The Lending Works Experiment

A little over a year ago I cried enough of the derisory instant savings account interest rates that were being offered by the banking sector, which after inflation and taxes, meant the value of my wealth was going backwards.  A quick trip over to Money Saving Expert reveals that the problem still exists.   The market-leading rate if you want instant access to your money is 1.6% meaning a higher rate tax punter, after inflation of 1.0%, is going backwards by 0.04% annually.  Additionally, this rate then reverts to 1.1% after a year meaning you have to do the savings account dance all again.  Even the best 3-year fixed rate account is only offering 2.65% meaning after inflation of 1.0% and higher rate tax our punter would only be getting ahead by 0.59%.  The chart below shows it’s been like this for a long time now and with no sign of an up-turn.

Click to enlarge, Average UK Savings Account Interest Rates

Meanwhile, while this has all been occurring I’ve been quietly shifting/building wealth with peer to peer (P2P) lending (while of course acknowledging that P2P has a different risk profile to bank savings accounts) as an alternative to a bank savings account.  Today I have as much money invested in P2P, £43,000, as I do in savings accounts.  Since starting out in May 2014 I’ve earned interest/bonuses of £1,342 which after taking into account deposits/transfers occurring over time is an annualised 4.3%.

Given my successes so far with P2P my interest was piqued this week when I was contacted by Lending Works enquiring whether there was any opportunity for us to work together.  At the time I wasn't using Lending Works as a P2P platform but I was aware of them as I know weenie over at Quietly Saving has money in their platform.  A few emails later we had agreed that rather than something like a boring advertisement that would add little value to readers I would instead run a published experiment with real money lent into the market.

My FIRE Number

Since starting this blog at 35 years of age in 2009 I have never revealed my portfolio values or targets in £ terms.  Rightly or wrongly I've always believed that it was irrelevant to readers given we all have different earnings, investments, risk profiles, savings rates and target retirement amounts.  This has resulted in posts that always focus on the theory and how I'm applying it but that in hindsight come across as dry and impersonal.

Today I'm going to try and change that by starting to talk in real numbers rather than percentages.  My hope is that it will up the debate a little and help us all continue to learn from each other.  I just hope it doesn't kill the community that has developed over the past 5 or so years.  Given the name of this blog and my closeness to FIRE (financially independent retired early) the amount of wealth I am trying to accrue is probably the number that is currently most important to me and probably one of the most popular topics debated/discussed within personal finance blogs and forums.  So let’s start there.

As a person who does not plan on receiving a State Pension and is not going to be receiving any sort of inheritance it is a crucial number for me as to fully FIRE it needs to be enough to last my family and I for the rest of my life.  That could be 45 or more years.  The methodology to calculate it was first devised back in 2007 when I first started on my DIY FIRE journey and went like this:

• I was renting in London, as I still am today and though of London as home
• I asked myself what a good salary would be that would enable me to live well including covering rent or mortgage payments.  That number was £30,000
• As I worked towards FIRE I would increase that salary annually by inflation.  Today that salary within my Excel spreadsheet is £37,691
• I calculated what I expected my portfolio to return annually in real terms.  This number still dynamically calculates in my Excel spreadsheet every week when I update my financial position.  That number after expenses was 3.8%.  A number I later learnt wasn't so far from the (in)famous 4% Rule

Dividing that FIRE salary by the expected return enabled me to calculate my number.  Today Excel tells me my early retirement number is £1,011,034.  To avoid discussions about me being obsessive compulsive let’s do a little rounding - I will be financially independent and have the option of early retirement with wealth of one million pounds.  My journey to the million is shown in the chart below.

The Exchange Rate Conundrum

It’s no secret that exchange rates can be and are volatile.  If you’re a person who’s earning in Pounds, has a reasonable portion of their wealth in Pounds and intends to retire in the UK spending Pounds then exchange rates are probably not going to lose you too much sleep.  Short term volatility might add a couple of hundred pounds to your continental holiday or repress the return on your international equities for a couple of years, where if you've made reasonable plans with a little contingency, is going to be noise in the scheme of things.  Long term volatility could end up resulting in some inflation but your Safe Withdrawal Rate has hopefully accounted for that as well.

Now let’s jump to somebody like myself and I'm sure I'm not along out there.  I'm earning in Pounds, have a reasonable portion of my wealth in Pounds, intend to retire early somewhere in the Mediterranean (still favouring Malta) but want to always give myself a chance of coming back to the UK if it for any reason turns ugly.  From today this is how the plans are unfolding:
1. 12 to 18 months still working for The Man in the UK and earning Pounds
2. Move to Malta (more likely Malta’s smaller island Gozo) and rent for 6 months to be sure I still love the place and know exactly which region I want to live
3. Buy a home for my family
4. Live happily ever after spending Euro’s but with my wealth still set up assuming the UK is home.  Longer term I may start to tilt more towards a European home assumption but that would be very gradual and take many years.

So I'm more heavily exposed to the GBP (Pounds or £’s) to EUR (Euro or €) exchange rate.  The Euro first started on the 01 January 1999 as an accounting currency and the chart below shows its monthly performance up to present day.

Click to enlarge, GBP to EUR Exchange Rate January 1999 to June 2015 

Even over that relatively short period big swings are evident.  It was at its weakest in October 2000 at 1.6977 and strongest in January 2009 at 1.0863.  The long run average is 1.3756 (the red line on the chart) which isn't far from today’s rate of 1.41287.

A Retirement Investing Today Half 1 2015 Review

On this blog I talk a lot about my own strategy and portfolio including how I'm managing and changing them as I learn.  Importantly, this is not a demonstration strategy or portfolio but instead reflects every penny I have to my name.  The journey also now represents a significant portion of my life with me now having been on this DIY Early Financial Independence (FI) path for seven and three quarter years which is nearly 20% of my life so far.  When I started in 2007 and even when I started this blog in 2009 I had no idea if I would succeed.  Today I'm far more confident that I’ll eventually get there and I also now believe that I have a level of personal finance knowledge that will enable me to self manage my portfolio to and into Early Retirement.  Even so I’m not yet going to relax.  At some point I'm also sure I’ll need to start thinking about how to set-up an autopilot portfolio (Vanguard LifeStrategy anyone?) but that’s for another day.

This strategy and portfolio is an essential enabler to how I want to live my later life – one not burdened by the need to work for The Man but instead able to focus 100% on what’s important to me which enables both location and time freedom.  Given its importance I like to stop every quarter and in line with my Plan, Do, Check, Act (PDCA) strategy do some Checking against 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 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%.  This is identical to last quarter.  While not achieving plan in pounds, shillings and pence it’s actually 56% more than I managed in Half 1 2014 thanks in part to a healthy bonus.

Click to enlarge, RIT Savings Rate

Saving Hard score: Conceded Pass.  While not achieving a plan of 55% in pound terms I’m a long way above 2014.  Savings have also added 7.6% to my net wealth in the first half of the year – a surreal amount given I’m towards the back end of my Financial Independence Retire Early (FIRE) journey.

HYP Mid-Year Update including Purchase 14

The vast majority of my investment portfolio is made up of passive index tracking funds.  Why?  Well as a person who’s now been investing heavily for a bit over 7.5 years I personally believe this is the best way for me to achieve my wealth ambitions.  One exception to this is my High Yield Portfolio (HYP) which is held within the Equities portion of my portfolio and can only be described as active investing.  So if I'm a tracker believer what am I doing actively investing I hear you ask.

Click to enlarge, RIT UK Equities Portion of Total Portfolio 

Simply, while 99% of my investing is all about non-emotional investing my HYP is an outlier as it’s there for psychological reasons.  I’m now fast approaching optional very early retirement and when in that retirement I’m going to be likely 100% living off my wealth.  I’m going to do this by drawing down from my wealth at the rate of 2.5%.  I have two ways to do this – spend dividends/interest and/or sell down capital.  For me, particularly in a severe bear market, I think that spending dividends/interest will psychologically be far easier and less disruptive to life than being forced to sell down capital.  With that in mind before retirement I’m trying to ensure that the dividends/interest I receive annually is as close to 3% of wealth as possible.  If I can achieve 3% in the good times I can draw down 2.5% and reinvest 0.5% and in the bad times I have some buffer to allow for dividend attrition.

This psychological advantage is however a fool’s errand if it causes my total portfolio to underperform the market.  Unemotionally what matters is Total Return which is Capital Appreciation plus Dividends.  So with this in mind I watch my HYP performance, particularly capital gains, like a hawk.  So as we pass the mid-year point of 2015 let’s take a look at my HYP's performance to date.

Firstly to what the HYP is all about – Dividends.  Performance here is still very good with the portfolio currently sitting on a trailing yield of 5.2% which is 1.4 times the FTSE100’s 3.6%.  So far so good.

Now let’s look at the risk associated with buying big, boring, non-cyclical industries – Capital Gains.  Since inception in November 2011 this is also ok.  The HYP has returned a gain of 31.0% vs the FTSE100’s 25.6%.  Where it gets interesting though is year to date gains to today.  Here the HYP has fallen by 1.7% vs the FTSE100’s gain of 1.6%.