The Buck Stops Here

Some might think this post a little cynical however I've found that it sometimes pays to be a little cynical so here goes.  Businesses and their marketing machines have few goals on their mind.  One of those is to remove as many pounds and pence from your pocket as legally possible.  Ideally they then get to do this more than once.  They then try and get you not to notice how many notes and coins you’re counting out by bringing other businesses into the game that can help you to pay the original business in one electronic form or another.  They certainly don’t assess whether the purchase will benefit you or your family’s life.  It’s nothing personal.  It’s simply maximising the revenue.

Once those businesses have completely emptied your pocket worry not.  That’s because another business will come along who will provide you with a product of one type or another that will allow those previous businesses to remove pounds and pence that aren't even yet in your pocket.  They also don’t assess whether the purchase will benefit you or your family’s life and are again simply looking to maximise the revenue.  It’s nothing personal.  It’s simply maximising the revenue.

You might even work for one of those businesses.  Again, they are not interested in whether the salary paid brings benefit to your family’s life or if you need additional State support simply to exist.  They are simply trying to pay you and all your colleagues the least amount possible that will prevent empty desks either in the form of people leaving and/or new people not joining.  If this should occur then some other business will maximise the revenue at their cost.  It’s nothing personal.  It’s simply maximising the revenue and profit.

The Path to Early Financial Freedom, Bicycles Optional

In my hunt for Early Financial Independence, maybe even Early Retirement, I'm unrelenting in my efforts to minimise my spending while not sacrificing the elements of family life that are really important to us.  This is essential behaviour as finding ways to minimise spending allows two things to occur:

• the reduction in spending allows another advance towards the Financial Independence goal  because it can directly become savings; and
• importantly by spending less the Financial Independence goal posts also move towards you.

There is however one area where this is not an appropriate course of action – spending required to earn money.  Generally, if you were just looking to minimise spending you’d be looking for the highest paying job where housing costs were low and your home would be within a walk or cycle to work.  Other considerations for some might include minimising child care or ‘uniform’ costs to name but two.  In the extreme this would be home working.  This is of course flawed because we need to actually be finding ways to Save Hard and not just spend less.  The mathematical way to think about it is Saving Hard is maximised by maximising earnings (which in a family unit could be 2 or more salaries), minus tax, minus national insurance, minus spending required to earn.  Of course it’s then appropriate to be unrelenting in your efforts to minimise your spending required to earn.

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

When nominal charts of the FTSE100 start looking like this:

Click to enlarge, Source: Yahoo Finance

Which are showing us being within 1% of the nominal 30 December 1999 record high of 6930, the chatter in the mainstream media about the potential to reach new highs kicks off.

So what do I think about the potential to reach new highs?  Well I don’t actually even waste brain power considering it for a few reasons:

• The most important is that my investment strategy is no longer based on any form of emotion but is instead now purely mechanical.  This was done because early on in my DIY investing career I realised that no matter how much energy I expended I actually had no idea whether the market was going to go up, down or sideways.  A lot of people out there do claim to know but from what I can see most of these seem to make their money by commenting on it in the media, writing books on the topic or by selling investing newsletters.  If they really do know why are they expending energy doing this rather than making a fortune trading with this great knowledge?  I really do now believe that unless you have inside knowledge, which you can’t profit on legally, then they are all actually just like me.  They have no idea. 
• As I’ll show in this post the market is actually nowhere near a new high.
• Again, as I’ll show in this post, while I believe the market is slightly overvalued it’s still only in the bottom 17% of monthly valuations since 1993.   

Let’s run the numbers.  Firstly we’ll remove the excitement and 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.  

Further Exploration of Safe Withdrawal Rates (SWR) for UK Investors

If you’re like me and don’t have a Final Salary Pension waiting in the wings, rich parents (which might include an inheritance), intention to buy an annuity and don’t want to be raiding bins for food scraps in old age then the amount of wealth you accrue before calling yourself financially independent, allowing early retirement is a critical number that you really can’t afford to get wrong.  Retire with too little wealth and you could expend it all before parting from this fair land making life in old age very difficult.  Be too conservative and fall into the “one more year of work” syndrome and well all I can say is you’re a long time dead.  So we’re looking for a Goldilocks amount of assets.  Let’s try and figure out what that amount might be for a UK resident.

Given the seriousness of the topic I must give the following Wealth Warning before we move on.  I’m just an average person on a DIY Investment journey to Financial Independence and am certainly not a Financial Planner.  The content of this post is for educational purposes only and is not a recommendation of any type.

We've looked at Safe Withdrawal Rates previously.  In that post we focused on the 4% Rule or 4% Safe Withdrawal Rate (SWR) which in brief works on the principle that if in your first year of retirement you withdraw 4% of your portfolio, then yearly up rate your withdrawals (your “Gross Earnings” plus any investment expenses) by inflation, the end result will be that you won’t exhaust your portfolio in your lifetime.  If you dig a little deeper what it actually says is that using past market performance (which we of course we know does not necessarily predict future market results) for a 50:50 Stocks : Bonds portfolio then you have a 96% of not expending your portfolio in a 30 year period.

Real Life Portfolio Performance

As I sit here writing this post the Excel spreadsheet that I use to track my wealth and portfolio performance tells me that I have accrued 76.1% of the wealth that I require for Financial Independence (and Early Retirement if I should choose to retire from work).  If there is one thing I've learnt over the 7 and a bit years that I've been accruing that wealth it is that if you want to be the person who retires by 40, who makes early retirement extreme work or who reaches financial independence in 10 years and not the one who retires when the government tells you to then you need to not only be tenacious and not blow with the wind but also rigorously PDCA (Plan, Do, Check, Act).

When I say this I'm not saying to continually alter your investment strategy to today’s new fad.  That’s just going to lead you astray and hinder your wealth creation.  Instead it’s going to have to be far more subtle and purposeful than that but it’s important because I can guarantee, if my example is anything to go, that a large portion of both your life and investments are going to be different from what you originally planned.  Therefore to reach your goal some course correction is going to be required.  Let me maybe demonstrate the principle with some personal examples:

• When I first went DIY in 2007 I was naive and really in a state of investment strategy flux as I learnt.  By 2009 the foundation of my strategy was built but it actually took until late 2011 to reach maturity with the addition of a High Yield Portfolio (HYP) portion.  As I move quickly forward to Financial Independence then I can see some more subtle change as I work to build regular income streams from areas like extending the HYP portion of my portfolio.
• When I started out Vanguard didn't exist in the UK.  They were of course big in the US but didn't actually come to the UK until 2009.  Vanguard funds and ETF’s now form a cornerstone of my portfolio lowering my investment costs.
• By 2010 I had cottoned onto the need to save hard, by both maximising income and minimising spend, and was regularly saving 60% of my gross earnings plus employee pension contributions.  That quickly moved to 2011 when I was without work.  Onto today and my family life has changed such that to maximise the benefit to the family I am paying all the family bills meaning over the last 15 months my savings rate has now fallen to an average of 50%.  Within this 50% I'm also making significant contributions to help my better half’s wealth (not detailed on Retirement Investing Today) to grow as quickly as my own meaning my wealth growth rate will also slow from what was planned.  To keep to plan I've had to work hard to continually increase earnings but also reduce costs through these changes. 
• In recent times we've seen and are seeing a lot of post Retail Distribution Review (RDR) change within the investment world.  It looks to now be stabilising and while I've generally not come out of it all too badly I am considering a shift away from Youinvest for my SIPP to again lower investment costs.
• The market moves and I respond with rebalancing according to my strategy as well as continually buying the most under performing asset class with new money.