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

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

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

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

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

Valuing the FTSE 100 - November 2013

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

Click to enlarge, Source: Yahoo Finance

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

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

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

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

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

Let’s firstly remove some of excitement by:

• Correcting the chart for the devaluation of the £ through inflation.  For this dataset I use the Consumer Price Index (CPI) to devalue the £.
• Plotting the Pricing on a logarithmic scale as opposed to a linear one.  By using this scale percentage changes in price appear the same.  

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

Click to enlarge

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

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

Target Retirement Income

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

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

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

Click to enlarge

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

Responding to Risk with Intelligent Analytics

By Joe Budden

Following the financial crisis of 2007-2008, many veteran traders were faced with a totally different financial landscape in which to operate. The ‘New Normal’, a term first coined by Pimco trader, Mohammed El-Erian, became the finance community’s go-to word for a new world order which bore more similarities with the post Depression era than anything investors had previously experienced.

This ‘New Normal’, characterised by persistently sluggish growth, high unemployment and political wranglings over debt ceilings and budget deficits, is now five years on and shows no sign of abating.
But it is not only political parties that stand to lose from this new period of economic stagnation.
Financial markets, as a result of huge injections of artificial liquidity from central banks, now reside atop a mountain of debt and are precariously placed should we see any reduction in liquidity or future drop in growth.

Indeed, it could be argued that the super loose monetary policy used in response to the biggest recession since the 1930’s has actually heightened risk, and the resultant artificial rally in global stock markets has created a world in which markets are now scarily dependent on the money flows from central banks.

Much like an addict becomes dependent upon a drug, the financial markets have become dependent on the monthly injections of quantitative easing from the Federal Reserve, and it is for this reason that every FOMC meeting is now watched with baited breath by most traders.
And just like the symptoms of withdrawal when such a drug is taken away, the potential for significant market volatility is profound and something that every investor and trader should be prepared for.

The next shock to the system: Inflation

At the heart of the problem financial markets face is a battle between stagnant economic growth and the coming onslaught of inflation, brought on by years of easy money. Normally this would not present too much of a problem since periods of economic stagnation can be easily prodded into life by central bank intervention.

However, to believe this is to forget that the central banks have now used up all of their bullets. Indeed, central banks now sit on a mountain of debt with no alternative but to scale back, or ‘taper’ as the Fed like to call it - rhetoric that has already caused significant turmoil in stock markets over the last couple of months.

And with the prospect of future unwinding, the already fragile growth picture seen in most developed nations, has the potential to stall even further. (Indeed, recessions typically occur every 4-6 years in developed countries meaning we are now overdue.)

A Method to Help Us All Save More

The road to wealth creation, which leads to financial independence if persisted with, is no secret.  In fact P. T. Barnum in his 1880 publication, The Art of Money Getting (available for free in Kindle Edition at the link), which is still as relevant today as when it was first published, reveals it by the second paragraph.  “Those who really desire to attain an independence, have only to set their minds upon it, and adopt the proper means, as they do in regard to any other object which they wish to accomplish, and the thing is easily done.  But however easy it may be found to make money, I have no doubt many of my hearers will agree it is the most difficult thing in the world to keep it.  The road to wealth is, as Dr Franklin truly says, “as plain as the road to the mill.”  It consists simply in expending less than we earn; that seems to be a very simply problem.  Mr Micawber, one of those happy creations of the genial Dickens, puts the case in a strong light when he says that to have an annual income of twenty pounds per annum, and spend twenty ponds and sixpence, is to be the most miserable of men; whereas to have an income of only twenty pounds, and spend but nineteen pounds and sixpence is to be the happiest of mortals.”

If “those who really desire to attain an independence, have only to set their minds upon it” and spend less than we earn I ask how do we find ourselves in a world some 133 years later where every 5 minutes and 7 seconds someone is declared insolvent or bankrupt and the average household debt in the UK (excluding mortgages) is £6,020?  Why is it “the most difficult thing in the world to keep it”?  While we shouldn't trivialise this as there likely many reasons depending on who you are, which includes some people who through no fault of their own fall on hard times, I also can’t help think of two major reasons which likely prevent the road to wealth from being found for many.  The first is that in the modern day a lot of people refuse to take responsibility for their own actions but instead prefer to act like a victim.  The second is education.

If nobody shows you where that needle in the haystack is then probability says you won’t find it.  The problem is in modern society who has it in their interest to show you where the needle is?  Of course the individual does but if they never know they are looking for it then it’s down to luck to stumble across it.  Family and friends possibly do but it relies on them having found the needle for themselves.  Worse it is actually in the rest of the world’s interest for you not to find the needle.  All those advertisements you are bombarded with day and night whether direct or more subtly via the current lazy mainstream media certainly don’t want you to discover it.  They want you spending “twenty pounds and sixpence” and not “nineteen pounds and sixpence”.

Let’s therefore make this post a needle in the internet haystack and hope that some find it.  If you’re reading this then feel free to Like or Tweet it, as every one of those places another needle in the haystack that might be found.  Let’s detail the simple method that helps me save more.

Step 1: Prepare a Budget

A budget is no secret and I’m sure 99.9% of the population is already aware of what a budget is.  Just about every personal financial site and book talks about them.  While well known they unfortunately don’t give you any answers but they do give you information.  They won’t help you save more but are a necessary first step as they:

• let you take a step back to see what the situation looks like;
• tell you how quickly you need to act; and
• tell where you should focus first.

If your budget shows you spending “twenty pounds and sixpence” then you clearly have an emergency on your hands.  Every second that passes is seeing you move further into debt which is then making it more difficult to ever get out of it.  Mr Money Mustache ‘eloquently’ advises that in this situation the correct response is to treat it like “there is a cloud of killer bees covering every square inch of my body and stinging me constantly!!!!  I need to stop it before I am killed!!!”  In this situation you need to get yourself to the point of only spending “nineteen pounds and sixpence” quickly.