My Property is My Pension (because of Leverage)

Within this great country of ours we have what appears to be an eye watering level of debt.  We learnt this week that household debt in the UK, including mortgage debt, has now grown to £1.43 trillion or £28,489 for every adult. We however need to be careful when digesting this type of information as what really matters for the Average Joe is actually Wealth which is the market value of all assets minus those debts.

The Office for National Statistics Wealth and Assets Survey, published on the 12 July 2012, tells us that the total Wealth (including private pension wealth but excluding state pension wealth) of all private households in Great Britain was £10.3 trillion.  That’s £373,000 of wealth for the Average Household and even if we switch to Median values, to try and remove some of the extreme Wealth held by the 1%, it’s still £210,000, making the debt seem a little less serious on the average (I acknowledge that the poorest probably have no wealth and a lot of debt with the richest having lots of wealth and little debt but that’s for another day).  32.9% of this wealth is Net Property Wealth which is the value of the property held minus the value of mortgage liabilities and equity release.  Not everyone is lucky enough to own a property but for those that do the Average Net Property Wealth is £195,000 and the Median is £148,000.

With so much Wealth tied up in Property it’s no wonder I still hear and read of people using the My House is My Pension statement.  This is in my humble opinion is a statement from someone who really hasn’t quite understood how they have generated all that housing Wealth they now possess.  Have they really stopped to understand how with average earnings of £474 per week and a property Compound Annual Growth Rate of 5.4% since January 1995 (Land Registry data) so much Wealth has been generated by property.  There are of course a number of ways this has occurred including the more obvious time in the market and riding the rapid rise in property values between the mid 90’s and 2007 but there is also another method that all those with a mortgage are employing which I don’t think the vast majority even understand.  This is Leverage or Gearing which is a financial technique used to increase gains or losses by giving the investor the return on a larger capital base than the investment personally made by the investor.  In home owning speak the investment is the house deposit and the capital base is the purchase price of the house.  The leverage is achieved by taking on a mortgage.

How to Become a Millionaire

Two thoughts:

• In life we all behave differently and have different aspirations.  As long as harm is not being done to others then this is ok and is what keeps the place interesting.  This means that there will be people who have opted out of consumerism and are practising limited frugality such as myself (and many readers) and people who are consuming either through choice or because they are just not aware of the alternatives.  That’s ok.  There will also be people like myself (and many readers) who have personal finance as a hobby and others who either have no interest in the subject or struggle with too much mathematical complexity.  That’s ok also.  I sometimes wonder what those of the opposite persuasion must think when they stumble across Retirement Investing Today via Google or other website link.  I can’t help but wonder if we might be perceived as a little extreme and also guilty of making personal finance topics unnecessarily complicated.  For this post I therefore want to take a step back and not be either extreme or complex to hopefully help many.
• A Million Pounds is a lot of wealth to all but a very few.  It is also a very emotive value.  Could anybody who was prepared to apply themselves in life, but not be as extreme (maybe they gain happiness from things or want more work/life balance or...) and analytical as we are on this blog ever accrue a million pounds?  Let’s try and develop a simple model to demonstrate if an Average Joe could become a Millionaire.

Let’s define our Average Joe.  I’m going to assume our Joe is not an “Average Earner” but instead intends to pursue a “profession” which will start on a salary of £20,000 at age 21 and finish on a salary of £40,000 at age 68 (State Pension Age for today’s young), for an average lifetime earnings of £30,000.  I can think of many arts, sciences or technical university/apprenticeship routes that would enable this level of attainment through persistence.  Our Average Joe also doesn’t aspire to the 60% savings rates that I do but does realise its important and so religiously saves 20% of earnings every month leaving plenty of cash for consumption today.

What Would I Do if I Fell On Hard Times (and Importantly How Would I Recover)

It’s been a surreal week.  Midway through it I received a phone call from a good friend who has just returned from the third family holiday of the year.  However this time instead of talk of how great the holiday was I was greeted with an “I'm in financial difficulty and could I borrow some money from you?”  A little clarification revealed we weren't talking about twenty quid until next payday but thousands of pounds.  I was dumbstruck.  Why?

My friend is intelligent, has a very similar educational background to my own and has been working a similar amount of time.  We have similar jobs, albeit at different companies, but I would guess our salaries are probably within 10% of each others.  We do however live very different lifestyles.  To give some examples:

• In my friend’s family only 1 of them works.  In my family 2 of us choose to work.  
• My friend’s family chooses to live in a lovely part of London in a very nice rented house.  I live with my family in a small rented flat in a less salubrious part of town which is actually perfectly adequate for or needs.
• That lovely house above is not well insulated and so already has the heating on where I'm still yet to even consider it.
• My friend’s family choose to holiday at least 3 times per year.  My family has a single holiday each year along with a family visit for Christmas.
• My friend’s family is always dressed like they've just walked off a catwalk.  My family while wearing clean, neatly pressed clothes are a little out of fashion and contain the odd darned sock.

I must be clear here.  I don’t begrudge my friend’s family any of the above.  Everyone in this world is entitled to live their own lives and make their own choices.  I've chosen to Save Hard, Invest Wisely and Retire Early which today means I have accrued 72% of the wealth I need to secure financial independence.  My friend’s family has chosen to live for today.  I’d never really thought about the differences between us previously but when you look at the differences above we are at very different stages in life and on a very different life path.  The now clear disparity in wealth really did bring the book The Millionaire Next Door by Thomas Stanley into the forefront of my mind.  The only difference is that I don’t have a million pounds nor do I think I will need that much for financial independence as I've found plenty of ways to live well while spending less.

Valuing the FTSE 100 - November 2013

A quick glance at one of the many FTSE100 charts published by the mainstream media might start to get the average punter a little excited.

Click to enlarge, Source: Yahoo Finance

Why?  Well, with the market closing at 6,735 on Friday we have now passed the previous nominal 15 June 2007 high of 6,732 following which the market proceeded to fall 48%.  We are also now only 2.8% from the nominal 30 December 1999 record high of 6,930 after which we saw falls of 52.6%.

A FTSE 100 Price of 6,732 also has us up 4.3% when compared with the 01 October 2013 Price of 6,460.  We are also up 14.9% year on year.

Am I getting excited?  In short, no.  This is for a few reasons:

• The most important is that my investment strategy is no longer based on any form of emotion but is instead purely mechanical.  Once I made this move I found very quickly that all emotion, whether that be pessimism or optimism, when it came to economic or market news drained from me.
• As I’ll show in this post I don’t believe that the market is actually anywhere near a new high.
• Again, as I’ll show in this post, while I believe the market is partially overvalued it’s still only in the bottom 16% of monthly valuations since 1993.   

Let’s now run the numbers.  The last time we looked at this dataset was on the 26 June 2013.

Let’s firstly remove some of excitement 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.  

Looking at the chart this way reveals the FTSE 100 in a very different light.  That light shows that Friday’s FTSE 100 Price is actually still 27% below the Real high of 9,273 seen in October 2000.  We’re also still 17% below the last Real cycle high of 8,084 seen in June 2007.

Click to enlarge

Birthday Greetings, Bottle of Wine (+ Strategy Defined Adjustments)

I’m not quite 64, for those who picked up on the song lyric reference within the post title, but I have just recently aged another year and now enter my 42nd year.  This requires two adjustments to my portfolio, as defined by the Retirement Investing Today Low Charge Strategy, which was first published in December 2009 and later refined in September 2012.

Target Retirement Income

Back in 2007 after plenty of research I set myself an income that I wanted in early retirement.  That number is greater than I need to live and leaves room for some enjoyment given I could be in retirement for a longer period than I have already been alive.  This became my Planned Income.  From this I could then calculate the amount of wealth I had to acquire through Saving Hard and Investing Wisely by taking this number and dividing it by my Safe Withdrawal Rate (SWR).

With the Low Charge Strategy defined which includes my savings rate, asset allocations and predicted returns from those asset allocations, plus armed with a Planned Income and SWR I was able to build an Excel model that predicts my retirement date based on the future being “average”.  I prefer to think in today’s money, rather than devalued by inflation future money, and so all of the calculations are based in Real (ie inflation adjusted) terms.

Obviously, we live in an inflation based society and so every year I need to increase that 2007 income by a cost of living adjustment to account for inflation over the past year.  Back in 2007 I decided that adjustment would be the Retail Prices Index (RPI).  The chart below tells me that my retirement “annual pay” is increasing at a much greater rate than the average punter out there but for me the model seems to be realistic as my retirement date has hardly moved since 2007.  When I started the blog in November 2009 I predicted 7 years until retirement (work becomes optional) and today I’m predicting that the day will appear some 2.5 years  putting me ahead of the game at this time.

Click to enlarge

Uprating my planned income results in a decrease in my progress to retirement given the formula: