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.

A Significant Milestone

Noel Whittaker in his book Making Money Made Simple states that in a country such as the UK (he actually cites Australia as an example) “the average person needs only two things to become wealthy – the knowledge of what to do, and the discipline to practise the things that need to be done.”  When put that way it sounds so simple (and of course it is) however reality is of course a different story all together particularly when I look back at my own potted history.

I graduated and started work in 1995.  Almost instantaneously I took on plenty of debt in the form of a car loan and was quick to ramp my standard of living by spending nearly everything I earned (I did save a small amount into an employer pension but it was nothing more than the default fund).  It actually took me until 2002 to make a small purchase into my first investment fund which was not part of any overall strategy but simply a random purchase.  I can’t even remember what prompted the purchase but it certainly wasn’t the “knowledge of what to do”.   It was a great selection [sic] with annual expenses of 1.78% along with a 4% contribution fee.  Hardly the road to wealth.

It actually took me until 2007 to wake up and start to figure out what the game was all about which is when my wealth building journey to financial independence really started.  It was in this same year I bought my first tracker - a FTSE All Share Tracker Fund.  That is 12 years from when I started earning a full time salary to even begin to have the personal finance “knowledge of what to do”.

The RIT High Yield Portfolio (HYP) – Adding GlaxoSmithKline

I’ve now been building my High Yield Portfolio since November 2011.  A reminder of my previous purchases:

• On the 28 November 2011 I purchased AstraZeneca (LSE ticker: AZN), Sainsbury’s (LSE ticker: SBRY) and SSE (LSE ticker: SSE).
• On the 21 December 2012 I added Vodafone (LSE ticker: VOD).  To avoid all the Verizon Wireless disposal fun and games I subsequently sold out on the 21 January 2014 and then repurchased the new VOD on the 30 April 2014.
• On the 11 October 2013 I received 227 shares as part of the Royal Mail Group IPO (LSE ticker: RMG).  I didn’t consider it a HYP purchase at the time (and still don’t) but simply the closest thing to free money I’ve come across in a long time.  The tax payer really was fleeced on that one.  It sits within my HYP as it is the closest match within the different portions of my portfolio.
• On the 03 March 2014 I then added HSBC (LSE ticker: HSBA)
• On the 30 June 2014 I added Pearson (LSE ticker: PSON) and Royal Dutch Shell (LSE ticker: RDSB).

The experience continues to be positive with the HYP as of Friday (excluding the GSK purchase) sitting on a trailing dividend yield of 4.6% compared to the FTSE 100 dividend yield of 3.3%.  At the same time the HYP is also outperforming the FTSE 100 from a capital growth perspective.  Year to date capital growth of the HYP is down 0.6% compared to the FTSE 100 which is down 1.0%.  Since inception the HYP has grown 35.4% compared to the FTSE 100’s 25.7%.

Wealth Warning: I don’t know if long term this HYP strategy will work.  There is every chance that a simple diversified portfolio of lowest expense index trackers that are invested tax effectively will in the long term outperform this strategy.  Only time will tell. 

Buying GlaxoSmithKline

So with hundreds of shares to choose from I grabbed GSK on Friday.  Let’s review why by sharing my usual selection criteria.  At the same time let’s also have a quick look at how HYP’able my current holdings also look today.

1. Is the business model simple to understand?

The first criteria is qualitative.  I want to understand how the business I’m buying makes its revenues in less than 10 seconds.  GSK and its brands hardly need an introduction.  They are a global pharmaceutical and healthcare company developing and supplying medicines to help people do more, feel better and live longer.  They make everything from Ventolin which any asthma sufferer will likely know well, through remedies such as Beechams Cold & Flu and onwards to day to day brands such as Macleans toothpaste.  They even own the Horlicks brand.  This is simple to explain and understand so meets my first criteria.

Freedom and Choice in UK Pensions : It’s Not All Good News for Responsible UK Personal Pension Holders

As part of the UK Budget 2014 George Osborne briefly announced the next tranche of government pension tinkering.  More detail in the form of the fifty page document entitled Freedom and choice in pensions : government response to the consultation has just been published so let’s briefly look at what I think is the good, the bad and the ugly as far as I'm concerned.

The Good

The Budget included the announcement that from April 2015 pension holders would get unrestricted access to their personal pension savings.  The mainstream media became all excited and started talking about people cashing in the lot and buying Lamborghini’s.  I ignored this nonsense and thought it actually might give responsible people (like myself?) who are saving for their future an intangible benefit so have been keenly waiting for the detail.

I currently have 44% of my wealth tied up in Pension Wrappers as they have the potential to (I say ‘have the potential to’ and not ‘will’ as once you’re in it’s difficult to get out again without punitive taxes and governments are guaranteed to continue to tinker) give me a healthy reduction in tax over my lifetime.  This comes from a few areas:

• As a Higher Rate taxpayer while working but expecting to be a Basic Rate taxpayer in retirement I’m avoiding 40% tax now in exchange for 20% tax as I start to withdraw from my pension.
• By salary sacrificing I’m also getting the employee national insurance that would have been paid on the sacrificed amount added into my pension as well as the majority of the 13.8% my employer saves by not having to pay employers national insurance on the scarified amount.
• Being able to take a 25% tax free lump sum at retirement. 

Best UK Savings Account Interest Rates & The RateSetter Experiment

I have been using Yorkshire Building Society (YBS) as my Savings Account provider for a few years now.  While once at the top of the best buy league they haven’t been there for some time now.  They have however always been pretty close from an interest rate perspective and have been no nonsense from a T&C’s perspective.  I was receiving 1.5% AER meaning as Higher Rate Tax payer and with inflation running at 2.6% I was receiving a Real interest rate of -1.7%.  In other words every pound sitting in YBS was being devalued monthly.

Recently, they have sent me a letter which starts out with “As your building society, you'll know that we have a tradition of looking after all our customers with good value products and great service...” Great start but of course the small print advised that they were further reducing my savings account interest rate to 1.25% AER.

Of course I’m not surprised given the latest average savings account data from the Bank of England shown in the chart below which show instant access savings rates down 0.27% in the last year.

Click to enlarge

Going to the market for the latest best buy savings accounts reveals very little.  Moneysavingexpert.com recommends the Santander 123 current account which has sliding scale interest rates (between 0% and 3% AER), a monthly fee and minimum deposit requirements.  The best clean rate looks to be Britannia or Coventry BS with a 1.4% interest rate but these accounts can’t be run online.