A Transition to Retirement

I am currently at the point where if I can maintain my current savings rate and forecast average investment return run rate I expect to have accrued sufficient wealth for full financial independence in a little less than 3 years.  This will mean I will have the option of either:

• continuing to work in my current full time career knowing that I don’t need the company but that the company needs me; or
• taking early retirement from my current day job which will allow opportunity for everything from doing nothing to side hustles to part time work (whether in my current or a new career) to a new full time career which might include my own business;

all at the relatively early age of 44.

With only a few years to run until Financial Independence I now believe I'm at the point where I need to start thinking about how to transition from my current position to retirement.  Before I document my first musings on what the strategy might look like to financially transition to early retirement let me first detail some relevant considerations that need to be accounted for based on where I am today:

• I am planning to be in the position where I will need to generate no active income with all expenses being covered by investment return from my accrued wealth.  Planning this way means any work undertaken, which might earn an income, becomes an activity that brings enjoyment or learning opportunities only. 
• I am a higher rate, 40%, tax payer and expect to be a basic rate, 20%, tax payer in retirement.  This along with the facts that as part of a pension salary sacrifice arrangement my employer adds to my pension a large part of the 13.8% Employers National Insurance Contribution that they now save, plus I also get the 2% Employees National Insurance contribution above the Upper Earnings Limit added to the Pension, means I have a lot to gain by making large pension contributions.  At current rates my pension contribution is about 50% of my monthly 60% of gross earnings savings rate.  This means that over the next 3 years, after accounting for expenses, taxes and investment types in and out of the pension, I expect my Pension wealth to move from 41% of total net worth today to something closer to 44%.  I am therefore left with only 56% of my total net worth to live off until age 55 when I can start to Drawdown on my Defined Contribution Pension.  Of course that assumes the UK government doesn't change the retirement age or other pension rules meaning I'm also carrying a bit of contingency in my planning.
• I haven’t yet bought a home and while I will have the assets to sell to buy the home outright a small mortgage looks prudent to maximise my wealth retention by paying some short term interest payments which will allow long term minimisation of taxes.  Some of these tax minimisations will include not cashing in any of my Stocks and Shares ISA wealth as I want that tax free income forever, avoiding payment of any capital gains tax and not selling some offshore Non-Reporting Funds where the gains are subjected to income tax rather than capital gains tax, which I foolishly bought before I knew what I was doing, while I'm a higher rate tax payer.  This will reduce any Capital Gains Tax from 28% to 18% after allowing for my Annual Exempt Amount (£10,900 for 2013/14) and the tax on the gains of my Non-Reporting Funds from 40% to 20% or possibly even a portion at 0% if I'm careful.

A Retirement Investing Today Review 6 Months into 2013

This is the regular quarterly feature that demonstrates the progress a person actively living the tools and techniques mentioned on this site can make towards early financial independence.  It also forces me to hold true to those tools and techniques because if I can’t live by them then this site becomes hypocritical like so many other sites out there and I become nothing more than a hypocrite like so many others with vested interests.    

My own personal situation follows everything I talk about on this site to the letter.  The site is all about Save Hard, Invest Wisely, Retire Early so as with the 2012 Review let’s continue to use those 6 words as a theme.

SAVE HARD

I am now into a fifth year of aiming to save 60% of my earnings, which I define as my gross (ie before tax) earnings plus any employee pension contributions.  This remains a very tough target in the current age where we have increased taxes and prices due to unrelenting inflation.  I feel fortunate to have been given some respite here earlier in the year with a 3.5% salary increase after receiving nothing in the previous year.

To maintain my Save Hard focus I continue to looking for ways to both Earn More as well as Spend Less which certainly requires frugal living and little to no consumerism.  This continues to be a very positive experience however when you live in a city, London, where it appears as though everyone thinks the world is going to end tomorrow it can become difficult to stay on the path I have chosen.

By tracking my net worth on a weekly basis, which also gives me a % towards early retirement figure, plus before making any purchase taking some time out to ask myself if I really need what I am about to purchase which includes considering will it help improve my health or increase happiness I typically don’t stray for very long.  Particularly as I carry the knowledge that by deferring that spend I get one step closer to early retirement which will mean a big reduction in stress plus the option to only work when I want and then only because I enjoy it.

Last quarter I managed a savings rate of 67% of earnings however I also advised that a large portion of that was caused by a HMRC error.  They are now in the process of recovering the “interest free loan” they provided me with which has caused a fall back in savings rate to 64% for the first half of 2013.  These savings have gone into both my own investments plus a portion has been provided to my better half to help keep her financial independence goal on track and in sync with my own.  The payback to HMRC still has some way to run so I’ll need to stay focused if I’m going to keep that savings rate above 60% in 2013.

So where did the money go:

• 22% was invested into Pension Wrappers
• 36% was invested into ISA’s and non tax efficient locations 
• 6% was used by my better half

Saving hard half quarter end score: Pass but I need to stay focused with the current increased tax pressure on my shoulders.

Is it More Important to Earn More or Spend Less

If we are ever to build wealth for financial independence then we must first get to the point where we are spending less than we earn.  The remainder after spending are the savings which can then be invested wisely for early retirement (or whatever cause you are looking to build wealth for).  To maximise our savings (hence accrue the amount of wealth we require in the shortest possible time for a set investment risk) we should first take all the earning more and spending less opportunities available to us that take little to no extra time.  On the earning more side this could include asking for a salary increase if you employer is paying you less than the market rate and on the savings side it could be living in a home that is well below what you can afford, not grabbing that Starbucks on the way to work, having the lowest price grocery bill or even taking on a cheaper mobile phone plan even if it means you don’t get the latest smart phone to name but four.

Once you've done that you’re now at the point where to increase your savings rate you need to start expending more time and energy.  On the earnings side this could be working paid overtime, working free overtime if you think it will give opportunity for higher earnings later, looking for a new job that will better recognise your current skills and hence pay you more, undertaking training which will arm you with more skills to enable you to earn more or even developing a side hustle job to bring in a little extra cash.  On the spending reduction side it might include learning how to and then making your own cleaning products, growing some of your own fruit & vegetables or even mending your own clothes.

To achieve a savings rate of 60% of gross earnings I know that personally I have taken all the earn more and spend less no extra time opportunities that I can think of plus I am expending huge amounts of time and energy on earning more.  I am also devoting some extra time to spending less but this area is certainly not maximised as both my living conditions (a small London based rented flat) plus earning more efforts filling the week restrict this somewhat.  The question is does this philosophy generate maximum savings or should more time be spent on spending less?  This site is all about fact based analysis and so let’s run some simple numbers to find out.

There is No Longer a UK Housing Market for the Average Joe

The latest Land Registry monthly release tells us that in March 2013 there were 52,090 house sales in England and Wales.  In March 2012 the volume was 61,334 a difference of -15% in 12 months.  Volumes are also only 38% of the peak volume seen in May 2002 and 64% of the long run average of this dataset.  Meanwhile house prices seem to be doing not much more than the dance of a damped sine wave since 2007.  So even with plenty of market manipulation including the Funding for Lending Scheme (FLS) and Quantitative Easing (QE), which have driven mortgage rates to record lows, this is the best that the Bank of England and UK Government can muster in terms of a market.  This is all shown in my first chart today.

Click to enlarge

This all looks pretty bad but it wasn’t until I read the Land Registry May 2013 HPI Statistical Report that I realised for normal people there no longer really even seems to be a market.  The table below shows the sales volumes by price range.  Look at the volumes for houses priced between £100,001 and £250,000.  They’re down between 17% and 27%.  In stark contrast volumes for properties greater than £1,000,000 are up between 15% and 24%.

Click to enlarge 

Jump to London and its insane house prices and the market is even more finished for all the Average Joe’s out there.  Between £100,001 and £250,000 volumes are down between 38% and 46%.  In comparison if you’re looking to spend over £1,000,000 then you have some competition with other would be “wealthy” future house owners with volumes up between 20% and 29%.

The FTSE 100 Cyclically Adjusted Price Earnings Ratio (FTSE 100 CAPE) Update - June 2013

Ever since Bernanke opened his mouth about potentially easing back (not stopping) on the amount of Quantitative Easing he is undertaking each month we've seen the price of many asset classes fall.  This has included the FTSE100.  Am I worried about it?  Well as a person who is investing large amounts every month into the markets the answer is no.  I hear you ask why.  Well if I use the FTSE100 as an example I’ll show today that both company earnings and dividends  are rising.  Therefore a falling price combined with rising earnings and dividends simply means a higher dividend yield and earnings yield.  That means that I'm simply buying the market at better value.

Let’s now run the numbers.  The last time we looked at this dataset was on the 30 April 2013.

FTSE 100 Price

In early morning trade today the FTSE 100 was priced at 6,160.  That is a fall of 4.5% when compared with the 01 May 2013 Price of 6,451.  It’s still 17.1% above the 01 June 2012 Price of 5,260.  How this pricing compares with history can be seen in the chart below.

Click to enlarge

This is a similar chart to that which you will see in many places within the mainstream media.  Let’s now remove the sensationalism 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 the compound annual growth rate (CAGR) in today’s £’s has only been 1.7%.  Correct it by the Retail Prices Index (RPI) and that falls to 1.0%.

Click to enlarge

FTSE 100 Earnings

As Reported Nominal Annual Earnings are currently 504, up from 481 on the 01 May 2013.  They are down 10.4% on last year and down 19.8% on October 2011’s peak of 628.  Or course this looks better than it really is as inflation flatters the result.  I therefore plot a chart below, again on a logarithmic axis, showing Real (inflation adjusted) Earnings performance over the long term.