Financial review at 31 December 2019

Twelve months Summary

This is an update on my previous reviews of four and six months ago.

A total return for the year of 20.24% growth, slightly above the FTSE All Share total return index growth of 19.17%, results after draw down expenditure in a capital uplift of 15.87%.

Source: Pixabay

Six years of drawdown results

As I am not earning any income from employment any more, I am in draw down in that I am drawing down some of my financial assets each month to cover our spending. I have been in draw down since December 2013 so the six years since then will be the main time period under review. My five key performance indicators in this review are capital, income, expenditure, total return, and income growth. My key comparisons are with an inflation index, an equity index, and the “safe withdrawal rate” (SWR).

Inflation (RPI)

My chosen inflation index is the retail price index. I have chosen this one because it has the longest history, it is perhaps more inclusive than other rival indices, it tends to be higher than these rivals, and is favoured less by politicians.  In 6 years the RPI index has increased by 15.23% (I have estimated the figure for December).

Equities (FTSE UK All Share)

My chosen equity index is the FTSE All Share total return index. I have chosen this one because I live in the UK and the majority of my portfolio is invested in UK equities. This index also has a history that extends back to when I started investing in 1986. In 6 years the FTSE UK All Share total return index has increased by 45.53%. If I chose to invest in funds that attempt to passively replicate and track the index these would return less than the index because of fees and tracking errors. A typical unit trust tracker (M&G Index Tracker Fund Sterling A Acc) had a total return of 41.56%.

“Safe Withdrawal Rate” (SWR)

This approach suggests taking an income, or drawing down, only 4% of your available capital in year one and then increasing that amount by inflation each year.

Capital

My capital has increased by 22.69%. This compares to an increase in RPI inflation of 15.23% (I have estimated the RPI figure for December).

Year endCapitalGrowthRPIGrowth
2013100.00100.00
2014100.180.18101.621.62
201596.05-4.13102.841.20
2016106.8711.27105.412.49
2017117.309.77109.754.12
2018105.88-9.74112.712.70
2019122.6915.87115.232.24
as % of 2013 assets

Income

My income has increased from 3.53% to 5.38% of my original capital. This compares to the income according to the “safe withdrawal rate” which has increased from 4.00% to 4.61%, based on inflation from December 2013 to December 2019.

Year end4% RuleIncome
20133.43
20144.003.53
20154.063.81
20164.113.92
20174.224.63
20184.394.89
20194.515.38
20204.61
as % of 2013 assets

Expenditure

My expenditure has increased by 32.87%. This is more than double the inflation increase and reflects some choices made in 2015/2016. I would be prepared to undo some of those choices in the future if that were needed. In the meantime I take comfort from the fact that income growth has exceeded this expenditure growth.

This year my spending as a percentage of my income is 78.10%. Expenditure is running at an annual rate of 3.67% of the average asset value during the 2019 year.

Year endIncomeExpenditureGrowthRPISpend %Expenditure
2013108.40100.00100.0092.25-3.52
2014111.5892.27-7.73101.6282.69-2.91
2015120.61104.7913.58102.8486.88-3.38
2016124.12122.1616.58105.4198.42-3.81
2017146.58123.340.97109.7584.14-3.48
2018154.75126.192.31112.7181.54-3.57
2019170.13132.875.29115.2378.10-3.67
as % of 2013 expenditureas % of year average assets

Total return

The portfolio total return has been 51.17%. This compares to 45.53% from the FTSE All Share total return index and 41.56% from the M&G Index Tracker Fund Sterling A Acc, a typical index tracker fund. I can’t compete with the total return of global and US equity indices because of my preference for UK and Asian equities.

Year endTotal ReturnGrowthIndexGrowthTrackerGrowth
2013100.00100.00100.00
2014103.143.14101.181.1899.69-0.31
2015102.28-0.83102.170.98101.291.61
2016118.2415.60119.2916.75116.5415.05
2017134.3913.66134.9113.10131.4612.80
2018125.72-6.45122.13-9.47119.69-8.95
2019151.1720.24145.5319.17141.5618.27

Income growth

Income has grown by 56.94%. The portfolio income yield has increased from an annual rate of 3.82% in 2013 to 4.70% in 2019. This is calculated on the average asset value during the year.

Year endIncomeGrowthRPIGrowthIncome Yield
2013100.00100.003.82
2014102.932.93101.621.623.52
2015111.268.10102.841.203.89
2016114.502.91105.412.493.87
2017135.2218.10109.754.124.13
2018142.755.57112.712.704.38
2019156.949.94115.232.244.70
as % of 2013 incomeas % of year average assets

Conclusion

My current main objective continues to be income growth rather than total return. Compound income growth is running at about 8% per annum. This is derived from increases in the dividends paid per share, from re-investing any unspent income, from re-positioning the portfolio towards higher yielding investments, e.g. high yield bonds and commercial property, and from remaining focused on the higher yielding stock markets in the United Kingdom and Asia. I have had to steer clear of lower yielding markets such as the USA.

Markets seem buoyant since the election but some concerns are ongoing and volatility in capital values is always a possibility. If that were to happen then I will aim to stay invested on the basis that any volatility would be short lived and the investment trusts I hold should be able to maintain or even increase their dividends.

Income growth has stalled a little in the last two months as I took the precaution of going global and also increased my cash holdings. I currently want to further raise my portfolio income but I expect to move towards more of a total return objective in the years ahead.

Back in the UK

Source: Pixabay

Last month I wrote about beginning to go global as I increased my non-UK exposure in response to the unstable political and economic situation. The impending general election could have resulted in a change of government to one much less supportive of business and of investors. In early November therefore I reduced my UK exposure from 58% to 52% as a precaution and I had plans ready to reduce this further depending on the outcome. In early December I sold a little more of my UK holdings in order to hold more cash.

As we now know such fears of a Labour government or hung parliament have proved to be unfounded and the Conservative government has won a landslide victory. In my view such a decisive outcome means that both the Brexit stalemate and the Labour threat are removed. Some Brexit uncertainty remains as to the shape of a future trade deal, but overall the UK is now a better place to be invested. Having reduced my UK exposure, I am now cautiously increasing it.

One week after the polls closed the FTSE All Share total return index is up by 4.2%. My portfolio has risen by 3.6%. This is acceptable to me given that I have some exposure to bonds and property and to international equities and that my UK exposure had been reduced to 52%.

Even after this “Boris bounce” following the general election UK equities are still relatively cheap compared to global and US equities. As at 19 December 2019, I calculate that buying £1 of income is 31% cheaper in the UK than it is globally, and 34% cheaper in the UK than in the US. The same calculation also shows the UK to be only 5% cheaper than Europe and only 9% more expansive than the Asia Pacific region. This is based on the dividend yield of selected income investment trusts. These show an average yield of 4.80% for Asia Pacific trusts (HFEL, AAS, SOI), 4.40% for UK trusts (EDIN, CTY), 4.20% for a European trust (JETI), 3.03% for global trusts (HINT, STS, SCAM), and 2.90% for a US trust (NAIT). I am still persuaded that UK equities offer good value but now I do want a few more of my eggs in that basket.

The latest information on these investment trusts can be found at the AIC website under find and compare investment companies. You can then filter on a particular AIC sector or else search a trust name or TIDM code (e.g. CTY).

After my changes last month my portfolio looked like this:

Investment Trust SectorPortfolio %UK %Non-UK %NDY %
UK Equity Income38.7833.095.693.67
Asia Pacific Income21.900.3221.584.98
Global Equity Income21.091.6819.414.11
Property - UK Commercial9.029.020.007.67
Debt - Loans & Bonds8.427.391.037.65
Total99.2151.5147.704.76

Note: Data is from my portfolio and from the AIC website as at 7 November 2019.

I now intend to leave my bond and property holdings unchanged but to reduce my global and Asia Pacific exposure and increase my UK exposure. Having added certain trusts in the global and Asia Pacific sectors just last month I intend to keep all of my holdings in these sectors but to trim the size of some of them. My non-ISA holdings are all in UK trusts and will not be changing. My ISA holdings are spread across three platforms and my increase in UK exposure will ensure that each platform has some UK exposure as well as some global and/or Asia Pacific exposure. I have initiated some trades this week and am now awaiting confirmation of them, but they should result in an increase in UK exposure of about 5%. This will bring my UK exposure roughly back to where it was two months ago. Arguably I should have not made any changes before the election, and I would not then need to make any changes now. That, however, is hindsight and I don’t regret my approach to this. This situation actually served as a good prompt to review my portfolio and consider how I would go global with my portfolio if that were needed.

All these portfolio changes and the raising of cash levels will likely curb the income growth from the portfolio in the last two months of this year. Income growth has been more of an objective for me than capital growth over the last six years. In the new year I expect to make further progress on that income growth once these portfolio changes are behind me. I expect UK, Asia Pacific and selected global equities to continue to provide good income and good income growth, so I will continue to invest in them. I may add further to my UK position as further events unfold. Although subject to some Brexit uncertainty continuing as trade talks proceed, I think UK equities will continue to make progress.

Can Bolton Man on 80k get to be a millionaire?

Source: Pixabay

On BBC’s Question Time TV programme, last week in Bolton, a man earning over £80,000 criticised Labour’s higher tax policy. He believed (wrongly) that earning over £80,000 didn’t put him in the top 5% of earners. That incorrect claim was swiftly rebutted. This led to a wider debate in the media.

I was interested to read that according to Torsten Bell, director of the Resolution Foundation: “You may need to earn only £80,000 to join the 5% club for earners, but that’s unlikely to ever be enough for you to join the top 5% club by wealth. To achieve that, you need housing or savings of almost £1m – which you’ll probably have to inherit or marry rather than earn. That’s the result of our stagnant incomes but soaring wealth of recent years.”

I commented elsewhere that I think many in the FIRE community (those seeking, or having achieved, Financial Independence Retire Early) will disagree with that pessimism on wealth building. I think someone earning over £80,000 in income should eventually accumulate over £1 million in wealth from reasonable saving and investing.

A follower of FIRE blogger Mr Money Moustache saving 31% of salary would look to be able to retire after 28 years of work on 70% of salary. This is based on 5% investment returns after inflation. You can run this calculation on the networthify calculator, or in an excel spreadsheet.

I used these annual figures in my calculations:

  • Gross salary £80,000
  • Income tax £19,500
  • NI £5,654 (UK current position at 29/11/2019)
  • Net Salary £54,936
  • Savings £17,030
  • Savings rate 31%
  • Spending £37,906

This gives the following year by year growth in net worth:

YearNet SalarySpentSavedGrowthNet Worth
154,93637,90617,03042617,456
254,93637,90617,0301,29935,785
354,93637,90617,0302,21555,030
454,93637,90617,0303,17775,237
554,93637,90617,0304,18896,455
654,93637,90617,0305,249118,734
754,93637,90617,0306,362142,126
854,93637,90617,0307,532166,688
954,93637,90617,0308,760192,479
1054,93637,90617,03010,050219,559
1154,93637,90617,03011,404247,992
1254,93637,90617,03012,825277,848
1354,93637,90617,03014,318309,196
1454,93637,90617,03015,886342,112
1554,93637,90617,03017,531376,674
1654,93637,90617,03019,259412,963
1754,93637,90617,03021,074451,067
1854,93637,90617,03022,979491,076
1954,93637,90617,03024,980533,086
2054,93637,90617,03027,080577,196
2154,93637,90617,03029,286623,512
2254,93637,90617,03031,601672,144
2354,93637,90617,03034,033723,207
2454,93637,90617,03036,586776,823
2554,93637,90617,03039,267833,120
2654,93637,90617,03042,082892,232
2754,93637,90617,03045,037954,300
2854,93637,90617,03048,1411,019,470
 Net SalarySpentSavedGrowthNet Worth
Total1,538,2081,061,364476,844542,6261,019,470

So, it may take 28 years and a savings rate of 31% but it is possible for someone who is just inside the top 5% of earners to accumulate over £1 million in wealth or net worth. This is a simple calculation and doesn’t allow for any earlier and lower earnings and savings, nor any later and higher earnings and savings. It ignores any contribution from employer pension contributions, or from house price growth.

The savings rate equates to our £80,000 earner effectively living on the equivalent of £50,638 of gross pay. At a marginal tax and national insurance rate of 42% the £17,030 of net pay saved is equivalent to £29,362 of gross pay. This saving of £17,030 in net salary is asking the top 5% earner to live on the earnings of a top 12% earner. This is based on government statistics from 2017 which showed that you needed £75,300 to be in the top 5% and £49,600 to be in the top 12%.

Moreover, the net worth accumulated would support a 4% “safe withdrawal rate” of £40,779 which is in excess of the annual spending of £37,906. Assuming that this net worth is all or mostly tax sheltered in an ISA or pension or is only subject to the 7.5% dividend tax then tax would be minimal and less than this excess. After the 28 years financial independence would therefore be achieved.

If you are able to earn at that 5% level but spend at that 12% level then based on these assumptions you can accumulate the net worth to become financially independent and to continue to live at that 12% level.

This also works for lower earners who can save that same percentage of their net salary. Someone earning £40,000 in gross pay would need to save so as to live on the equivalent of a £25,983 in gross pay. Spending would be only £21,208 but saving £9,528 each year should grow and accumulate to £570,381. This would then support a “safe withdrawal rate” of £22,815.

At all levels of earning you would need to be able to spend significantly less than you earn, as in these examples, in order to achieve financial independence and be able to retire much earlier than is the norm. That should be easier to do the more you earn but it requires the commitment to do it. Maybe that was what Torsten Bell thought would be unlikely. What do you think? How likely is it that someone can follow this path to the destination?

Sleepless night

Source: Pixabay

I had moved to London to start my first proper job in my early 20’s. At first, I moved into a hostel and shared a room and ate in a communal dining room and watched TV in a communal lounge. It was a more downmarket version of my student hall of residence from an earlier year.

Nevertheless, I had started a job and was earning money, serious money it seemed, so I could start planning. Even before coming to London to work I had looked at property articles and adverts in the newspaper and was starting to form an idea of what was possible. The estate agent’s windows near my hostel showed properties that were out of reach, but there were magazines that promoted new build flats not too far away that seemed a possibility. A new studio flat could be bought for about 3 ½ times my salary in some areas. I had some savings, no debts, and felt able to ask my parents to help a little in the guise of tax planning. My bank would lend me just under three times my salary and with parental help I had a 20% deposit which meant I didn’t have to pay a fee for having a high level of mortgage debt.

As a first-time homebuyer the idea of a new build with some built in furniture and appliances appealed to me. At that time the cheapest new build flats in the London area were on reclaimed marshland but I found that this was an area of completely new property quite some distance from amenities, shops and the train station. There was one other development elsewhere on a former industrial site in an established area with shops, amenities and a train station within a ten-minute walk. This was the one I chose. I remember my parents being supportive but quite concerned as I put down a stakeholder deposit of £100 to reserve my flat just six weeks after moving to London to start my first proper job. Later on, writing my deposit cheque, the first four figure cheque I had written, I had a rather sleepless night as I considered how much I was spending and committing.

Source: Pixabay

With hindsight, I later realised that this was in some ways a reckless move that could have quickly gone wrong if my first real job had not worked out or if living in the capital had not suited me. On the other hand, it was in some ways a bold move that committed me to my job, my location, and to home ownership. I was on the property ladder. In the next few years it seemed to be a good move as property prices rose rapidly in the mid to late 1980’s. In some years my small flat made more money than I did in my job. As I progressed in my job and my earnings grew, I was able to move up to a bigger two bedroom flat. The capital gains from the first flat meant that I had over 40% equity in the second flat. The mortgage was now for less than 60% of the value of the property and represented three times my salary.

For a time, property prices continued to rise in the late 1980’s and peaked as changes were made to tax relief on mortgage interest. Then as interest rates rose up to 15% property prices fell significantly in the early 1990’s. My second flat developed a building problem that involved protracted monitoring and remedial works that meant we couldn’t move on from it until these were resolved. I remember noticing that ten years after buying my first flat the price for flats in that same development, which had doubled, had now fallen by half, back to the price I paid. Shortly thereafter we were able to move on from the second flat but I had to sell it at a loss. Most of my 40% equity was lost and I had just about broken even on my first decade in property having experienced boom then bust. I could have probably rented for that time and emerged in about the same financial position. Others we knew at the time were less fortunate. They had only experienced the downturn which had given them negative equity where their property was worth less than their mortgage debt. They had to save up to make up the difference if they wanted to move. More than ten years after my sleepless night I had experienced and survived a property market cycle.

Beginning to go global

Source: Pixabay

Last month I wrote about reviewing the situation. I was reviewing my 58% exposure to the UK against some possible alternatives. I was doing this because of the unstable political and economic situation arising from the Brexit impasse and the prospect of a general election. I wanted to have a plan ready in case I decided to reduce my UK exposure as events unfolded.

The general election could result in a change of government to one that is much less supportive of business and of investors. I’m surprised that there has not been much commentary in the mainstream media about the possible need to diversify away from the UK because of this. Maybe there is some complacency there. The odds of a Labour government may be 20/1 at present but I believe I should consider this as a possible black swan event.

UK equities are still relatively cheap compared to global and US equities. As at 13 November 2019, I calculate that buying £1 of income is 33% cheaper in the UK than it is globally, and 37% cheaper in the UK than in the US. This is based on the dividend yield of selected income investment trusts. These show an average yield of 4.60% for UK trusts (EDIN, CTY), 3.10% for global trusts (HINT, STS, SCAM), and 2.90% for a US trust (NAIT). I am still persuaded that UK equities offer good value but I don’t want too many of my eggs in that basket.

At the end of September my draw-down portfolio looked like this:

Investment Trust SectorPortfolio %UK %Non-UK %NDY %
UK Equity Income50.0542.747.313.96
Asia Pacific Income19.720.2719.454.86
Global Equity Income14.771.3313.444.50
Property - UK Commercial8.838.310.528.00
Debt - Loans & Bonds5.775.450.327.50
Total99.1458.1041.044.79

Note: Data is from my portfolio and from the AIC website as at 26 September 2019.

Trusts can hold some investments outside of their sector, e.g. a UK trust can hold up to 20% outside of the UK, which is why I needed to look into the geographical distribution of each trust in preparing this summary.

My first actual step just over three weeks ago was to reduce UK equity income and increase bonds. Last week I made further reductions in UK equity income and increased global equity income and Asia Pacific equity income. Some of my global and Asia Pacific selections had lower dividend yields but the increase in bonds has maintained my dividend income at about the same level. I was constrained in these actions by about 26% of the portfolio being in non-ISA accounts and all invested in the UK equity income sector where I didn’t want to incur capital gains tax on some substantial unrealised gains. Also, these non-ISA holdings that I have retained are in lower yielding trusts so my UK dividend yield percentage is now lower.

The portfolio now looks like this:

Investment Trust SectorPortfolio %UK %Non-UK %NDY %
UK Equity Income38.7833.095.693.67
Asia Pacific Income21.900.3221.584.98
Global Equity Income21.091.6819.414.11
Property - UK Commercial9.029.020.007.67
Debt - Loans & Bonds8.427.391.037.65
Total99.2151.5147.704.76

Note: Data is from my portfolio and from the AIC website as at 7 November 2019.

There have also been some dividends re-invested and some small movement in share prices that is reflected in this table.

The changes between late September and now are analysed in this table:

Investment Trust SectorPortfolio %UK %Non-UK %
UK Equity Income-11.27-9.65-1.62
Asia Pacific Income2.180.052.13
Global Equity Income6.320.355.97
Property - UK Commercial0.190.71-0.52
Debt - Loans & Bonds2.651.950.70
Total0.07-6.596.66

These changes represent about one-third of what I was contemplating. Overall the reduction of UK equity income sector by 11.27% has resulted in a reduction of only 6.59% in my UK exposure. Total UK exposure of 51.51% rather than 58.10% does give me more comfort against the possible headwinds. I also maintain good exposure to the UK in case my concerns prove unfounded. I am not yet ready to reduce my UK exposure to below 50%.

This exercise has forced me to widen my investment trust holdings in the Asia Pacific income and global equity income sectors and leaves me poised to increase these holdings in the future if necessary. The difficulty in future may be in selling the non-ISA UK holdings and incurring capital gains tax, and in selling the UK property and bond holdings and thereby reducing my portfolio income. I don’t want to take these steps if I don’t feel that they are absolutely necessary.

Depending on the situation after the election on 12th December I could be making further increases in my global exposure or alternatively increasing my UK exposure and in effect reversing these recent changes. This is my record of my current thinking about my investment situation and it may not be suitable or appropriate to anyone else’s circumstances.

Where to invest – equities or property?

Source: Pixabay

A key choice for investors has been whether to opt for equities (company shares) or for property (buy-to-let).


I recently read an article entitled “Where should you invest for the best returns: Isa, pension or property? Use our calculator to find out” (Paywall). It asked whether you should invest your money in a pension, an ISA, or a property.

I tried the calculator and selected an investment of £100,000 over 30 years for a higher (40%) rate tax payer. The calculated results shown were pension (after 25% tax-free cash taken and with the remainder taxed at 20%) £583,119, ISA £411,614, and Buy-to-let (after CGT) £465,868. For a standard rate tax payer the results were pension £437,339, ISA £411,614, Buy-to-let £562,634. These six results show a compound annual growth rate between 4.83% and 6.05%.


The calculator is something of a “black box” in that you can’t see all the workings used, but some of the assumptions used were: Mortgage interest rate 3%, Housing deposit 30%, interest only mortgage, annual property price growth 1.5%, Annual pensions/ISA interest 5%, Rental yield 5%. Playing around with some of these assumptions showed that a Buy-to-let without a mortgage resulted in only £261,059 for a higher rate tax payer, or £307,340 for a standard rate tax payer. Adding in an assumption of no property price growth resulted in only £198,646 for a higher rate tax payer, or £232,556 for a standard rate tax payer. These four results show a compound annual growth rate between 2.31% and 3.81%. I estimate that the gross rental yield of 5% is reduced by about 25% to a net rental yield of around 3.75% within the “black box.” This is before tax and with no mortgage costs.


It strikes me that unless you believe that from now on property prices will increase faster than inflation, then property investment is not so appealing. Also, a net yield of around 3.75% suggests to me that property may be over-valued, unless you believe that from now on rents will increase faster than inflation.


A UK Buy-to-let yield map shows that the best gross yields (top 25) are above 6.99% and the worst (bottom 10) are below 2.28%.

Estate agent Knight Frank’s guide shows net yields of between 3.50% and 5.25% after operating costs. They don’t provide a definition of operating costs. I suspect they include agent’s costs but exclude repair costs. The annual yield would also be lowered by any months where the property was empty (voids).

Some bloggers have chosen to share their results in using Buy-to-let.


Life after the daily grind has one property, I assume to be in London, and has a net income goal of £19,000 per annum by 2022. That is a net yield of 3.65% on a property valued at £520,000. The gross rental income is £22,000 (4.23% gross yield) and he is aiming to reduce costs from about 25% of the rent to below 15% by not using a property management company and thereby saving over £2,000.

Our Tour have three properties and a shop and in 2016 they had a gross rental income of £22,460 (5.62% gross yield) and costs of £6,498 (29% of rent), resulting in a net income of £15,962 (3.99% net yield).

I retired young has a portfolio of eleven properties in England and in 2017/18 they had a gross rental income of £89,914 (5.30% gross yield) and costs of £21,876 (24% of rent), resulting in a net income of £68,038 (4.01% net yield).

These bloggers are diversified (or not) over one, four or eleven properties. To what extent their investment is passive, and how much time it requires from them, will also vary. Any major problems with tenants, voids or repairs would likely reduce these returns.

In a draw-down situation where you are living off your portfolio income, I favor equities over property. My portfolio income yield has been between 3.82% and 4.84% in recent years. I consider my investment trust portfolio to be quite well diversified across hundreds of underlying companies, bonds and properties, and although my investment choices are for actively managed funds my approach is rather passive with few actions being taken.

I think you can get a higher income yield than the 3.50% to 4.01% mentioned above from a number of alternatives. The UK equity income investment trust sector (average yield 4.00%) has 15 trusts with a yield between 4.20% and 5.60%. The UK commercial property investment trust sector (average yield 5.10%) has 17 trusts with a yield between 4.10% and 8.50%. I invest in these sectors and in the Global equity income, Asia Pacific income and Debt – Loans and Bonds sectors. These would also offer diversification across many companies or properties, and would be more of a hands-off investment. More information is available on the AIC website.

Reading the fame and fortune columns in the weekend press almost always has the famous favoring property over pensions. I interpret that as mostly older people reflecting on their past gains on their properties over the last twenty or more years. I have taken the opposite view and have consistently favored equities over property and have resisted buy-to-let. Looking back with hindsight there are times in the past when that may have been the wrong decision. I will explore that in a future post. Looking forward I think it is the right decision for me.