Insuring Against Sequence of Returns Risk with the State Pension

Anybody who is intending to retire (particularly those taking early retirement) without a healthy Defined Benefit Pension or without knowledge of a guaranteed healthy inheritance should be wary of and maybe even have a healthy fear of sequence of returns risk.  It is the risk of receiving a series of investment returns that are negative (or lower) during a period when you are in portfolio/wealth drawdown which then never allows your wealth to recover even when investment returns normalise.

Blackrock have a couple of charts which demonstrate the phenomena nicely.  Firstly, let’s look at Sequence of Returns during the Wealth Accrual Phase (ie before Retirement).  The chart below shows 3 investors who each make an initial investment of $1,000,000 at age 40 and then never invest again.  Each has an average annual return of 7% but each experiences a different sequence of returns.  25 years later each has the same portfolio value even though valuations varied along the way.

Click to enlarge, Sequence of Returns during Wealth Accrual Phase

Now let’s look at Sequence of Returns during the Wealth Drawdown phase.  Again we have our 3 investors making the same initial $1,000,000 investment, the same average annual return of 7% with annual returns following the same sequences as during the Wealth Accrual Phase.  25 years later each have very different portfolio values with Mr White now forced to beg for food under a bridge.

Valuing the UK Equities Market (FTSE 100) - May 2015

My investment strategy requires me to moderate my equity holdings based upon my view of current equity market values.  I run this valuation monthly for the Australian (currently targeting 15.5% of total portfolio value at current valuation vs 17% at fair value), US (as a proxy for my international equities and currently targeting 10.4% vs 15%) and UK (currently targeting 19.0% vs 20%) Equity markets.  Let’s look at the UK Equity market in more detail.

Firstly nominal values.  Between yesterday and the 1st April 2015 (“month on month”) prices are up 3.3% and since the 1st May 2014 (“year on year”) prices are also up 3.3%.

Chart of the FTSE 100 Price, Click to enlarge

Regular readers will know I’m not a fan of this type of chart as:

• the unit of measure, £’s, is being constantly devalued through inflation (although in the current market one wonders for how much longer); plus
• Pricing should be plotted on a logarithmic scale as opposed to a linear one as by using this scale percentage changes in Price appear the same.  

So let’s correct the chart for the devaluation of the £ through inflation (I use the Consumer Price Index (CPI) here) and convert to a log chart.  This normalised chart shows that Friday’s FTSE 100 Price of 7,031 is actually still 25% below the Real high of 9,331 seen in October 2000.  We’re also still 14% below the last Real cycle high of 8,164 seen in June 2007.

Chart of the Real FTSE100 Price, Click to enlarge

Life’s Great Saving Hard and Investing Wisely for Early Retirement

This week as I was thumping up and down the motorway on my lengthy daily commutes I couldn’t help but take some glimpses of the current and potential future life that this journey to Early Financial Independence is providing.  There are of course negatives but the positives really did override my thoughts.  Let me share a few random musings.

Saving Hard

In a post back in March I shared a little about my personal life which included my ‘9 to 5’.  Today is my 397th post on Retirement Investing Today and that post is right up there when it came to Comments at 51 to date.  Some of them pointed to a punishing work life which prompted me to look around at my colleagues and I do agree that I work much harder than most but this is a little by design as I always want to stay in the top 10% of my peer group.  The rub is that what seems a negative to some is now just normal and on autopilot to me plus on the whole my health and wellbeing is as good as it has ever been.  The positive though is that this approach allows things like earnings increases of 44% in a year and I can already see a door potentially opening that may allow another step change in earnings.  So while I admit to being tired come Friday night I also think my colleagues probably are as well.  The difference is that I have an extra chunk of cash which I can save to power me towards Financial Independence Retire Early (FIRE) which means I’ll be done in the not too distant future and they’ll retire when the government lets them.

On the spending front I've also realised that Living Well Below My Means is now just an autopilot activity.  I no longer crave stuff and get zero satisfaction from consumerism.  I do still track spending religiously just in case I need to correct course but I no longer have any sort of budget and certainly don’t have a £0 one.

These two mind sets currently allow me to save 54% of gross earnings.  Sure it’s not at my target of 55% but do you know what – I really am starting to not care anymore.

Click to enlarge, Gross Savings Rate

Investing Wisely

My investment portfolio which is largely just a set of diversified tracker funds is running pretty close to plan through nothing more than passive portfolio rebalancing and to the end of April 2015 has grown by a Real (after inflation) Compound Annual Growth Rate after expenses of 4% since inception.  It’s also now pretty close to being an autopilot activity.

Click to enlarge, Performance of £10,000 within RIT Portfolio and Benchmark vs Inflation

One active element with my investment portfolio is of course my High Yield Portfolio (HYP).  Trailing dividend yield is a healthy 5.0% when compared to the FTSE100 at 3.5%.  Capital Gain since inception is also a healthy 38% vs 31% for the FTSE100.  Over the shorter term it’s not so rosy with Capital Gain year to date at 3.5% vs 6.0% for the FTSE100.  So this non passive piece is not quite on autopilot but the strategy is well defined and I'm still happy with the results.  The question I'm starting to ask myself though is can I really be bothered with it.  I'm going to watch it for a year or two more but if results do start to converge toward the index I may just go passive.

Valuing the Housing of England and Wales at County Level – Year 3

Every year in May I like to spend a few hours of my life that I’ll never get back preparing a house Valuation metric that goes beyond that generally presented by the mainstream media by getting more granular and trying to Value housing at County level.  This should then for example help us to understand if there really is a north south divide when it comes to housing.  Last year’s efforts can be seen here.

My definition of Value is simply how many years of gross earnings (median and average) are required to buy an average house.  This is a simple average Price to Earnings Ratio (P/E) and is not unlike how some might value a company share.  Importantly I am not interested in Affordability which is one’s ability to service debt at current interest rates and is what I think actually drives the UK housing market.  This is because I believe that the average punter doesn’t ask is this house good Value but instead asks how much can I borrow and then spends to that limit.

For House Prices I am using average house prices as published by the Land Registry. This is calculated by using:

• The Land Registry House Price Index (HPI) dataset.  This index uses repeat sales regression (RSR) on houses which have been sold more than once to calculate an increase or decrease.  As it analyses each house and compares the latest buying price to the previous buying price it is by definition mix adjusting its data also.  It uses all residential property transactions made in England and Wales since January 1995 so covers buyers using both cash and mortgages.
• Average prices are then calculated by taking Geometric Mean Prices (as opposed to an arithmetic mean), to reduce the influence of individual values, from April 2000 and adjusting these prices in accordance with the Index changes.  They are seasonally adjusted. I am using the latest published data which comes from March 2015.  

The Valuation analysis is arranged according to the Regions and County’s defined by the Land Registry and is shown in the Table below.  Unlike the mainstream media I am calling high house prices bad (unsurprisingly the County with the highest house price is London at £462,799 and is shown in dark red) and low house prices good (the County with the lowest house price is Middlesbrough at £62,546 and is dark green) with all other prices shaded between red and green depending on house price.

For Earnings I am using the 2014 Annual Survey of Hours and Earnings (ASHE) which provides information about the levels, distribution and make-up of earnings and hours paid for employees within industries, occupations and regions in the UK.  To ensure that our Earners and Homes are located within the same County I’m using the Earnings by Place of Residence by Local Authority.  This dataset presents weekly Earnings at both median (the middle point from each distribution) and mean (the average) levels which we have arranged into each Land Registry Region and County in the Table below.  I then multiply the data by 52 weeks to convert it to an annual salary.  I am calling low earnings bad (the lowest average earnings are £17,638 in Blackpool and are dark red) and high earnings good (the highest average earnings are £36,982 in Windsor and Maidenhead and are dark green) with all other earnings shaded between red and green depending on earnings.

Transferring my Company Pension into a SIPP – Part 2

On Saturday the SIPP of choice for my Company Pension transfer was heading towards Interactive Investor and their annual costs of £176.  Valued reader comments plus some more DYOR has instead led me to Hargreaves Lansdown.  Before you Comment that they are an expensive percentage fee broker/platform with annual charges of 0.45% let’s run through my thinking.

Firstly, dearieme highlighted that provided you stick with Shares, investment trusts, ETFs,
gilts & bonds and don’t add any funds Hargreaves Lansdown become a percentage fee broker/platform but with a capped maximum annual expense of £200.  I can work within that no fund criteria.  So now once your pension is greater than £44,444 that 0.45% starts to reduce.  Transfer £100,000 and it’s down to 0.2%.  On top of that John and Cerridwen also raised some red flags against Interactive Investor.

Secondly, even though the SIPP is now capped I hear you saying that it’s still £24 a year more expensive than Interactive Investor and sweating the small stuff matters.  This is where it gets interesting.  Hargreaves Lansdown currently have a promotion running until the 12 May 2015 that provides a cash back incentive for transfers of Stocks & Shares ISA’s, Cash ISA’s, Junior ISAs/Child Trust Funds (CTFs), Funds, Shares and Pensions.  They also advise that “if you need more time to decide please let us know and we will extend this deadline for you (up to three months for ISA, fund and share transfers, and six months for pensions).”  Transfer big sums and it’s a significant amount.  Between £100,000 and £124,999 and its £250 cash back which means you’re now ahead of Interactive Investor’s current annual charges for 10 years.  Transfer £125,000 or more and its £500 which puts you ahead for 20 years.  Dealing costs for me are going to also be £1.95 more expensive than Interactive Investor but I think I can set the SIPP up with 9 trades which would take a bit under 1 year off that benefit.

I highlighted in Saturday’s post that the reason for not just using my current YouInvest SIPP was the all eggs in one basket risk.  I currently have some of my HYP in a Hargreaves Lansdown Vantage Fund & Share Account and so adding a Hargreaves Lansdown SIPP will increase my exposure with this provider from 6% to 21%.  I’m ok with that level of risk.

So by switching from Interactive Investor to Hargreaves Lansdown I can save some money while also moving to a wrapper that I know and am happy with while keeping provider risk to acceptable levels.

Transferring my Company Pension into a SIPP

About half of my current monthly savings are salary sacrificed into my employers Defined Contribution Pension plan.  I do this over adding directly to my own personal SIPP for a few reasons:

• My employer matches contributions up to a certain level;
• My employer adds the majority of the employers National Insurance that they save into the pension; and
• The 2% employee National Insurance that I would have paid is also able to be added into the pension

Wealth Warning: Before I proceed it’s worth reinforcing that my employer pension plan is a Defined Contribution Pension and not a Defined Benefit Pension.  It also provides absolutely zero additional benefits.  If it was or did either of those things what I describe below may not be the right approach.

These benefits definitely outweigh the high 0.6% to 0.76% expenses I'm then paying for trackers and the lowest cost active funds (where a tracker is not available) within the Pension.  That said if I could find a way to get the money in through salary sacrifice as I do today but then transfer at regular intervals into my SIPP I’d get all the salary sacrifice benefits of the company pension as well as all the low cost benefits of a DIY SIPP.  This effect would be noticeable as I've been with my current employer for a large portion of my Financial Independence Retire Early (FIRE) journey meaning some 15% of my total wealth is now held within the company pension.  I estimate it would reduce my total wealth annual expenses from 0.31% per annum to about 0.25%.  0.06% doesn't sound like much until you run the numbers and realise its £60 per annum if your wealth is £100,000 and £600 per annum on £1 million.

Regular readers will know I've been trying to find a way to do this for some time.  I've tried two different angles:

• Get my employer to open me a new Pension policy with them salary sacrificing into that new account.  The old account would then be dormant allowing a trivial SIPP transfer by simply filling out the short transfer form that is available from any SIPP provider.  Unfortunately my employer wouldn't budge here as it was just too much “admin”.
• Ascertain from the insurance company who provides the Defined Contribution pension if and how this can be done.  They obviously have a vested interest in being as slow and obstructive here as possible.

I am however pleased to announce that many emails, phone calls and a lot of time later I have achieved success.  In case any readers are trying to do something similar the form I needed is what is called a Declaration of Claim Discharge which is a simple 2 page form which importantly includes a section called a Partial Transfer Request which enables me to check a box entitled “If you wish to move the ‘maximum amount’, please tick the box opposite”.  All I have to do is complete this form and then attach it to the SIPP transfer form from my chosen SIPP provider and I'm away.

The £0 Budget

A lot of my posts in more recent times have been focused on how to earn more and spend less.  I acknowledge they’re pretty dry topics, quite personal and certainly nowhere near as exciting as deciding should I buy the Vanguard FTSE Emerging Markets UCITS ETF or the iShares Core MSCI Emerging Markets IMI UCITS ETF for the Emerging Markets portion of my portfolio.  So why do I keep coming back to the non-exciting topic of earn more and spend less?  Simply because my personal journey has shown me thus far that saving has a much bigger impact on reaching Early Financial Independence or even Early Retirement than investment return.  While investment Compound Interest is for sure a very important concept, particularly over the long term, and is certainly making a contribution it’s just not making as big a contribution as my saving.  This is not what I expected when I started on my journey.

Let’s have a look at my journey data thus far in the chart below.  This chart shows for each year (2015 is only until end of March and so shows as 2014.25) the percentage contribution made to my change in wealth each year from both Saving Hard and Investing Wisely.  Therefore the percentage for each year that shows as greater than 50% has been the greatest wealth contributor for that year.  So in 2008, 2009, 2010, 2011, 2013 and 2014 the honour of most wealth growth contributor has gone to Saving.  In contrast 2012 and 2015 year to date has gone to Investment Return.  So even in year 7 of my Financial Independence Retirement Early (FIRE) journey Saving is still out in front.

Click to Enlarge, Wealth Growth Year on Year

Of course regular readers will know my Savings Rate is quite high and I’m trying to reach FIRE quickly but I'm not going to make apologies for that.  As savings rate decreases journey time to the goal, whether it’s FIRE or some other objective, should increase with an average wind which should mean that Saving will make less of a contribution and Investment return a greater one.  So maybe I'm just an anomaly given I'm trying to reach Financial Independence in less than 10 years.

Buying Gold – April 2015 Update

With Gold well off record highs the mainstream media currently have no interest in the precious as they need sensational headlines.  Even the blogs, unless the owners are predisposed to tin foil hats, are these days rarely mentioning the yellow stuff.  I'm going to mention Gold today though and I can assure you that all tin foil is still firmly located in the kitchen.  I'm mentioning it as I've just bought a healthy dollop.  It was the fourth place I deployed my bonus.

I bought the ETF Securities Physical Gold ETC (Ticker: PHGP) which is physically backed with allocated metal subject to LBMA rules for Good Delivery, has UK reporting fund status, is ISA eligible, SIPP eligible, is priced in £ and has a Management Expense Ratio (MER) of 0.39%.  I paid £77.47822 a unit so with prices closing at £78.12 on Friday I'm up a little.  Not that I'm worried as I am prepared to hold for a long time.

Let’s look at some Gold numbers.

My first chart shows how the Monthly Gold Price in Pounds Sterling (£’s) has changed since 1979.  Over the past year its Price has risen 3.5%.

Click to enlarge, Gold Priced in Pounds Sterling (£) 

Regular readers will know that I despise these nominal charts that are so often presented because the unit of measure they are presented in is continually being devalued by inflation.  Let’s therefore correct for that and show the Real Gold Price in Pounds.

A Retirement Investing Today Q1 2015 Review

The primary purpose of this blog is to hold myself accountable and chart my progress to Early Financial Independence (FI).  At FI my wealth will also be sufficient to make Early Retirement optional at the same time.  This is not a model or demonstration but my real DIY financial life.  Get it right and it’s smiles all round in a short period of time.  Get it wrong and my derisory State Pension is still a long way off and likely to get longer still given the financial and demographic state of this great country.

In line with my Plan, Do, Check, Act (PDCA) strategy let’s today some Checking by examining 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.  It’s a different and tougher measure to most of my fellow personal finance bloggers who don’t include tax in the calculation.

Savings Rate for the quarter ends at 53.8% against a plan of 55%.  While a miss it’s a lot better than the 37.2% I managed for the first quarter of 2014.  Additionally in physical pounds, shillings and pence in my pocket it’s more than twice as much as Q1 2014.  The miss was also a conscious decision with the RIT family taking a winter trip to Puglia, Italy to assess the location as a possible Early Retirement location.  At these savings rates I'm also now in the surreal situation where my spending is significantly less than the tax I pay.

Click to enlarge, RIT Savings Rate

Saving Hard score: Conceded Pass.  Savings, including help from a healthy bonus where I saved 100% of the after tax amount, have added 5.7% to my net wealth in this quarter alone.  My big problem remains taxes which I'm struggling to control as I'm a simple PAYE employee.  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 continue to grow in size I'm being taxed on these as well.

INVEST WISELY

Investment returns for the first quarter of 2014 were 5.8%.  An incredible amount given the structure of my portfolio.  This return means for only the second time in my investing career investment return has exceeded savings rate.  Is compound interest finally starting to do its thing or has Mr Market just become a little excited?

Click to enlarge, RIT Year on Year Change in Wealth

My investing strategy remains largely in line with that developed at the start of my DIY journey except in recent times I've started making 2 tweaks given my closeness to Financial Independence.  The first is to increase cash like holdings to give the option of a family home purchase.  Cash moves from 8.2% of portfolio value at the end of 2014 to 9.4% at the end of the quarter.  Increasing portfolio dividends to 3% of non-home purchase wealth on the other hand is not going so well even though I continue to add to my HYP.   At the end of 2014 I was at 2.3% and today this has fallen to 2.1%.  Not much I can do here as it’s simply been caused by the Mr Market price rises over the quarter and is not something I can control.  My plan is to just keep at it and see what washes out in the next 12 months or so.  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.

Safe Withdrawal Rate (SWR) Thoughts

Many of us in the Early Financial Independence, Early Retirement, community are chasing an amount of wealth which when achieved will allow us to as a minimum call ourselves financially independent and as a maximum allow us to head into full early retirement.  To calculate that target wealth number it’s likely (I know I have) we've ascertained how much we intend to spend per annum and then divided that number by a Safe Withdrawal Rate (SWR) we’re happy with.

The 4% Rule is a SWR that is bandied about freely as a rule of thumb.  Personally it’s too bullish for me and so as I type this I'm planning on an SWR of 2.5% plus 0.25% to allow for investment expenses for a total withdrawal rate of 2.75%.

When we choose a SWR we’re likely trying to calculate the maximum real inflation adjusted annual income we can take while ensuring we don’t run out of wealth before we run out of life.  In doing so what we are really doing is trying to protect ourselves from worst case sequence of returns risk.  In trying to protect ourselves from this sequence of returns risk (and assuming history repeats which we all know is not guaranteed) we actually end up with a scenario where in the vast majority of cases we end up with a lot more wealth than we started with at check out time.

Let me demonstrate with an example.  To do this I'm going to teleport myself to the US and use the excellent cFIREsim calculator as we’re pretty starved of decent free tools here in the UK.  I'm going to assume I retire with one million dollars ($1 Million), give myself a 60% US Equities : 40% US Bonds asset allocation, spend at an inflation adjusted $25,000 per annum (a 2.5% SWR), assume annual expenses of 0.25% and assume I need that level of spending for 40 years.  The output of that simulation is shown below:

Click to enlarge, cFIREsim output

How about those falling iron ore prices – Adding Rio Tinto to my High Dividend Yield Portfolio

While those around me at work are talking about the holidays, fashion and gadgets they have bought with their bonuses I've kept fairly quiet as I have chosen to save 100% (after HMRC has of course taken 40% Higher Rate Tax and 2% National Insurance) of mine.  So having saved all of it where have I invested it wisely?  I've gone for 4 main areas and I’ll cover 3 of them today, saving the fourth for a separate post.

The first deployment was sending 35% of the bonus to my better half to keep both of our financial independence end dates synchronised.

With only 18 months or so to go until Financial Independence I also want to make sure that I have positioned my financial life to also give myself the option of Early Retirement.  From where I am today this means I need to do two things:

• I am currently renting in London but want to give myself the option of buying a home in whichever country my family chooses.  I therefore need cash for this and lots of it.  My second deployment was therefore sending 33% of the bonus to my savings account and RateSetter P2P account (plus a little to my Stocks and Shares ISA which is yet to be invested so is currently cash but ensures I've at least used all of my 2014/15 £15,000 Allowance).
• I don’t like the idea of having to sell down assets to eat in Early Retirement and would much prefer to be simply spending dividends/interest with a little left over to invest.  After I net off the cash I've saved for a home my investments are currently yielding 2.1% and I’m planning on drawing down at 2.5% after investment expenses.  I therefore need to find ways to improve my dividend yield and fast.  My High Yield Portfolio (HYP) is one way I have been trying to do this.  My third deployment was therefore 15% of the bonus into Rio Tinto (Ticker: RIO).  So why Rio Tinto?

The price of the FTSE100 is today near record nominal highs (the real high is something different altogether but that’s for another day). In comparison the price of Rio Tinto is almost half of previous highs:

Click to enlarge, Price History of Rio Tinto (Source: Yahoo Finance)

To FIRE Fast we must know what we really Value

I think we've had enough about what I eat for breakfast and what I want to be when I grow up for now.  Let’s get back to what this blog is all about – an unrelenting focus on Saving Hard and Investing Wisely to enable Early Retirement in my case.  Your end game could of course be different.

I work hard for the money that I earn.  Given how much effort I've put into acquiring it the least I can then do is now put a bit of effort into retaining as much of it as possible.  Why?  Well, now that I have some money in my pocket I'm up against millions of people and corporations trying to extract as much of that money from me as possible.  It’s nothing personal but just the way it is.  Importantly, it’s also not just the big purchases.  I’ve found that sweating the small stuff is possibly more important because leakages here often have very little impact on your health and wellbeing.

So why at this stage do I want the minimum extracted from me while still living the life I want to live?  For me it’s not emotional and is simply by learning how to spend less I can save more which is then an enabler to help me FIRE faster (Financial Independence Retire Early).  Seven and a half years into my journey I'm at the point where this is probably the most important lesson I have learnt thus far.  Sure earning more helps but that just helps accelerate you to the goal posts and minimising investment expenses/taxes also helps but I’ve found savings have had a bigger impact on my wealth creation so far as the short time I have given myself to accrue the assets to FIRE don’t get much time to compound.  Spend less and two things occur which is why it is a critical element – it both moves you more quickly towards the goal posts but also moves the goal posts towards you.

Am I Making a Mistake?

Security of employment is not what it was once.  Changes including globalisation, technology, automation and lean (lean is basically doing more with less through the elimination of waste), amongst others, have sent it well on its way.  We see lack of security of employment manifest itself in many ways with one of the more recent ones making headlines in the mainstream media being zero hours contracts.

The problem with this change is that without security of employment there is always the risk of starving to death (maybe an extreme example given the UK’s welfare state status, but certainly not in some countries and hopefully you get my drift).  According to Maslow’s Hierarchy of Needs inability to correct for this deficiency need (or d-need) then prevents one from ever reaching Self-Actualisation which is essentially the realisation of your full potential.

Click to enlarge, Source: www.convene.com

Personally, in my current career I’m also under no illusion of having any sort of security of employment.  I know that my current security is linked to nothing more than my last performance review or (not and) nobody anywhere else in the world being able to offer the equivalent service for a lower cost.  Part of this is within my control, but mistakes do happen, and part of this is outside my control.

With time I’ve come to realise that my solution to this problem in the short term has been to keep my skills current (the 1% inspiration) and then work hard (the 99% inspiration).  So far this is working with a recent notification that I’ll be receiving a salary increase of 4% and a bonus that exceeds my notional amount in recognition of my performance last year.  I never thought too much of this work hard approach, including was it too extreme, but when readers last week made comments like;

“I appreciate this is the path you've chosen, and for well thought out reasons, but your hours of work sound awful“;

and;

“Holy s**t - good job you have an escape plan as that is a brutal life you currently have carved out for yourself - 16 hour days!  You must be tough as nails!”;

it really did make me take a step back and think.

My Non-Financial Life

This blog is focused on charting my progress to Financial Independence and optional Early Retirement.  By having to continually to write about it I am forced to stay the course because I’m continually held accountable.  You the reader get to see my journey, warts and all, which also includes most of the financial research I do behind the scenes.  It stays very unemotional and fact based as that’s what personal finance in my opinion should be.

Behind all this though is a living breathing human being and also my family who are personally affected daily by what I publish here.  I rarely write about this side for a few reasons:

• At this time my anonymity is important.  I don’t think this will always be the case but right now it’s probably not a good idea if my boss knows I might retire in 18 months at 43 years of age;
• This is a personal finance site and not mumsnet;
• Even though I'm a STEM graduate it’s the financial side including all the planning that I've found the most difficult.  Executing on it including finding ways to Earn More, Spend Less by Living Well Below Your Means, Spend Less by effectively opting out of consumerism or even Spend Less by sweating the small stuff I haven’t found difficult at all; and
• Finally but importantly while achieving Financial Independence by 43 is pretty exciting stuff knowing that I eat Weetabix (I don’t BTW because I wouldn't buy a more costly brand when equivalent lower cost alternatives are available) for breakfast probably isn't.

All of that said it is of course relevant for anyone considering, but not currently on, a similar journey to my own.  Some 7 and a bit years on it’s now just the life my family and I live but thinking back our personal lives have changed a lot.  This was reinforced this weekwith a reader making the following comment:

“Have you previously posted on what you get up to in your daily life? I have a lot of respect for what you're achieving and would enjoy hearing how you enjoy daily living while being frugal. When last did you go on holiday? What do you do for entertainment? Etc. Does that make sense? Just trying to get a feel for the types of adjustments I'd have to make.”

So without further ado let me give some insights into how I live my personal life.

18 Months to Go?

6 Months ago, almost to the day, I made the bold statement that I had 2 Years to Go before Financial Independence beckoned and optional Early Retirement was staring me in the face.  If I'm on plan for that then today I need to be writing that I have 18 Months to Go.  So do I?  As always let’s run the numbers.

Saving Hard

One of the key pillars of my overall Retirement Investing Today strategy is to find ways to earn as much as possible while finding ways to spend as little as possible by living healthily and intentionally well below my means.  The difference between the two is savings that can be invested to start working for me.  So how have I done on this front given that to be successful I need to maintain a savings rate of 55% of gross earnings, which I define as Savings plus Employer Pension Contribution divided by Gross Earnings (ie before HMRC takes their portion) plus Employer Pension Contribution?  Against that 55% target I've actually averaged a savings rate of 53.9% over the last 6 months.

Note that here I don’t include any investment returns, EBay sales, savings account interest, credit card cashback or 5p coins picked up on the roadside as earnings.  I do however make it hard on myself by counting the tax from both my salary and investments/interest as spending which encourages me to structure my finances as tax efficiently as possible.

On a chart my savings look like this:

Click to enlarge

So I've failed to meet this objective but I'm actually still happy with the result.  Why, because you’ll see the savings dip occurred just before and just after the end of 2014 during which time as a family we conducted some Early Retirement research by spending some time in one of our preferred Early Retirement locations – Puglia, Italy.  We went in the depths of winter as we know that part of the world is beautiful in summer as a tourist but we’re talking about living there permanently and so wanted to see it in its worst light.  The conclusion?  As a tourist location it’s still a pretty impressive part of the world:

Click to enlarge, Trullo in Alberobello, Puglia

Active vs Passive Portfolio Rebalancing

When I set out my Investing Strategy some years ago, which included my initial asset allocation as well as how that allocation would change over time, I effectively established a portfolio risk vs return characteristic.  Over time that asset allocation has and will continue to change as different asset classes provide different returns in relation to each other.  To recapture the required portfolio risk vs return characteristic I then need to periodically rebalance the portfolio.  Importantly, I rebalance to manage risk rather than to maximise returns.  Over the years I've found that I follow effectively two types of rebalancing – what I call Active and Passive Rebalancing.

Active Rebalancing

Active is what you will predominantly read about in books or online.  There is not much conflict out there as to what it is.  It is simply selling down the assets that have performed the best and using those funds to top up those assets that have performed the worst.  What you will see plenty of conflict about is the frequency of when you should rebalance.  I've seen preset frequencies talked about which could be monthly, quarterly, half yearly, annually or even longer periods.  It could also be triggered by a memorable date such as a birthday or the New Year.  Personally I'm conscious that every time I rebalance Actively it’s likely I’ll be staring down the barrel of trading expenses, possibly taxes and certainly lost time that could be spent doing something else.

With this in mind and given my whole mantra has always been to minimise expenses and taxes I instead adopted and have stayed with a valuation based rebalancing approach.  This is not complicated and is simply if any asset allocation moves more than 25% away from a nominal holding I will either sell or buy (as appropriate) enough of that asset to move the allocation back to nominal.  This methodology plus the Passive Rebalancing element, which I’ll cover in a minute, has meant I've been forced to do very infrequent rebalancing.

Why I Hold Gold in my Portfolio

In my experience if you’re discussing UK Equities as part of an investment portfolio its validity is unlikely to be challenged and any response is likely to be fairly passive.  A typical response might be something like what percentage allocation do you have.  If you say to somebody that you hold Gold then the responses can be far more variable.  At the extreme they can range from I don’t believe in Gold as an investment as it doesn’t pay a dividend because it just sits there looking shiny to I’m 100% invested in Gold, guns, ammo and tinned beans.

Within my own portfolio I target a holding of 5%.  So why do I hold gold?  It’s for the same reason that I buy property or gilts on top of my equities.  To quote Bernstein’s The Intelligent Asset Allocator it’s simply because ‘Dividing your portfolio between assets with uncorrelated results increases return while decreasing risk’ which is a key concept within Modern Portfolio Theory (MPT).  Bernstein continues with ‘Mixing assets with uncorrelated returns reduces risk, because when one of the assets is zigging, it is likely that the other is zagging.’  The keyword in the first quote is uncorrelated.  In the book he works up some examples to validate these statements.

Let’s run a simple analysis looking to see if we can find an example of gold being uncorrelated with another asset class.

My first chart shows how the Monthly Gold Price in Pounds Sterling (£’s) has changed since 1979.  Over the past year its Price has fallen by 0.6%.  We looked in detail at the FTSE100 last week so let’s use that as a different asset comparator as that dataset is up to date.  Over the past year the Price of the FTSE100 has risen 7.0%.

Click to enlarge

Diverting quickly for completeness, as I always like to show charts in Real terms to remove the emotion that comes with the unit of measure continually being devalued by inflation, let me quickly also show the Real Gold Price in Pounds.

Click to enlarge

Valuing the UK Equities Market (FTSE 100) - February 2015

I have an investment strategy that requires me to moderate my equity holdings based upon my view of current equity market values.  I run this valuation monthly for the Australian, US and UK Equity markets.  While I run it monthly I've just realised that I haven’t shared that analysis for the UK market for 4 months now.  So without further ado let’s run the numbers for all to see.

Firstly nominal values.  Between yesterday and the 2nd February 2015 (month on month) prices are up 5% and since the 3rd February 2014 (year on year) prices are up 6.3%.

 Click to enlarge

Regular readers will know I'm not a fan of this type of chart as:

• the unit of measure, £’s, is being constantly devalued through inflation (although in the current market one wonders for how much longer); plus
• Pricing should be plotted on a logarithmic scale as opposed to a linear one as by using this scale percentage changes in Price appear the same.  

So let’s correct the chart for the devaluation of the £ through inflation (I use the Consumer Price Index (CPI) here) and convert to a log chart.  This normalised chart shows that Friday’s FTSE 100 Price of 6,874 is actually still 26% below the Real high of 9,317 seen in October 2000.  We’re also still 23% below the last Real cycle high of 8,152 seen in June 2007.  We are therefore a long way from previous highs.

Click to enlarge

The Investment Products to Build a Portfolio should be Trivial : Time Suggests Otherwise

Once you’ve done plenty of your own research (which in my opinion must include a thorough read of Tim Hale's Smarter Investing: Simpler Decisions for Better Results), decided upon the different asset classes that will form your balanced investment portfolio and then decided on the percentage allocation to those different asset classes it’s time to select (and buy) the Investment Products that will give you that real world balanced portfolio.

The theory says that this should be trivial and achievable with only a small amount of products.  At an extreme it could be nothing more than a Vanguard LifeStrategy Equity Fund.  Having now been at this investing game for over 7 years I've personally found that in its infancy you will need more products than you really should and you’ll also not always be able to select the optimum products so will end up with compromise.  Then as time progresses you will end up with more and more stamps for your stamp collection.

There are many reasons for this but some might include spreading provider (whether wrapper and/or investment) risk, new products that give benefits over what you currently hold, inability to buy your preferred product in a particular account, tinkering because personal finance is a hobby and even as a result of some good old fashioned investing mistakes.

Let me demonstrate with my own investment portfolio.  These are the top level asset classes and allocations to each class I'm currently holding:

Click to Enlarge

Looks simple doesn’t it?  Now let’s look in detail at ALL of the investment products that make up my portfolio.

UK Equities:

• Vanguard FTSE UK All Share Index Unit Trust (Income).  This fund tracks the FTSE All Share Index, has a TER of 0.08% and a Stamp Duty Reserve Tax at initial purchase of 0.2%.  I'm happy with this fund however there is one small consideration that would make me 100% satisfied.  I'm with the ermine in that psychologically during retirement I would very much prefer to live only on dividends rather than having to also sell down capital.  In partial conflict with this the Vanguard fund pays dividends only once per year.  One idea to keep expenses low but increase dividend frequency would be to create a pseudo All Share Index.  85% of the FTSE All Share Index is the FTSE100 Index with the majority of the remainder being FTSE250.  By buying 75% Vanguard FTSE100 UCITS ETF (VUKE) and 25% Vanguard FTSE100 UCITS ETF (VMID) results in a TER of 0.09% but dividends paid quarterly instead of yearly.  At this time I won’t act on this as in retirement I’ll be keeping at least 12 months essential living expenses in cash so should be able to manage with annual dividends.
• My High Yield Portfolio (HYP) which continues to build nicely.  This portfolio has a TER of 0.0% (but it does have buy/sell dealing fees and 0.5% stamp duty on initial purchase) and as a believer of expenses matter that’s fine by me.
• I'm generally happy with what’s going on with the UK Equities portion of my portfolio.

Increase Earnings to Accelerate Progress to Financial Independence

UK pay or earnings seems to have reached the main stream media again.  By my calculations Average Whole Economy Annual Earnings are increasing at a rate of 1.7% with inflation over the same period at 2.0%.  So on the whole the average punter’s purchasing power continues to be eroded.  To be honest I can’t say I'm surprised and think this is going to continue for a long time yet.  As the world continues to globalise then the difference between poorer salaried and richer salaried countries must close.

The Private Sector is fairing a little better than average and has kept pace with inflation having risen by 2.1%.  Austerity does look to be biting the public sector though with increases of 0.8% which is well below inflation.

The chart below shows the wider real adjusted for inflation UK earnings story.  The summary is pretty simple – real UK earnings for both the public and private sectors are still well below those of 2007 to 2009.  Though is that a sustainable uptick I can start to see beginning to occur before me?  Given what I’ve said above I’m not convinced.

Click to enlarge

For anyone seeking Early Financial Independence, giving the option of Early Retirement, finding methods to increase earnings is extremely important.  Importantly this does not have to mean increasing your day job earnings but instead can involve a new business, a second job, a side hustle, even selling stuff you no longer need now that you’ve opted out of consumerism so think creatively. So why is it important?  I believe there are 3 elements to reaching the Financial Independence – generating cash savings, investing those savings to gain a return and then understanding how much wealth you need to accrue and how to manage it before calling it a day.

The RateSetter Experiment (6 month update)

My low charge investment portfolio today holds 7.4% of my total wealth in cash.  I currently use 2 main repositories for this.

Click to enlarge

The first of these is a Yorkshire Building Society (YBS) Savings Account which 6 months ago was earning an interest rate of 1.25% AER.  Looking today they seem to have stealthily reduced that to 1.24% AER for which I have received no notification.  YBS, if you’re reading this, I hope you make good use of that extra 0.01%!  As a higher rate tax payer and with inflation now running at 2.1% this savings account is allowing my savings to be eroded at the rate of 1.36% per year.  So every day that goes by a pound held in this account has less purchasing power than it did the day before.  I’m going backwards.  If you happen to be a basic rate taxpayer then you’re also going backwards, albeit at a more leisurely 1.11%.

Little to no movement here is of course no surprise given the latest average savings account data from the Bank of England shown in the chart below.  It shows instant access savings rates up a mere 0.03% in the last 6 months.

Click to enlarge

What alternative do I have?  Well moneysavingexpert.com tells me the Santander 123 current account which pays interest of 3% AER on balances between £3,000 and £20,000 is still hanging around.  It of course also comes with a monthly fee and minimum deposit requirements but it also offers cashback opportunities although I already get that with my American Express Platinum cashback credit card.  Personally, I prefer clean simple accounts and today that looks to be Coventry Building Society with a 1.4% interest rate but these accounts can’t be run online.  I mean honestly an account that cannot be accessed and managed online.  Do the Directors have shares in Royal Mail or something or are they just trying to grab headlines...  For now I’ll just leave what I have in YBS and continue to deposit new savings into my second newer different risk profile repository, Peer to Peer lending (P2P).

How about those falling oil prices – Adding BP to my High Dividend Yield Portfolio

Unless you've been living under a rock you will be very familiar with oil prices falling for a few months now.  Regular readers will know that I have a monster commute so I’m certainly noticing the difference at the petrol pump.  That said I also have Royal Dutch Shell within my High Yield Portfolio (HYP) which as I write this post is now under water by 15.3%.   Search online for some oil data and you won’t have to go far before you find a chart not unlike this:

Click to enlarge

I have a problem with these types of charts because the unit of measure used to compare oil against is being constantly devalued through inflation.  Let’s therefore correct for that:

Click to enlarge

With West Texas Intermediate Oil (WTI) for February delivery settling at $48.69 a barrel on the New York Mercantile Exchange the real oil price is certainly now below the trend line.  It’s also 15% below the real average of $57.08 but it’s 7% above the real median price of $45.57.   What do you think, is oil now over or under valued?  Personally, I’m not even going to think about it because I’ve proven in the past that I’ll probably lose money if I do.  What I do know is that the oil price change has had a big effect on the share price of Oil & Gas Producers like Shell and BP.  It’s also had a big effect on Oil Equipment, Services & Distribution companies like AMEC Foster Wheeler and Petrofac.

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%.

Click to enlarge

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.

The High Yield Portfolio (HYP) – Year 3

We've just completed the 3rd calendar year for my real life, warts and all, High Yield Portfolio (HYP) that’s still in the accrual stage.  While at the moment it only forms a small portion of my total wealth I keep a close eye on it for 2 reasons:

• Ideally at the point I reach Early Financial Independence I can have enough dividends being spun off that should I choose to Retire Early I can be in a situation where living expenses can be covered by dividends and interest only plus a bit.  I think psychologically this would be easier than having to sell down assets to live from.  With me targeting a withdrawal rate of 2.5% of wealth I'm targeting dividends and interest after I net off the cash I’ll need for a home of 3%.  Today I'm at 2.4% so have a way to go yet and the HYP is key to increasing that value.
• With the majority of my wealth being tied up in index trackers this is one of the few areas where I'm stock picking and trying to beat the market.  It’s fine to have a high dividend yield but if my total return (dividends + capital gains) can’t beat a simple FTSE tracker over the medium term then I might as well pack it in, buy that tracker and accept I may have to sell down some assets in retirement.

The HYP today now has 12 stocks.  These are:

• Sainsbury’s.  Bought on the 28 November 2011 and currently sitting on an annualised capital loss of -5.7% and a forecast dividend yield of 5.4%.
• Astra Zeneca.  Also bought on the 28 November 2011 and currently sitting on an annualised capital gain of 17.2% and a forecast dividend yield of 3.9%.
• Scottish and Southern.  Again bought on the 28 November 2011 and currently sitting on an annualised capital gain of 7.7% and a forecast dividend yield of 5.5%.
• Vodafone.  First bought on the 21 December 2012 and then sold on the 21 January 2014 to avoid the Verizon Wireless sale palaver.  Then re-bought on the 30 April 2014 for an annualised capital loss of -1.9% since re-purchase and a forecast dividend yield of 5.1%.
• Royal Mail Group which is not strictly speaking HYP but I lump it here as I have no other holding like it within my portfolio.  I saw it as a government bribe and it’s turned out to be exactly that with an annualised capital gain of 22.4% and a forecast dividend yield of 5.0%.
• HSBC.   Bought on the 30 March 2014 and currently sitting on an annualised capital loss of -2.6% and a forecast dividend yield of 5.3%.
• Royal Dutch Shell.  Bought on the 30 June 2014 and currently sitting on an annualised capital loss of -22.4% and a forecast dividend yield of 5.3%.
• Pearson.  Also bought on the 30 June 2014 and currently sitting on an annualised capital gain of 2.1% and a forecast dividend yield of 4.3%.
• GlaxoSmithKline.  Bought on the 01 August 2014 and currently sitting on an annualised capital loss of -8.1% and a forecast dividend yield of 5.8%.
• Amlin.  Bought on the 29 August 2014 and currently sitting on an annualised capital gain of 14.8% and a forecast dividend yield of 6.3%.
• BHP Billiton.  Bought on the 29 September 2014 and currently sitting on an annualised capital loss of -54.7% and a forecast dividend yield of 5.1%.
• Tate & Lyle.  Bought on the 31 October 2014 and currently sitting on an annualised capital loss of -13.4% and a forecast dividend yield of 4.8%.