Easier Said Than Done

Cliffs of Dover
High on a trophy raised of useless arms, He sits, and threats the world with vain alarms.

I am in my third year of working towards early retirement. There are others aiming for a similar goal, and some have already achieved it, but there aren’t many of us. What we’re trying to do is rather unusual in terms of saving and investing for retirement.

Normally, in retirement planning, our accumulation phase is longer than our retirement.

We all know the drill. In our first 20 years we’re meant to learn how to earn money, then we’re supposed to earn it in the 40 years that follow, and spend the remainder of our lives, say, 30 years or so, as pensioners. In those 40 years of earning, saving and investing, we’re bound to encounter a few recessions, a few stock market busts, as well as bull runs. Exchange rates will go this way and then that way.

The long accumulation phase helps build experience of being invested in the market and gives time for the snowball effect to kick in. It also averages down the impact of the macroeconomic environment.

That chap from Omaha thinks that macroeconomics don’t matter in investing. Over the the long run they probably don’t. However, the FI community don’t invest over the long run; we invest for the long run over a comparatively short period of time. This presents a number of challenges.

1. Less experience in traversing a varied terrain

So far I’ve only seriously invested in stocks in a bull market. How would I react if my portfolio halved in value? There are various tools on the internet that can give me an idea of what my risk tolerance is (moderately high), and I’ve read books about what I should do in a bear market (brace and ride it out), but do I have any experience of actually doing it? No.

2. That thing called snowball

Ermine has written about it, as well as RIT, so I won’t rehash what they have already explained and demonstrated. I’ll only add that both these guys bought shares in 2008 and 2009. If the magic power of compounding didn’t help them all that much, then I, having started on this path in 2015, shouldn’t count on it to make a significant difference either.

3. A longer retirement means less certainty about social policy

My employer pays for my private medical insurance, but what happens after I retire? Can I rely on the NHS for the rest of my natural life? I don’t know. A lot will hang on how this Brexit thing works out, and so far it’s looking like a major clusterfuck overseen by a bunch of retarded monkeys dead set on dismantling the welfare state.

Should I plan to receive a state pension when I’m 68? Frankly, I don’t think so. It will depend on whether, in 30-odd years’ time, those in charge feel that the country can afford to pay me a pension in exchange for my vote.

4. Asset allocation and volatility

We’ve all heard about starting out with 100% of our portfolios in equities and then slowly increasing the bond allocation as retirement draws closer. You know what I mean. Take 120, subtract your age, and the result should be your allocation to equities.

If I retire at 45, then according to this formula 75% of my portfolio should be invested in shares. That’s quite a lot of volatility.

The challenge is to balance the sequence of returns risk against the risk of not having enough investment return overall. I don’t know this for a fact, but I suspect that the latter is a greater risk, and more difficult to manage, than the former. Because: inflation.

5. Less time to average down the macro impacts

Achieving financial independence within a 10-year timeframe means that I have to build up my entire capital base under a set of conditions that could be significantly different from the average.

Let’s take a look at the exchange rates (we could do the same with gold, oil prices, or a stock market index). Here’s the GBP/USD exchange history for the 40 years ending November 2017.

GBP/USD ROE 40 Years to 2017
GBP/USD ROE 40 Years to 2017

There’s a slight downward trend for the pound, however, in the scheme of things, over the long run, the ups and the downs have roughly offset each other. The average GBP/USD rate is 1.66.

But look what happens if we divide the same data into 10-year increments. For the 10 years to 1997 the average exchange rate is similar to the 40-year average. Not so much for the other three periods:

  • 10 years to 1987: average GBP/USD rate is 1.74 (5% higher than the 40-year average);
  • 10 years to 2007: average GBP/USD rate is 1.69 (2% higher than the 40-year average);
  • 10 years to 2017: average GBP/USD rate is 1.56 (6% lower than the 40-year average);


All else being equal, S&P500 is more expensive for a UK investor in 2017 than it was in 1987 purely due to the different rates of exchange. Yes, life is partly a game of chance, and I think chance plays a bigger role for those whose accumulation phase is shorter.

One paranoia to rule them all

I worry about inflation the most.

Before I’m fitted for a tin foil hat, let me quickly say that I don’t think hyperinflation is on the cards for Britain. Save for a nuclear war or a complete collapse of the ecosystems, hyperinflation in Europe is a thing of the past. But inflation doesn’t have to be stupidly high to do damage to bonds, and equities provide only a partial hedge against it. In times of high inflation real stock market returns tend to be lower and more volatile. Dividends are paid from last year’s profits.

I don’t think inflation gets the air time it deserves in the FI/RE community, probably because much of the material is rather US-centric. Historically in the US imported inflation has been down to oil prices, and now that they’ve agreed an oil deal with Iran and learned how to frack, this issue has reduced in significance.

The British economy is much smaller and more open than the US of A, and hence more exposed. The  current devaluation of the pound is pushing inflation ever closer to 3%, and for food it is over 4% already. And this is with next to no GDP growth and with real oil prices being at about the mid-90s’ level, when the GDP was growing at 3% annualised and inflation was 2.5%.

While I’m working and saving for retirement inflation is a drag on my real earning power. Its real danger however comes in retirement. I can think of only two mitigating strategies:

  1. Diversify my investments across asset classes, countries and currencies (as an aside, I don’t think shortening the duration of the fixed income portfolio would do much good); and
  2. Reduce my withdrawal rate.

A lower withdrawal rate means that I must have even more capital saved up when I pull the plug on work…. And so we’re back to the problem of stashing away enough, over a short period of time, in spite of whatever curveballs the economy throws at me, without very much help from compound interest.

It’s easier said than done.


4 thoughts on “Easier Said Than Done”

  1. Two more options:
    – gold
    – do a bit of freelancing on the side if needed (same effect as reducing withdrawal rate)

    Could you elaborate what’s wrong with shorter maturity fixed income?


    1. There’s nothing inherently wrong with short or intermediate maturity bonds, but, in theory, in retirement I should be matching the duration of my portfolio to the duration of my retirement (although this does not have to be the case during the accumulation phase, where the goal is to maximize wealth within the bounds of acceptable volatility). Also, both interest rates and inflation rates impact the price of bonds, and they don’t have to move in unison.


  2. Shouldn’t you make the difference between world inflation and the specific case of UK inflation? If the latter is your worry and your income comes from a broad portfolio of world equities then the UK is only 7% of the MCSI World Index so a lot of your UK inflation hedging comes from that?

    I do agree with the premise that investing over several market cycles is valuable. I made a total pig’s ear of it in the dotcom boom and bust, but I was earning and I consider the losses a chaep education in what not to do. I applied that this time round, but I am aware one is never safe from one’s screaming monkey self 😉


    1. I agree, a globally diversified equity portfolio should provide a hedge against inflation. I recently started diversifying my fixed income holdings as well (previously it was all UK gilts). The fixed income portion of the LifeStrategy 80% fund is already there, although, speaking of LifeStrategy, the allocation to UK equities in these funds is a little high. I haven’t quite come up with a solution yet, I like the hassle free factor of the LifeStrategy funds.
      As an aside, my problem with a disproportionate UK equity allocation is not so much the country exposure (most of the UK FTSE earnings originate overseas anyway) but the sector exposure. LSE is heavy on extraction industries and financials and light on tech…


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