My Property is My Pension (because of Leverage)

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

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

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

How to Become a Millionaire

Two thoughts:

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

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

A Simple Low Expense, Low Tax Investment Portfolio for DIY Beginners

There are about as many investment strategies and investment options as there are investors. I also believe that many of these are offered because the people behind them have already worked out that it is in their favour to offer them but I am sometimes accused of being cynical. I don’t actually begrudge them for this as we all have to make a living in this increasingly complex world but I do have a problem with how some products and services are made to sound more complex than perhaps they should which the cynic in me again believes is being used to deter people from going DIY.

I think back to 2007 when I first realised that for the first 12 years of my life I had been working for everybody but myself. And if I didn't start taking responsibility for my own future quickly I was going to end up with little more than a State Pension (or some other form of welfare) that would be provided at an age chosen by the government of the time. I needed to start saving and investing without further delay.

I did what the mainstream world tells us all to do. I spoke with Financial Planners who I believe in hindsight were making what they were offering sound more complicated than it needed to be. I also read about what looked like complex investment products which would not only give me a fantastic return but would in some instances possibly even put man on the moon.  I'm possibly even guilty of it when I talk about my own low charge strategy and some of the other concepts we cover on this site. I think it’s a simple concept but thinking back to what I knew when I first started down this road it would have been nothing short of confusing. Of course the difference is that I don’t get wealthy at your expense. I'm not for a minute suggesting that there is anything illegal or misleading going on but I am glad that I went DIY as I believe that I would have had no better return plus I've saved on all the fees and expenses which are now part of my wealth which is compounding nicely.

Since going DIY I am happy with progress however one area I know I went wrong is during the first couple of years when I knew nothing and was trying to learn. This period of time definitely cost me and while I don’t regret it as it taught me what I know today, thinking back I really should have just used the KISS rule until I’d educated myself. So let’s do that today and try and build a simple portfolio and strategy which could maybe tide a DIY investing beginner over until they were ready for more complexity. When they are finally ready they probably won’t even have to sell but instead could just build upon what would then be a core holding and if they were never ready then they’d still likely do ok.

What type of Investor are you?

There are a multitude of investment opportunities and investment products available today to help investors meet their goals, which might include retirement or financial independence.  Before you look at those products in detail you must first ascend to 30,000 feet and decide what type of Investor you are or intend to be.  At this level I see there are essentially 4 types of investor which can be profiled by answering 2 questions:

1. Am I going to be an Active or Passive Investor?
2. Do I want to be DIY or have somebody make my investment decisions for me in consultation with me?

Let’s look at each in turn.

Active vs Passive Investing

The debate over which of these strategies is better has been going on for years.  Passive investments aim to do nothing more than track a market index.  That could be a stock market index like the FTSE All Share Index or a bond market index like the Barclays UK Government Inflation-Linked Bond Index.  These types of investments don’t need talented managers or analysts but simply a decent computer system that will enable the assets purchased to replicate the market.  Importantly when selecting these types of investments you will be looking for ones that track the chosen index as closely as possible.  Therefore if you are passive investing well you will never beat the market but should get pretty close to its nominal performance.

Active investments on the other hand are run by professional managers who are supported by analysts and researchers.  They will conduct extensive market research on the investment opportunities within their remit with the specific aim of beating the market.  It must however be remembered that the law of averages dictates that for every active investment manager that beats the market somebody or something has to not beat the market.  Some of these will be other professional managers.   Pick one of those and you would have been better off going passive.

Active investments typically carry higher expenses than passive investments.  After all those managers, analysts and researchers aren’t working for free and expect to be paid.  Therefore they must beat the market by at least their expenses if they are to be a better bet than the passive investment option.

DIY or Financial Advisor Investing

The second decision you need to make is are you prepared to go it alone, make all of your own investment decisions and live with the consequences.  It should not be underestimated how important planning for retirement or financial independence is.  In many instances you will only ever get one shot at it.  If you go DIY you must be therefore prepared to read a lot and really think through what you are trying to achieve.  You’ll need to accurately assess where you are today, where you want to go and when you want to get there.  You will need to determine how risk tolerant you are, while also realising that, for example, 100% of the lowest risk asset class today will likely not give you the lowest risk portfolio.  You’ll then need to crash all of that information with a lot of research on different asset classes and investment wrappers to build a diversified, tax minimised investment portfolio, with expenses at a level you are happy with, that will give a high probability of meeting your goals.  You’ll need to t
hen review your portfolio regularly to determine if or when you want to rebalance those investments and also ascertain if you are still on target to meet your goals.

Dividend Reinvestment is a must to Maximise Wealth Building

There are almost as many investment strategies as there are financial websites.  These might include everything from you must buy this share as it’s a guaranteed ten bagger through to a fund that looks like it will protect you no matter the economic weather.  Of course the strategies discussed will also likely be dependent on whether the person writing the strategy has a vested interest of some description.

I’ve laid out my strategy for all to see however it glossed over an exceptionally important element.  That element is share dividends and specifically how crucial it is to reinvest them while you are building your portfolio.  If you are a UK Investor Monevator touched on this topic back when I was first starting on my Retirement Investing Today journey and more recently DIY Investor has also reinforced their importance but it’s the must have Investing Bible for UK Investors that really reinforces the point with the section entitled “Spend dividends at your peril”.  Dividend reinvestment is important because it is likely they make up a significant proportion of the total return that comes from your individual share holdings, High Yield Portfolio (HYP) or Index Tracking Fund to name but three.  By reinvesting you both get that extra cash into your portfolio, instead of being tempted to buy something you likely don’t really need, but additionally you also then get those dividends compounding year on year.

Let’s look at whether reinvesting dividends is still important in more recent times using my recently built FTSE100, FTSE250, FTSE Small Cap and FTSE All Share data sets.  For today’s analysis I am using the period 18 March 2008 (the first date I was able to source all data required) to the recent market close of the 28 March 2013.  The annualised return or compound annual growth rate (CAGR) for capital growth only and dividend reinvestment for these four datasets is shown below.

Click to enlarge   

Is it really that novel, innovative and value adding a strategy?

Ok I’ll admit it.  I read the Investment Times which is a monthly publication issued by Hargreaves Lansdown.  It’s clearly a piece of marketing material aimed at keeping Hargreaves Lansdown fresh in your mind but I read it because occasionally I do find an interesting titbit that encourages me to go off and do some more research.  I’ve just received the December 2012 edition and within it there is a review of an actively managed fund called the Troy Trojan Fund.

Important: Before we get started, I must point out that what follows is not a recommendation to buy or sell anything, and is for educational purposes only. I am just an Average Joe and I am certainly not a Financial Planner.

I don’t normally comment on actively managed funds as I am a supporter of passive index funds however the Troy Trojan Fund promises a lot.  The manager “believes that sooner or later the inflationary effects of QE (Quantitative Easing) will take hold” however he also does not rule out the rule possibility of a ‘Little Ice Age’ of deflation beforehand”.  The fund manager has apparently prepared for both scenarios by building a portfolio around blue chip equities, index linked bonds, gold and cash.  The actual asset allocation is listed as:

• 11% UK Equities
• 20% Overseas Equities
• 17% Cash (including UK T-Bills)
• 7% Singapore T-Bills
• 12% Gold
• 6% Gold Shares
• 13% US Index Linked Bonds
• 14% UK Index Linked Bonds

KISS Investing for Retirement

Alright I’ll admit it.  Investing for retirement is my hobby.  This means that I continually run all sorts of detailed analysis, some of which I share on this site, to try and squeeze a little extra investment performance from my portfolio.  An added benefit of this particular hobby is that it’s a frugal type of activity which other than the cost of running this site really costs nothing at all other than an old laptop and an internet connection.  While this is my chosen behaviour I’m also the first to admit that I could probably remove 99% of the complexity and still get 99% of the result by following the Keep It Simple Stupid, KISS (bet you thought I was talking about an American Rock Band there for a while), rule.  Today let’s take a step back and look at what that effective 1% effort might entail to enable this 99% result.


Important: Before we get started, I must point out that what follows is not a recommendation to buy or sell anything, and is for educational purposes only. I am just an Average Joe and I am certainly not a Financial Planner.

1.    Start.  If you never decide to take control of your retirement planning then you will never achieve early retirement.  Instead you’ll retire when the government tells you to which sounds a bit depressing to me.

2.    Spend less than you earn.  Sounds obvious doesn’t it?  It mustn’t be because a lot of people fall at this hurdle by being in debt.  If you don’t spend less than you earn then you are never going to reach Early Retirement or even have a little extra than the State Pension provides if you retire at State Pension Age.  This I believe is a critical point as no matter what other decisions you make about your investments it all multiplies by the level of saving you are making.  The level of saving is I believe one of the key differences between Early Retirement Extreme, Early Retirement, Typical Retirement and Late Retirement.  You can start this saving lark long before you’ve completed any of the activities below, whether it be firstly paying down debt in readiness or simply saving it in a high interest savings account until you know what you want to do with it.

The Retirement Investing Today Low Charge Strategy and Portfolio

This blog is fast approaching its third anniversary.  In my first naive post I laid out in very brief terms “what” some of my investing strategy was about having developed it from the decision to go DIY in 2007.  This post also briefly described “why” I was taking the road I had chosen.  Soon after I laid out in detail the construction of what I called My Low Charge Investment Portfolio.  To this day I have continued to improve on the original portfolio methodology ever so slightly while holding true to the fundamentals of the strategy.  Since October 2009 that strategy and portfolio has seen my net worth increase by 73% in nominal terms.  Additionally, since October 2007 my net worth has increased by 306%.

Since that first post I have made 239 posts covering many topics.  If you’re interested some of the latest or most popular can be found in the sidebar.  Every post can also be found in the blog archive also found in the side bar.  While it’s all there as a fully accountable record I’m going to use today’s post to bring a number of my key fundamentals which cover strategy, portfolio and portfolio rebalancing into one single aide memoir.

Retirement Investing Today Strategy

The strategy is set around a decision to retire as early as possible.  It’s important to note that retirement for me does not mean a life of leisure.  It simply means that work becomes optional.  I may choose to stay in my current career, may start a new career which could involve voluntary work or it could be a life of leisure.  I don’t intend to make that decision today as anything can happen between now and retirement.  At the time of writing this post my portfolio models show my early retirement window appearing in around 3.5 years when I will be in my early 40’s.

The Importance of Reinvesting Dividends

The S&P500 is today yielding somewhere around 1.8% per annum.  This doesn’t sound like a lot and indeed it isn’t if the investment amount is small. To demonstrate this let’s say an Average Joe had an index tracking (to keep fund fees down) S&P 500 fund/ETF with £1,000 in it today.  Having bought a year ago he would have accrued somewhere around £18 (ignoring fees and taxes) in dividends by now.  If he didn’t know any better he could assume that amount will make no difference to his Retirement Investing Today portfolio and instead ‘blow’ it on a few beers.  What I’m going to show today with some charts is just how much damage that would do to his portfolio in the longer term.

The challenges of value investing

Unlike some people out there I am not a value investor in the true sense of the word. That is I don’t go looking for individual stocks which through the use of valuation metrics appear under priced. I would more class myself as a pseudo value investor. My strategy is to be either under weight or over weight equities depending on whether the market appears over or under valued using the cyclically adjusted PE ratio (CAPE or PE10). I now track this for 3 markets:
- The UK FTSE 100 CAPE
- The US S&P 500 CAPE
- The Australian ASX 200 CAPE

It’s been a good year to date, well maybe it has - my Retirement Investing Today Current Low Charge Portfolio – August 2010

Why has it been good year to date for my portfolio? Well year to date my Personal Rate of Return is 3.9%, which compares favourably against my Benchmark Portfolio which has returned 3.0%. For non-regular readers my Benchmark Portfolio is as simple as it can get by using 28% iBoxx® Sterling Liquid Corporate Long-Dated Bond Index total return (capital & Income) index and 72% FTSE 100 total return (capital & income) index.

My Retirement Investing Today Current Low Charge Portfolio – July 2010

I first started taking my retirement investing asset strategy seriously in 2007 when I became disillusioned with the financial sector and decided to go it alone. While I made a start in 2007 the majority of the time was spent reading about personal finance and it wasn’t until 2008 that I really started to formulate the strategy that you see today. The strategy could be called extreme. I aim to save on average 60% of my after tax earnings and pension salary sacrifices. Following this strategy has me currently forecasting retirement in 6 years. This monthly entry calls me to account and forces me to assess if I am still on track and to determine if all the effort is worth it or whether I would be better off with a simple bond/equity asset allocation that is rebalanced yearly. What I call the Benchmark.

Buying Australian Equity Index Tracker (ASX200)

As I’m sure everyone knows the Australian Stock has seen some falls of recent weeks. Using my monthly data set it’s down 13% from the monthly peak of 4876 in March 2010. Of course it’s still well above the monthly low of 3345 in February 2009 by some 27%. These falls have meant that my target asset allocation of ASX200 equities within my Low Charge Portfolio has risen to 20.9% and my actual has fallen to 17.0%. If you’re not sure about how I built my asset allocation and particularly how I use tactical allocations then please read here and here.

My Current Low Charge Portfolio – June 2010

Buying (New money): Since my last post I have had a good month of savings and managed to save 72% of my after tax earnings and pension salary sacrifices. Total new money entering my Retirement Investing Low Charge Portfolio was around 0.8% of my total portfolio value. The allocation was as follows: 42.0% to cash, 8.7% to UK equities, 12.2% to international equities, 2.3% to index linked gilts and 34.8% to UK commercial property. This money was invested outside of tax wrappers and also within a pension.

Buying NS&I Index Linked Savings Certificates

As I highlighted here National Savings and Investments (NS&I) today released a new issue of both 3 and 5 year Index Linked Savings Certificates. I’ve made use of this and invested around 4% of my retirement investing low charge portfolio into the 3 year 20th issue of these certificates by transferring some cash holdings. This new issue is paying index linking + 1%. This now means that I have 19.6% of my retirement portfolio invested with these tax efficient certificates.

2010 Quarter 1 Retirement Investing Portfolio Review

Edited 06 June 2010: I have found more exact data allowing me to determine benchmark returns to the day. I have therefore updated the data in this post to reflect this. As the blog has developed I have also changed the method used to calculate the returns as I have learnt more accurate methods. I started with:
- [assets at end of period – assets at start of period – new money entering portfolio] divided by [assets at start of period],
- then used the mid-point Dietz which was a more accurate method,
- and now use Excel's XIRR function for anual returns. If it is not a full year I then adjust XIRR by the PRR (Personal Rate of Return) = [(1+XIRR Annualised Return)^(# of days/365)]–1.
Apologies for the confusion but I'm learning here too.
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The first quarter is over so it’s time to benchmark my low charge retirement investing portfolio against a simple Strategic Asset Allocation that anybody could implement in next to no time. It’s a basic stock/bond asset allocation with the stocks portion being represented by the FTSE 100 total return (capital & income) index and the bond portion being represented iBoxx® Sterling Liquid Corporate Long-Dated Bond Index total return (capital & Income) index.

My Current Low Charge Portfolio – April 2010

Buying (New money): Since my last post I have continued living frugally and saved 81% of my net earnings and pension salary sacrifices. Total new money entering my retirement investing Low Charge Portfolio was around 1.5%. These were allocated as follows: 69.5% to cash, 4.6% to UK equities, 6.4% to international equities, 1.2% to index linked gilts and 18.3% to UK commercial property. This money was invested both outside of any tax wrappers and also within a pension.

Buying Gilts, Property, International Equities and UK Equities

As an employee of a company I have the option to contribute to a pension scheme. I have made the choice as part of my retirement investing strategy to contribute to the pension scheme for the reasons laid out here.

My Current Low Charge Portfolio – March 2010

Buying (New money): Since my last post I have saved 83% of my net earnings. In addition some more good news was that significant earnings that I had been waiting on for the past year were paid to me this month meaning my total savings amount was also very large at 6.1% of my Low Charge Portfolio assets. These were allocated as follows: 84.7% to cash, 2.3% to UK equities, 3.2% to international equities, 0.6% to index linked gilts and 9.2% to UK commercial property. This money was invested both outside of any tax wrappers and also within a pension. Unfortunately no investment was made into my stocks and shares ISA as I have already made my £7,200 worth of contributions. I am eagerly waiting for the new ISA year starting on the 06 April 2010.

Guest post – alternate investing strategy

Today is a guest post from a reader of Retirement Investing Today. Two elements of their investing strategy have inspired me. Firstly, they are in their early twenties and have already clearly accepted full responsibility for their own actions with respect to their own economic well being. I certainly wasn’t at that point at that age. Secondly, rather than just following the herd mentality with regards to investing they have adopted an investing strategy which includes a very interesting asset class – whisky. As with all Retirement Investing Strategy readers I wish them much success and I hope you enjoy reading their story. I know I did.

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I am fairly new to the investment game, this being my second financial year as an investor. I decided against joining a pension scheme as I do not like the idea of saving for all of my working life and planning my retirement on the faith (that is very low) of an annuity company providing me with a good income. I want to plan my retirement and manage my own investments. I am in my early twenties and my plan is to accumulate enough capital by the time I am in my mid-fifties to provide an acceptable income that can be enjoyed for the rest of my life. When I have finished retiring, the income from my capital will then be able to be enjoyed by my successor(s), rather than an annuity company. Following the recommendation on this blog, I have purchased a copy of “Smarter Investing - Simpler Decisions for Better Results” by Tim Hale. I cannot recommend this book enough.

My target portfolio at the moment is:
Cash - 65%
UK Equities - 25%
Gold - 5%
Whisky - 5%

The large percentage that is allocated to cash is not because I am cautious but because I have a short term goal to save enough to use as a deposit to fund a home within three years, which is too short to invest.

My contribution to this blog today will be about whisky as there is a noticeable lack of information on the Internet about this asset class. Whisky currently makes up approximately 5% of my portfolio.

Whisky is a spirit that is enjoyed all over the world. Recently, we have witnessed a very large growth in the demand of Scottish whisky due mainly to the rapidly growing middle classes in developing countries. Supply has not been expanding nearly as fast (I can tell you this personally as I live in Moray, which has the largest concentration of single-malt distilleries anywhere in Scotland). My reason for allocating 5% of my portfolio to single-malt Scottish whisky is that I aim to profit from the expanding ratio between supply and demand. Historically also, whisky collecting has generally been a very profitable pursuit, although a certain level of knowledge on the subject is essential.

There are essentially three ways to invest in whisky:
1 – Buy shares in a company that makes profit from the whisky industry
2 – Buy young whisky casks en primeur and hold them until that have matured
3 – Buy bottles of whisky and hold them in order to take advantage of dwindling supply.

I am concerned with the third option.

It is important to point out at this point that bottled whisky does not mature further and will not change in character if it is stored correctly (more on this later). It is also important to select bottles from iconic well established distilleries, as these are the ones that will be most in demand. The main distilleries that I am interested in are Ardbeg, MacAllan, Balvenie, Talisker, Glenfiddich and Port Ellen. These are all very well respected and are in high demand all over the world. The last one that I mentioned has closed so it goes without saying that demand for their expressions are going to increase.

Most of these distilleries have an online committee/club that is free to join. Quite often, special limited edition expressions are offered only to member. The last committee exclusive that Ardbeg offered (Ardbeg Supernova) was ranked as the world’s second finest whisky and now sells for 150% of the price less than one year on. In years to come as more of these limited bottles are consumed I expect the value to increase.

The ideal bottle of whisky for investment purposes will be (in order of preference):
1 – From an iconic distillery (and if it has closed even better).
2 – Part of a very limited release
3 – Aged beyond 30 years (although younger expressions are also worth considering if they meet the rest of these requirements)
4 – Mostly unavailable to the open marker (i.e., committee releases or distillery exclusives)
5 – Taste good (I use the latest edition of Jim Murray’s whisky bible for this).

Take note that bottles are also produced by external bottling companies who buy casks en-primeur and bottle them much later. Often this is the only way to buy expressions from closed distilleries. Some external bottling companies to consider include Duncan Taylor & Co and Douglas Laing & Co.

I recently acquired a 30 year old bottle of MacAllan, bottled by Douglas Laing & Co. This particular expression was bottled after the whisky has matured in a rum cask and is one of just under two hundred bottles. I believe that this expression has a very high chance of increasing in value significantly.

There are also quite a few rare bottles that are only available by visiting the distillery. This can be very costly if you do not live near them (this is where I have an advantage). If you are able to visit a distillery at a small cost, it is definitely worth having a look to see what exclusives are available.

Whisky bottles are not as sensitive to wine as they have a high alcohol content. They can be stored anywhere that is not subject to major temperature fluctuations, however they must be stored within their tube or box, to prevent light from oxidising the whisky.

As far as taxes is concerned, duty is obviously paid when you purchase the bottles (unless you buy them from an airport), however I believe that like wine, whisky is exempt from capital gains tax.

I am very optimistic that my ever growing whisky collection will generate a good return for my portfolio however there is the possibility that some bottles will not increase in value as much as I hope they will. If this is the case I might even enjoy a nice dram of scotch when I retire!

Please do your own research.
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