I've ever really invested in choosing instead to go for index linked gilts which returned a crazy 19.2% last year.

      As you know I have a monster commute and so burn quite a lot of fuel. I'm therefore noticing the fuel price drops more than groceries.

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    4. Are you picking up on me? Fine, enjoy.

      In deflation, index gilts would probably be the worst investment. They are used to preserve capital from inflation. But think about what would happen when its index goes negative with deflation. what would be your cashflow? Note, I am almost sure that unlike such US bonds, UK does not have "deflation floor" so you CAN lose your principal.

      Corp is different, they are unlikely to default when there a lot of liquidity around and would pay something.
      K.

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    5. Sorry K trying to be funny on a topic which probably shouldn't have humour. Tried to indicate with a :-) but I never have been one to do good humour and trying to do it via a keyboard makes it even more difficult.

      I understand what you are saying about deflation. The bit I'm thinking is are we really going to have long term deflation. I honestly don't know. It looks likely but I'm wary that in the past I tried to think about what was happening and trade it which ended with a big FAIL as a result. I've written about that in the past. It's for that reason I'm reticent to make any changes.

      Instead I'm thinking to stay mechanical and see what comes. If index linked gilts take a big hit then when they are 25% down I'll buy some more. Then if they fall another 25% I'll be buying again. The same goes for all my asset classes.

      Interesting times as they say.

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    6. I think this is reasonable approach but I would be hesitant to commit to it for ALL asset classes, like for equity - yes, but for fixed income .... hmmm not sure..
      K.

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