Decisions … Decisions

Atlanta USA 145 - Version 2When I first embarked on this FI project I felt like a kid in a candy store with very little money: want everything can afford next to nothing. I wanted to pay off that ridiculously large mortgage asap, use all my annual ISA allowance, stash away more moolah for the rainy day, and contribute more than the bare minimum into a workplace pension. But I also wanted a (very expensive and completely unnecessary) basement conversion because, y’know, nowadays basement conversions are all the rage in London, and alcove shelving, and a drip irrigation system for the patio, just a regular one, not a green wall or anything, no need to be extravagant, and a new kitesurf board since mine is rather old… soon it became apparent that I needed to prioritise.

I zeroed in on overpaying the mortgage; there’s a consensus on the FI blogosphere that debt repayment comes before investing, and I didn’t have any non-mortgage debt. It turned out to be an ok decision, albeit ridiculously tax inefficient. My marginal tax rate is such that I can’t even think of it without swearing [1]. So overpaying the mortgage was not a completely shite move, however, now that its balance has reduced and a mere sight the annual mortgage statement no longer brings on a tachycardic attack, I’ve decided to give it a rest and focus on the pension.

In the UK at least, a pension, be it a workplace pension or a SIPP, is the most tax efficient FI vehicle on offer. The only downside is having to wait until you are  56  58 before you’re allowed to get your mitts on the loot. But given how low interest rates are at the moment it makes no sense paying 40%-60% income tax and then overpaying the mortgage from after-tax income. I’m timing my Mortgage Free Day to coincide with my FI Day. Virtually all my savings are going into the pension so as to reduce income tax. I have enough carried over pension allowance to last me until 2018. When that runs out pension contributions will be limited to £40k p.a., and I’ll have to decide on what to do with any additional savings. I suspect that it’ll be a tossup between mortgage overpayments and ISA contributions. I also suspect that I’ll choose to fatten up my emergency stash in the form of a cash ISA first and put the rest into S&S ISA. I’ll need a freedom fund to live on between early retirement and the ripe old age of 58.

Some might say that investing in S&S ISA with an outstanding mortgage is a somewhat risky proposition. Perhaps it is, but then again, that’s what an emergency fund is for. I’ll go out on a limb here and say that I don’t think interest rates will rise from where they are now in foreseeable future. First world economies are creaking under a mountain of cheap debt; they’d outright collapse if that debt became expensive. The more cheap debt gets accumulated in the system, the less possible it will be for those in charge to ever raise the rates back to normal levels where markets can function as mechanisms for moving savings into productive investments. Everyone knows it, but events (dear boy) keep rolling in. The GFC ended, but then Brexit happened, and when that shitshow gets sorted out [2] then China’s bubble will pop with a bang [3]… China will have to lift capital controls at some point. Hence given a mortgage rate of c.1.3% vs a tax rate of 40%-60%, it’s a no brainer. Maybe.

Notes:

  1. I can swear in 6 languages, and when you do it quietly in your head there are no forbidden words. It is Known.
  2. Don’t start on it and I promise to do my utmost to not disintegrate into a rant about the stupid, xenophobic, irresponsible, stupid, economically illiterate, intellectually dishonest, stupid brexiteer twits, to whom I usually refer as ze clusterfuck implementation committee, ya?
  3. China is a qualitative constraint on my early retirement plan. The current goalpost is c.£1m (depending on  the rate of inflation between now and 10-or-so years from now), but only if the Chinese bubble has burst in the interim. Otherwise I’ll consider carrying on at the salt mines until it does, because when it does I might just get a redundancy payout.
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Fookin Taxes

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Hello little guy! It’s the tax man coming!

My P11D has finally arrived, and now I have no more excuses to procrastinate; it’s time to complete my SA. With this in mind I immediately began to trawl through my records for something to listen to when doing taxes.

Here’s what’s in the Tax 2016 playlist:
“Taxman” – The Beatles
“No Money” – Kings of Leon
“Yes Sir, No Sir” – The Kinks
“You Never Give Me Your Money” – The Beatles
“Money Maker” – The Black Keys
“Hold On To What You’ve Got” – Dennis Brown
“Poney Honey Money” – CSS
“Box Full Of Letters” – Wilco
“Money For Nothing” – Dire Straits
“Money” – The Drums
“Nothing To Hide” – Yo La Tengo
“What If We All Stopped Paying Taxes” – Sharon Jones and The Dap-Kings

Wealth: How Am I Tracking?

TomTomMost people have “a-ha” moments; somehow I just seem to have “oh for fuck’s sake, seriously!?” moments. One of those occurred about a year ago and resulted in me wising up to the fact that earning good money and blowing it all on holidays, sports gear and gadgets was not making me either rich or happy. Just like Xanax doesn’t really make you relaxed. The realisation was rather sobering. The corrective action was decidedly unpleasant.

So these days I don’t haemorrhage money like a drunken sailor. I have spreadsheets. They  track my net worth.

They say what gets measured gets done, and if you’re traveling somewhere it’s good to know where you are and how far you still have left to go. For those of us working towards financial independence keeping an eye on progress might help in that sense. I also like spreadsheets, so there’s that.

In The Millionaire Next Door Stanley and Danko provide a formula for calculating what your net worth should be given your income and age.

Target net worth = Age x Income / 10

If you’re good with money, your net worth should be twice the above number. Personally I prefer Trent Hamm’s modified The Millionaire Next Door formula. It’s more forgiving to those of us under the age of 40.

Target net worth = (Age – 27) x Annual pre-tax income / 5

But a general question remains of what assets should be counted (home equity?) and what comparative values they should be assigned. Surely a £100 in an ISA is worth more than £100 in a SIPP, because of this thing called tax. How much more, depends on how much you already have where (ISA/ SIPP/ taxable accounts) and on your expense run rate at FI, as these factors will determine your marginal tax rate.

Louis XIV’s finance minister, Jean-Baptiste Colbert, famously declared that “the art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” Governments, bless them, tend to stick to tax policies that mostly work for those who voted them into power. Alas, it appears that the FI community represents a rather small proportion of the electorate.

As I work towards FI I have to put liquid funds in place to finance each chunk of my future FI life. Having all my wealth tied up in my home and pension may be the most tax efficient option*, but it puts a limit on my earliest possible retirement age. If I want to quit being an office drone before I turn 58 (which I very much do) then I’ll have to sacrifice some tax efficiency in exchange for earlier access.

ONS released their Wealth and Assets Survey the other week, which made for an interesting read. I took their numbers for my income decile, adjusted them (albeit crudely) for age, and lo and behold, this is what my household wealth distribution looks like, using the four categories as defined by ONS. The blue graph is the ONS household wealth distribution by asset class and the green graph is me.

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The silly property / financial wealth split in the green graph is due to mortgage overpayments; in my circumstances these two are interchangeable as I’ve been overpaying mortgage in lieu of investing in, y’know, investments.

The one thing this really does bring out is that I’m way too light on pension. This will need to be rectified, pronto.

 

Notes:

* It is in the UK at least. I know the Yanks get taxed on houses… tough shit, that.

3652 Days to Financial Independence

3652 Days

The countdown has begun.

What do we want? Financial independence.
When do we want it? Now. (But, failing that, in 10 years or 3652 days).

Below is the how.

Investment philosophy.

Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth.
– John C. Bogle

Asset allocation.

Allocate assets to three main sub-portfolios:

  1. Emergency Fund.
  2. The Freedom Fund. This will finance my life between 2025 and the year when I’m allowed to get my mitts on my pension.
  3. Pension, which I will be able to access in 20-odd years. Probably later.

Emergency Fund
Three months’ salary in cash.

Freedom Fund
Maintain overall 60% stock + 20% fixed income + 10% property + 10% gold allocation to accommodate both short-term and long-term requirements. Assets should be diversified across major asset classes including domestic equity, international equity, conventional bonds of short to intermediate term, and index linked bonds.

Pension
Divided between a SIPP of my choice and the Employer’s Scheme.

Funds and accounts.

Use low cost funds and ETFs – index trackers preferably – which do not overlap and provide maximum diversification across asset classes. Try to assume only market risk as far as possible. Try to shelter tax-inefficient investments in tax-advantaged accounts to reduce tax drag.

Target allocation.

Freedom Fund
The target Freedom Fund portfolio allocation is set out below.

Asset class Vehicle Asset allocation
Equity ETFs 60%
Property Funds or ETFs 10%
Government bonds ETFs 20%
Gold ETFs 10%

Pension
Invest SIPP in low cost tracker funds or ETFs. Equity % allocation will be (120 – [my age]).

Other considerations.

Automate future contributions wherever possible.

No market timing.

Rebalance annually using Larry Swedroe’s 5/25 rule. Asset classes with a target allocation of 20% or more: rebalance when it moves by 5% versus the entire portfolio. Asset classes with a target allocation below 20%: rebalance when they drift by 25% in proportion to their target allocation.

Exact sub-allocations between ISA / trading accounts are not as important as maintaining the overall asset allocation – no need to make things complex in order to meet sub-allocation targets.