A Retirement Investing Today Q1 2015 Review

The primary purpose of this blog is to hold myself accountable and chart my progress to Early Financial Independence (FI).  At FI my wealth will also be sufficient to make Early Retirement optional at the same time.  This is not a model or demonstration but my real DIY financial life.  Get it right and it’s smiles all round in a short period of time.  Get it wrong and my derisory State Pension is still a long way off and likely to get longer still given the financial and demographic state of this great country.

In line with my Plan, Do, Check, Act (PDCA) strategy let’s today some Checking by examining the three key focus areas that I believe are essential to get over the Financial Independence line - Save Hard, Invest Wisely and Retire Early.

SAVE HARD

Saving Hard is simply defined as Gross Earnings (ie before taxes) plus Employee Pension Contributions minus Spending minus Taxes.  Earn more and one is winning.  Spend less or pay less taxes and you’re also winning.  Savings Rate is then Savings divided by Gross Earnings plus Employee Pension Contributions.  To make it a little more conservative Taxes include any taxes on investments but Earnings include no investment returns.  This encourages me to continually look for the most tax efficient investment methods.  It’s a different and tougher measure to most of my fellow personal finance bloggers who don’t include tax in the calculation.

Savings Rate for the quarter ends at 53.8% against a plan of 55%.  While a miss it’s a lot better than the 37.2% I managed for the first quarter of 2014.  Additionally in physical pounds, shillings and pence in my pocket it’s more than twice as much as Q1 2014.  The miss was also a conscious decision with the RIT family taking a winter trip to Puglia, Italy to assess the location as a possible Early Retirement location.  At these savings rates I'm also now in the surreal situation where my spending is significantly less than the tax I pay.

Click to enlarge, RIT Savings Rate

Saving Hard score: Conceded Pass.  Savings, including help from a healthy bonus where I saved 100% of the after tax amount, have added 5.7% to my net wealth in this quarter alone.  My big problem remains taxes which I'm struggling to control as I'm a simple PAYE employee.  Any extra £ that I now make is taxed at the Higher Rate of 40% plus 2% National Insurance plus as my non-tax efficient investments continue to grow in size I'm being taxed on these as well.

INVEST WISELY

Investment returns for the first quarter of 2014 were 5.8%.  An incredible amount given the structure of my portfolio.  This return means for only the second time in my investing career investment return has exceeded savings rate.  Is compound interest finally starting to do its thing or has Mr Market just become a little excited?

Click to enlarge, RIT Year on Year Change in Wealth

My investing strategy remains largely in line with that developed at the start of my DIY journey except in recent times I've started making 2 tweaks given my closeness to Financial Independence.  The first is to increase cash like holdings to give the option of a family home purchase.  Cash moves from 8.2% of portfolio value at the end of 2014 to 9.4% at the end of the quarter.  Increasing portfolio dividends to 3% of non-home purchase wealth on the other hand is not going so well even though I continue to add to my HYP.   At the end of 2014 I was at 2.3% and today this has fallen to 2.1%.  Not much I can do here as it’s simply been caused by the Mr Market price rises over the quarter and is not something I can control.  My plan is to just keep at it and see what washes out in the next 12 months or so.  The 3% number comes from a decision to drawdown at 2.5% after expenses which then leaves a little for reinvestment also.  Psychologically I feel this would result in a more relaxed Early Retirement than one where you are selling assets off continually to eat.

Safe Withdrawal Rate (SWR) Thoughts

Many of us in the Early Financial Independence, Early Retirement, community are chasing an amount of wealth which when achieved will allow us to as a minimum call ourselves financially independent and as a maximum allow us to head into full early retirement.  To calculate that target wealth number it’s likely (I know I have) we've ascertained how much we intend to spend per annum and then divided that number by a Safe Withdrawal Rate (SWR) we’re happy with.

The 4% Rule is a SWR that is bandied about freely as a rule of thumb.  Personally it’s too bullish for me and so as I type this I'm planning on an SWR of 2.5% plus 0.25% to allow for investment expenses for a total withdrawal rate of 2.75%.

When we choose a SWR we’re likely trying to calculate the maximum real inflation adjusted annual income we can take while ensuring we don’t run out of wealth before we run out of life.  In doing so what we are really doing is trying to protect ourselves from worst case sequence of returns risk.  In trying to protect ourselves from this sequence of returns risk (and assuming history repeats which we all know is not guaranteed) we actually end up with a scenario where in the vast majority of cases we end up with a lot more wealth than we started with at check out time.

Let me demonstrate with an example.  To do this I'm going to teleport myself to the US and use the excellent cFIREsim calculator as we’re pretty starved of decent free tools here in the UK.  I'm going to assume I retire with one million dollars ($1 Million), give myself a 60% US Equities : 40% US Bonds asset allocation, spend at an inflation adjusted $25,000 per annum (a 2.5% SWR), assume annual expenses of 0.25% and assume I need that level of spending for 40 years.  The output of that simulation is shown below:

Click to enlarge, cFIREsim output

How about those falling iron ore prices – Adding Rio Tinto to my High Dividend Yield Portfolio

While those around me at work are talking about the holidays, fashion and gadgets they have bought with their bonuses I've kept fairly quiet as I have chosen to save 100% (after HMRC has of course taken 40% Higher Rate Tax and 2% National Insurance) of mine.  So having saved all of it where have I invested it wisely?  I've gone for 4 main areas and I’ll cover 3 of them today, saving the fourth for a separate post.

The first deployment was sending 35% of the bonus to my better half to keep both of our financial independence end dates synchronised.

With only 18 months or so to go until Financial Independence I also want to make sure that I have positioned my financial life to also give myself the option of Early Retirement.  From where I am today this means I need to do two things:

• I am currently renting in London but want to give myself the option of buying a home in whichever country my family chooses.  I therefore need cash for this and lots of it.  My second deployment was therefore sending 33% of the bonus to my savings account and RateSetter P2P account (plus a little to my Stocks and Shares ISA which is yet to be invested so is currently cash but ensures I've at least used all of my 2014/15 £15,000 Allowance).
• I don’t like the idea of having to sell down assets to eat in Early Retirement and would much prefer to be simply spending dividends/interest with a little left over to invest.  After I net off the cash I've saved for a home my investments are currently yielding 2.1% and I’m planning on drawing down at 2.5% after investment expenses.  I therefore need to find ways to improve my dividend yield and fast.  My High Yield Portfolio (HYP) is one way I have been trying to do this.  My third deployment was therefore 15% of the bonus into Rio Tinto (Ticker: RIO).  So why Rio Tinto?

The price of the FTSE100 is today near record nominal highs (the real high is something different altogether but that’s for another day). In comparison the price of Rio Tinto is almost half of previous highs:

Click to enlarge, Price History of Rio Tinto (Source: Yahoo Finance)

To FIRE Fast we must know what we really Value

I think we've had enough about what I eat for breakfast and what I want to be when I grow up for now.  Let’s get back to what this blog is all about – an unrelenting focus on Saving Hard and Investing Wisely to enable Early Retirement in my case.  Your end game could of course be different.

I work hard for the money that I earn.  Given how much effort I've put into acquiring it the least I can then do is now put a bit of effort into retaining as much of it as possible.  Why?  Well, now that I have some money in my pocket I'm up against millions of people and corporations trying to extract as much of that money from me as possible.  It’s nothing personal but just the way it is.  Importantly, it’s also not just the big purchases.  I’ve found that sweating the small stuff is possibly more important because leakages here often have very little impact on your health and wellbeing.

So why at this stage do I want the minimum extracted from me while still living the life I want to live?  For me it’s not emotional and is simply by learning how to spend less I can save more which is then an enabler to help me FIRE faster (Financial Independence Retire Early).  Seven and a half years into my journey I'm at the point where this is probably the most important lesson I have learnt thus far.  Sure earning more helps but that just helps accelerate you to the goal posts and minimising investment expenses/taxes also helps but I’ve found savings have had a bigger impact on my wealth creation so far as the short time I have given myself to accrue the assets to FIRE don’t get much time to compound.  Spend less and two things occur which is why it is a critical element – it both moves you more quickly towards the goal posts but also moves the goal posts towards you.

Am I Making a Mistake?

Security of employment is not what it was once.  Changes including globalisation, technology, automation and lean (lean is basically doing more with less through the elimination of waste), amongst others, have sent it well on its way.  We see lack of security of employment manifest itself in many ways with one of the more recent ones making headlines in the mainstream media being zero hours contracts.

The problem with this change is that without security of employment there is always the risk of starving to death (maybe an extreme example given the UK’s welfare state status, but certainly not in some countries and hopefully you get my drift).  According to Maslow’s Hierarchy of Needs inability to correct for this deficiency need (or d-need) then prevents one from ever reaching Self-Actualisation which is essentially the realisation of your full potential.

Click to enlarge, Source: www.convene.com

Personally, in my current career I’m also under no illusion of having any sort of security of employment.  I know that my current security is linked to nothing more than my last performance review or (not and) nobody anywhere else in the world being able to offer the equivalent service for a lower cost.  Part of this is within my control, but mistakes do happen, and part of this is outside my control.

With time I’ve come to realise that my solution to this problem in the short term has been to keep my skills current (the 1% inspiration) and then work hard (the 99% inspiration).  So far this is working with a recent notification that I’ll be receiving a salary increase of 4% and a bonus that exceeds my notional amount in recognition of my performance last year.  I never thought too much of this work hard approach, including was it too extreme, but when readers last week made comments like;

“I appreciate this is the path you've chosen, and for well thought out reasons, but your hours of work sound awful“;

and;

“Holy s**t - good job you have an escape plan as that is a brutal life you currently have carved out for yourself - 16 hour days!  You must be tough as nails!”;

it really did make me take a step back and think.