Saving Hard – We’re An Interesting Bunch

Thanks to all readers who took part in the earnings and savings poll.  The results make for some very interesting reading but before we go there let’s just take a second to review what we were really looking at with this poll.

I see three distinct phases when it comes to personal finance.  I summarise it as Save Hard, Invest Wisely and Retire Early but these phases could be called many things.  In a little more detail:

• Save Hard is how we go about building capital that we can then deploy to investments that hopefully with time will give a return on that capital.  For me, and I'm sure many other readers, that is earnings from the day job that aren't spent on living today.
• Invest Wisely is how we go about maximising the return on the capital we've built from Saving Hard.  For me that’s a balanced portfolio of different asset classes invested as tax effectively and at as low a cost as possible.
• Retire Early is how big the capital pile needs to become before the goal is achieved.  For me I’m chasing enough wealth to be Financially Independent and have the option of Early Retirement but there are many other reasons why we might want to build capital.  Having a Retire Early reason is important.  Without it there is no reason to build the capital in the first place and you’re probably then just hoarding.

The polls were really looking at the Save Hard portion.  The first question asked was what are your gross annual earnings?  The results are surprising particularly when I chart them below against UK individuals who have some liability to income tax.  The surprising part is just how much we all earn.  For example 19.4% of us earn more than £100,000 a year!  In the UK that puts those readers in the top 2% of UK tax payers.  The median reader earns between £40k and £50k per year where across the UK median earnings are only £20,300.  A RIT.com median reader is earning somewhere between 2 and 2.5 times that of the UK as a whole!  The mode of readers is also £40k to £50k however across the UK it is only £10k to £20k.  These high earnings then give us all a fantastic chance to save if we live below our means and we don’t disappoint there.

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The Typical RIT.com Reader

When presenting my current financial situation or giving quantitative examples about financial problems (whether as thought experiments or actual experiences) regular readers will have probably noted that I typically always try and talk in percentage terms rather than absolute numbers.  Why do I do this?

Firstly, let me demonstrate what I’m talking about with a simple example.  Let’s say in Early Retirement I have calculated that my spending will be £20,000 per annum before tax and I've decided that I will drawdown on my wealth at the rate of 2.5%.  Running the maths tells me that I’ll need to accrue £20,000 / 2.5% = £800,000 of wealth before I'm financially independent and can take an early retirement that doesn't require any extra earnings other than those that come from the portfolio in the form of dividends, interest or capital gains.  I’m still a bit short of the target at the moment having only £500,000 stashed away in various asset classes.  There would be two ways I could present these facts:

1. Simply state that I’m going to draw down at 2.5%, will therefore need £800,000 and have currently amassed £500,000; or
2. State that I have now accrued 62.5% of the wealth I need to Retire Early which requires a little more work.  The calculation is simply £500,000 / £800,000 = 62.5%.  I choose to present this way.

So back to the original question, why only talk percentages rather than absolute numbers?  Simply because every reader including myself is an individual with different earnings, wealth targets, wealth requirements, needs and wants.  Therefore the fact that I have £500,000 currently invested is completely irrelevant to every reader but me.  However some of the principles or theories that I or other readers valuably contribute via the Comments could be very relevant making it worthwhile to go off and conduct further research.  What I have however found is that when I stray away from percentages the thought I’m trying to get across can be lost amongst the discussion about the numbers used.

It’s All About Living Well Below Your Means

I've mentioned previously in passing that as I build the wealth necessary to reach Early Financial Independence I'm noticing that the major wealth contributor for me has actually been the Saving Hard portion of my strategy rather than the Investing Wisely.

Let’s firstly quickly remind ourselves of what each portion contains.  Saving Hard is the methods used to acquire Capital for investment.  For me that is a full time professional career with Megacorp where I’m continually working to Earn More, as well as continually working on methods to spend less, while achieving the standard of living my family desires.  The spending less is typically called Living Below Your Means or LBYM in the financial independence blogosphere.  Investing Wisely is the methods used to maximise return on that Capital.  For me it includes low investment expenses, tax minimisation, modern portfolio theory, tweaking of asset allocations based on market valuations and even my HYP.

The below chart separates the wealth I've personally built each year from both Saving Hard and Investing Wisely.  Every year except 2012 more wealth has been built from Saving Hard.  It even includes the last couple of years where significant monthly savings are given to my better half so that Financial Independence day is synchronised.  So as I alluded to at the start of this post for somebody like myself who’s trying to become Financially Independent in 10 years or so Saving Hard is essential.

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So Saving Hard is important.  Let’s look at each element in turn.  When it comes to Earning More I've been fortunate, having been able to increase earnings by 128% since 2007, however I can also say it has come at a price.  I am also very aware that in the modern continually globalising economic climate where average earnings in the UK are increasing at a less than inflation 1.3% this is currently not easy and importantly is not 100% in our control.  I'm going to ignore Earning More for the rest of this post for these reasons.

10 Habits to Become a Millionaire

Anton is a 27 year old dollar millionaire – at least in net wealth terms.  While he seems to have made about two thirds of that wealth through the US equivalent of leveraged Buy to Let property investment it’s still a pretty impressive feat.  Building that type of wealth in such a short time is not a lot different to what I’m trying to achieve, that is financial independence giving the option of early retirement in less than 10 years.  His 10 Habits That Made me a Millionaire post this week therefore intrigued me.  Let’s look at these 10 habits in turn and compare notes.

1. Setting Detailed and Actionable Goals

I have a proverbial shopping list of financial goals that I've set and then track myself against.  They cover everything from weekly targets for fuel economy on my monster commute and grocery shopping spend targets through to longer term goals including the amount of wealth I require for financial independence including timescales to get there.  I even go one step further and publically score myself against some of these goals at regular intervals.

2. Religiously Tracking My Net Worth

If you’re chasing financial independence then the buck stops at Net Worth.  I have recorded the values of every one of my investments which I then sum to give net worth every week since 2007.  I've never missed a week.  From that history I can then build charts like that below which track my progress to Financial Independence.  It also enables me to easily measure progress against my goals.

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3. Having the Discipline to Save 60% of My Income

He doesn't say whether this is Gross or Net Income but for a long time I was saving 60% of the more difficult Gross.  I've had to recently relax that to 55% only because a recent healthy pay rise has pushed me well into Higher Rate Tax where including National Insurance I'm losing 42% which makes it impossible to save 60% of Gross.  With that in mind I'm declaring a pass against this habit.

Practice Makes Perfect

2007 was the year I started to Save Hard and Invest Wisely for Early Retirement. While today this is a mature strategy (with some 364 posts on this site reflecting that) back then I was an amateur who was reading continuously and running so many Excel simulations that I’m sure at one point I saw smoke rising from my computer.  As it was a year of transition and my financial record keeping was quite sketchy it’s quite difficult for me to say exactly when I started really following the strategy.  I do know that 2008 was the year where the strategy that you see today really matured and I also know that the 5th anniversary of RetirementInvestingToday.com will occur next month.  What however I don’t know is when I really “officially” started living most of the principles that are today mature.

What I do know is that by August 2007 I was already saving large chunks of money while spending little however throughout that month I was also still talking to Independent Financial Advisor’s, IFA’s, who at the time I thought were the secret to success but today firmly believe are not (at least for me, they may be for some).  I also know that it took me until the end of November 2007 to finally sell some funds that were charging me up to 1.78% in fund expenses per annum.  So the “real” Retirement Investing Today anniversary is probably somewhere between September and November.  Given we’re between those 2 dates today I’m going to call October 2007 the date when my journey really began.

October 2014 therefore represents the 7 year anniversary of my journey to financial independence and optional Early Retirement.  The question then becomes has 7 years of practice made perfect?  Well to answer that question I’ve just spent a couple of hours sorting through sketchy old records (this bit wasn’t by choice but rather my better half ‘encouraging’ me to participate in a very late spring clean) which really do make for interesting reading.

Valuing the UK Stock Market (FTSE 100) - October 2014

Over the past couple of weeks the mainstream media have been getting all excited about recent share price falls.  As a group of people who are paid to write stuff I guess you could easily get excited by a graph like this:

Click to enlarge, Source: Yahoo Finance

Eyeball this short term chart and of course they’re right.  Over the past 6 or so weeks there is no denying the FTSE100 has fallen 8% or so.  Personally, as a long term investor with a mechanical investment strategy I ignore it all and simply think that markets go up and they go down.  This is more the view I’m interested in looking at:

Click to enlarge, Source: Yahoo Finance

On this scale the recent pull back is a bit of noise that means nothing more than my next share purchase is likely to be made at a better valuation than it was going to be.  Providing of course that earnings hold up.  Given I’ve now mentioned the valuation word as investors let’s today spend some time valuing the FTSE 100 over the longer term rather than wasting our time on short term price movement discussions.

Firstly let’s normalise the data 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.  

The normalised dataset shows that Friday’s FTSE 100 Price is actually still 32% below the Real high of 9,339 seen in October 2000.  We’re also now 23% below the last Real cycle high of 8,171 seen in June 2007.  We are therefore a long way from previous highs.

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A Retirement Investing Today Review 9 Months into 2014

My personal finance life follows a Plan, Do, Check, Act (PDCA) approach.  As I do every quarter it’s time to Check whether my Save Hard, Invest Wisely to Retire Early Plan is working.  It’s important to highlight that unlike many blogs what I write here is a real life, my life, and very serious DIY experiment. If I get it wrong then it’s likely that a ‘derisory’ State Pension awaits.  If I get it right then the world (or Europe in my families case) is our oyster.

SAVE HARD

This quarter I've continued to work very long hours, including a long commute, while as a family we continue to challenge all spending to ensure that every £ will bring improved health and/or happiness.  If it won’t then we don’t spend on it.  The end result is a savings rate for the quarter of 54% of my earnings, where earnings are defined as my gross (ie before tax) earnings plus any employee pension contributions.  This is against a target of 55%.

For the non-regular readers my H2 2014 review details why the target is now 55% compared with 60% when I first started down this road.

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Saving Hard score: Conceded Pass.  Close, but no cigar.  1% below target means a little more effort required as we head into the Christmas quarter.  A difficult challenge ahead.

INVEST WISELY

My investing strategy remains pretty much intact however with financial independence now fast approaching this quarter has triggered the need to now start increasing my cash holdings which when combined with my NS&I Index Linked Savings Certificates will eventually buy my family a home.  My current asset allocations are:

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A quick full disclosure in relation to a comment in that last link:  When I first started down this Retirement Investing Today road my family thought that Australia was a preferred early retirement location.  For that reason I divided the “domestic equities” portion of my portfolio equally between Australia and the UK.  That is no longer the case and so I am now actively and gradually reducing my Australia allocation by not investing new money into Australian equities as well as reinvesting Australian equity dividends elsewhere.  The sum of Australia and UK Equity is still aimed to be at target though which simply means my UK Equity portion will increase with time.

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

• 44.3% held within Pension Wrappers with the majority being within a SIPP
• 14.4% held within the no longer available NS&I Index Linked Savings Certificates (ILSC’s)
• 9.9% held within a Stocks and Shares ISA.  

Tax efficiency score: Conceded Pass.  At the end of June 2014 I was 68.9% tax efficiently invested.  In this quarter that has reduced slightly to 68.5% however with NS&I Index Linked Certificates currently unavailable and a definite unwillingness to expose myself much more to Pensions given the continual risk of government meddling I'm a little stuck.  If any readers have tax efficiency ideas I’d love to hear about them.

Investing mechanically with index trackers is boring

My retirement investment strategy has been relatively unchanged since I started this blog in 2009.  When you boil it all down around 90% of it is nothing more than a diversified portfolio of assets that do nothing more than track indices through the use of low cost ETF’s and funds.  Each month I add to this portfolio with new money and all I do is buy whichever asset class has been performing the worst (ie whichever class is most underweight).  Should an asset class ever deviate from its target holding by 25% then I would either buy or sell back to nominal holding.  This however seems to happen very infrequently because of my continual new money entering the portfolio

Let me demonstrate just how boring this all is.  It is the morning of the 3rd of October 2014 and already all of my mechanical index tracking investing decisions for the month have been completed.  This is what has occurred:

• Last weekend, as I do every weekend, saw my Excel spreadsheet that shows my financial position and compares it to my long ago mechanically set target allocation updated.  Boring and absolutely no brain power required.  Total time spent 10 minutes.
• My employer paid me on the last day of the month, Tuesday.  Total time spent to ensure money had cleared in my account was 5 minutes.
• I’m a big believer in the Pay Yourself First mantra and I’m ruthless at it.  This means before I pay any bills, before I buy any food, before I do anything I Save Hard.  So with money in the bank and one eye on my Excel spreadsheet I knew I needed to allocate to cash and so 100% of my savings were moved over to RateSetter.  Total time to move my money and set-up an auto investment in their 3 year market at 5.0% was 5 minutes.  Again, boring and absolutely no brain power required.  
• Over the next few days my employer will get around to salary sacrificing a big chunk of my salary into my employer selected defined contribution pension fund.  I know that my current set-up will have 20% of this invested into an Emerging Markets Index Tracker and 80% will go to an Index Linked Gilt Tracker.  Next weekend I’ll login to make sure that my employer has completed the transfer and the investment is correct.  Total time will be 5 minutes and again it will boring plus require absolutely no brain power.

By next weekend I will have spent 25 minutes managing what is now a very large amount of wealth.  I am also done until next month.  However while it’s incredibly boring and requires no brain power boy is it effective.  Having been at it for a few years I now honestly believe that this strategy is all that somebody needs to build wealth successfully.

How difficult is it to segregate our assets

In the modern, in my opinion overly complex, financial world there must by now be nearly as many investment risks as there are grains of sand on that now long forgotten Spanish beach where you spent your summer holiday.  One of these is that your broker/wrapper/online provider goes belly up and takes your wealth with it because they failed to segregate your assets from their own through fraud, negligence or even good old fashioned incompetence.  Here I am currently most exposed through my SIPP provider Youinvest, my ISA provider TD Direct, my trading account provider Hargreaves Lansdown and the large insurance company (the name of which I won’t mention as I could never recommend any element of their offering) who ‘looks after’ my defined contribution pension offered through my employer.

The same problem exists if the same fate befalls your fund manager.  Here I'm personally seeing significant exposure through Vanguard, State Street Global Advisors (SSgA) and BlackRock (think iShares).

It’s a risk I've known about for some time but on a scale of risks that I’m conscious of I had it ranked fairly low, thus wasn't doing too much about, as I thought that:

1. The process of segregating your customers assets from your own really isn't very difficult so it should occur through negligence or incompetence very infrequently;
2. Given its simplicity non-segregation would be easily and quickly identified by the firms accountants, compliance officers, auditors and/or regulator should it occur; and
3. Non-segregated amounts, should they occur, would be relatively small in relation to total assets under management so result in only a relatively small loss given a large sum would be like an elephant standing in the room for those same accountants, compliance officers, auditors and/or regulators.

News this week tells me that my assumptions were naive and just plain wrong with Barclays investment arm having owned up to having “£16.5bn of clients' assets "at risk" between November 2007 and January 2012”.  This is neither a small amount of money nor a short period of time.  It also happened to occur during the period when Barclays was in severe financial difficulties and had to be ‘bailed out’ by the state investment funds and royal families of Qatar and Abu Dhabi to the tune of £7.3 billion.  It’s also not the only time with them having been penalised back in 2011 for “failing to ring-fence client money in one of its accounts for more than eight years”.  Of course Barclays say that ‘it did not profit from the issue and no customers lost out’ but they would say that wouldn't they and given the timing it could have easily been a very different story.

2 Years to Go

Only three weeks ago I was writing about my 75% of the wealth required to retire milestone and now as I sit writing this post, drinking a tasty homemade coffee which is helping me save hard ( ), it’s time to write about yet another.

Today my top level asset allocation looks like this:

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The detail behind this is still very much in line with my strategy that I first published in 2009.  Between the 04 January and 02 August 2014 (funny dates as I record my financial position weekly) this investing wisely portfolio returned 3.9%.  Move forward to today and that year to date return has morphed into 7.0% in around a month.  Should long run history repeat to average this portfolio should return about 4% per annum in real inflation adjusted terms over the long term (it’s returned exactly that since I started this journey in 2007) going forwards.

On top of that I continue to work on methods to save hard:

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Every little 0.01% helps

Today’s post title will possibly make High Yield Portfolio (HYP) advocates think I'm about to talk about Tesco’s (Ticker: TSCO) Friday action which included a 75% cut in the half-year dividend to 1.16p and a share price fall of 6.6%.  I'm not though because my own HYP contains alternate Sainsbury’s so I'm not (yet) affected plus there is already plenty of good blog coverage on the topic.

Instead I want to cover an important announcement that could with time save passive index investors a lot of money but which for some reason gained no MSM press inches that I'm aware of.  I don’t know why but the cynic in me thinks it could possibly be because the company that made the announcement doesn't advertise heavily and that is what much of the news is today – thinly veiled advertisements.  It was however picked up by the very astute non vested interest Monevator team.  Some Vanguard UK and Irish Domiciled Index Mutual Fund’s, ETF’s and LifeStrategy Fund’s have had their investment charges lowered.

Personally this affects me in the following ways:

• I hold a lot of the Vanguard FTSE UK Equity Index Fund in my Youinvest SIPP.  Ongoing Charges on that fund from Monday reduce from 0.15% to 0.08%.
• I hold the Vanguard S&P 500 UCITS ETF in my TD Direct NISA.  Ongoing Charges on that ETF will reduce from 0.09% to 0.07%.
• I also hold the Vanguard FTSE Developed Europe UCITS ETF in my TD Direct NISA.  Ongoing Charges on that ETF will reduce from 0.15% to 0.12%.

The Two Phases of Wealth Building

Every week I religiously capture the value of each of my investments which I then sum to give me an instantaneous net worth.  This week saw my net worth increase by more than £5,000 without contributing any new money.  For me that is a very large amount of money, and of course Mr Market could take that £5,000 away this week, but it reminded me of the two phases of wealth building that I'm seeing as I'm working to build wealth over a quite short period of time.

The first phase is Building Capital.  As you start on your wealth building journey this is the first phase you pass through.  Here you just want to be adding as much capital to your wealth as quickly as you can get your hands on it.  Saving Hard by Earning More and/or Spending Less will have a much bigger effect in this phase than Investing Wisely.

The second phase is Return on Capital.  Here while Building Capital is still providing a big boost to your wealth it’s now more important to have a stable investment strategy which is very tax and investment expense efficient.  In this phase you could even start to ease of the Saving Hard by for example going part time or taking up that lower paid higher enjoyment opportunity you’ve always desired without moving your financial independence day greatly.

Let me demonstrate the two phases with a simple example (where I’ll ignore inflation) that tries to cover many of the points that I personally live (and have lived) as well as regularly capture on this site.  Average Joe works hard and for his hard work receives £45,000 per year making him a 40% higher rate taxpayer.  Joe wants early financial independence to give the option of early retirement and so starts to think about he might achieve that.  He realises he firstly needs to focus on Building Capital by Saving Hard.  His employer offers a pension scheme where if Joe salary sacrifices 5% of his own salary then they will match it.  There’s some free money there so he goes for it.  Salary sacrificing also brings the benefit of lowering Joe’s taxable salary to £42,750 saving both employee and employer National Insurance.  Joe’s employee NI saved is added immediately to his pension but his employer also generously adds the 13.8% employer NI that they also save.