Reviewing the situation

Source: Pixabay

Just over six months ago I wrote about the Brexit blues and how UK equities were relatively cheap compared to global and especially US equities. Since then UK equities have become even cheaper. This could be a value opportunity or a value trap. I’m now reviewing my 58% exposure to the UK against some possible alternatives.

As at 1 October 2019, I calculate that buying £1 of income is 32% cheaper in the UK than it is globally, and 39% 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), 3.13% for global trusts (HINT, STS, SCAM), and 2.80% for a US trust (NAIT).

The political and economic situation continues to be unstable as discussions about Brexit continue. There is much concern about whether we leave or postpone again, or remain, and whether we have a deal or not. There is also concern about an impending general election which could result in a change of government to one that is less supportive of business and of investors, to say the least. I don’t want to get into all that but I do want to review my investment situation. I want to have a plan ready in case I decide to reduce my UK exposure as events unfold.

I have traditionally had high exposure to the UK because I live in the UK. This could be described as home country bias. I maintained high exposure to the UK as my strategy became one of seeking income, and growth in income, because of the good availability of UK equity income investment trusts with good track records. Many are recognised as “dividend heroes” because they have increased their dividends for more than twenty years. Global trusts can also be “dividend heroes” but they are mainly growth trusts with lower dividend yields. Global equity income trusts are fewer in number, their dividend yields are mostly lower, and very few qualify as “dividend heroes”. Asia Pacific income trusts are also few in number and most do not yet have a twenty-year record.

My draw-down portfolio currently looks 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.

I wanted to have a plan that would reduce my UK exposure without overly reducing my income (net dividend yield). My highest income UK holdings are in property and bonds so I decided to leave those holdings unchanged. That meant that I would have to reduce my UK equity holdings. I decided that those could be reduced by about two-fifths and the proceeds re-invested about one-third in Asia Pacific and two-thirds in global trusts. I would sell 22% of my total portfolio. These possible changes look like this:

Investment Trust SectorPortfolio %UK %Non-UK %
UK Equity Income-21.92-18.03-3.89
Asia Pacific Income7.400.137.27
Global Equity Income14.520.0014.52
Total0.00-17.9017.90

The revised portfolio would then look like this:

Investment Trust SectorPortfolio %UK %Non-UK %NDY %
UK Equity Income28.1324.713.423.87
Asia Pacific Income27.120.4126.714.97
Global Equity Income29.291.3327.963.95
Property - UK Commercial8.838.310.528.00
Debt - Loans & Bonds5.775.450.327.50
Total99.1440.2058.944.77

This revised portfolio would sustain my current income as the net dividend yield is virtually unchanged from 4.79% to 4.77%. It would reduce UK exposure to 40% and UK equity exposure to 26%. Given that the global funds would be about one-quarter invested in Asia Pacific then that would be the biggest exposure at about 34%. In seeking higher dividend yields I would need that investment in the higher yielding Asia Pacific income sector.  The three areas of North America, Europe, and Latin America and other, would each only have less than about 8% exposure in the overall portfolio. So, the portfolio would be reasonably diversified but with a greater exposure to Asia Pacific (34%) and UK equities (26%). In seeking income, I would continue to neglect North America.

These possible changes could be made in a relatively small number of trades. Some of the sales would likely incur capital gains tax but it may be best to incur that at current tax rates as these may rise. It may be that I will make some small moves to begin these changes in the next few weeks or months.

If I wanted to reduce my UK exposure any further then I would need to make more radical changes. Ignoring my current portfolio, I have prepared a possible global portfolio where UK exposure is reduced to below 15%, but a dividend yield of 4% is achieved. To create this portfolio, I would have to sell all my current UK trusts, but I could retain my Asia Pacific and Global trusts. 66% of my current portfolio would be sold.

Investment Trust SectorPortfolio %UK %Non-UK %NDY %
Global18.006.3211.682.30
Global Equity Income37.001.7135.293.96
Flexible18.005.9412.064.60
Asia Pacific Income27.000.6026.404.77
Total100.0014.5785.434.00

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. I may have to decide whether it becomes appropriate for mine.

Our friends electric and gas

Source: Pixabay

One significant cost that households have that they can take action to reduce is electricity and gas utility costs. According to energy market regulator Ofgem, the average dual fuel variable tariff as of April 2019 was £104.50 per month, or £1,254 a year, but the cheapest tariff available was around £880 a year, or just £73 a month. That is a 30% saving. Today I ran a price comparison using Money Supermarket based on UK average household kWh usage. The standard cost for our current provider is £1,197 but the cheapest tariff was £948, and that is a 20% saving.

We have lived in our current home for over twenty-four years now and have spent over £25,000 on these utility costs. Our costs in 2018 were 78% higher than in 1996 which compares with an 85% increase in inflation (RPI measure). Over those twenty-three complete calendar years our actual total costs were, however, some 2.44% higher than a calculation of our 1996 costs uprated for RPI each year. This is reflected in there being nine years when our costs ran ahead of RPI (2005-2010, 2012, 2013, 2015). During these twenty-four years we have moved from a two-person household to a four-person household. We have moved from no one being at home during week days to someone being at home most days. We did have to buy a new central heating unit and efficiencies from that have maybe helped to cover these greater demands.

Initially we stayed with the default energy providers for our area but after significant increases of 27% in 2005 we then began switching providers every year or every other year in order to control or reduce our costs. Interestingly just looking at the 1996, 2005 and 2018 years gave the following results. From 1996 to 2005 our utility costs rose at a compound rate of 3.63% compared to 2.58% for RPI inflation, then from 2005 to 2018 our utility costs rose at a compound rate of 2.65% compared to 3.02% for RPI.

Recently we initiated our latest energy switch as a two-year deal came to a close. We ran a price comparison using the Cheap Energy Club on 26th August with these annual cost results:

Best price £1284
Current plan £1356
OK or Good review £1404
Big company £1452
Current provider best £1560
Current provider rolling £1913
Worst price £2412

We chose to go with the “OK or Good review” provider at £1,404 per annum (i.e. £117 per month). This may be £120 more than the best price from a provider with no reviews or bad reviews, but it is £509 less than our current provider’s rolling standard default plan, a 27% saving, and £1,008 less than the worst price on the market.

Switching can be done quite easily. The Money Saving Expert website founded by Martin Lewis, but now part of Money Supermarket, has its own comparison tool the Cheap Energy Club. You need to know your annual usage of electricity and gas in kWh but that should be provided in a renewal offer from your current provider. Alternatively, you should be able to obtain it from your bills for the last twelve months.

The regulator Ofgem has approved a number of other online price comparison sites where you can look when comparing energy tariffs and supplier deals:- Energy Helpline, Energylinx, The Energy Shop, Money Supermarket, My Utility Genius, Runpath, Simply Switch, Switch Gas and Electric, Quotezone, Unravel It, uSwitch.

I’ve just rerun the price comparison using Money Supermarket this time. You need to give your email, your property address, your required supply, e.g. electricity and gas, your current supplier, payment method and tariff, your current annual usage and your intended payment method. You will then receive an email detailing the top quotes and how much you would save. Using the same data as before this gave an annual cost of £1, 407 from the same provider as before. I then ran the calculation again based on our house type rather than the kWh usage and this time the cost was £1,445 suggesting our usage is near average for our house type.

We can’t be certain of how much we have saved over the last thirteen years by continually switching but based on the latest switch saving us about 27% against the default plan we may have saved over £6,000. If such a saving had been invested it could have grown to be over £10,000 based on growth of 8% per annum. It is worth taking the time to switch providers with such a good payback for such little time.

Financial review at 31 August 2019

Source: Pixabay

Eight months Summary

A total return in the year to date of 9.92%, slightly behind the index, results after drawdown expenditure in a capital uplift of 7.24%.

Drawdown

As I am not earning any income from employment any more, I am in drawdown in that I am drawing down some of my financial assets each month to cover our spending. I have been in drawdown since December 2013 so the five years and eight months since then will be the main time period under review. I have estimated the annual income and expenditure for the full 2019 year.

Capital

My capital has increased by 13.55%. This compares to an increase in RPI inflation of 15.23% (I have estimated the RPI figure for August).

Income

My income has increased from 3.53% to 5.31% of my original capital. This compares to the income according to the “safe withdrawal rate” which has increased from 4.00% to 4.51%, based on inflation from December 2013 to December 2018.

Expenditure

My expenditure has increased by 30.05%. This year my spending as a percentage of my income is 77.43%. Expenditure is running at an annual rate of 3.75% of the average asset value during the 2019 year.

Total return

The portfolio total return has been 38.21%. This compares to 35.71% from the FTSE All Share total return index and 32.62% from the M&G Index Tracker Fund Sterling A Acc, a typical index tracker fund.

Income growth

Income has grown by 54.93%. The portfolio income yield has increased from an annual rate of 3.82% in 2013 to 4.84% in 2019. This is calculated on the average asset value during the year.

Conclusion

My current main objective is 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, and from remaining focused on the higher yielding stock markets in the United Kingdom and Asia. If there is economic trouble ahead, I am hopeful that my dividend income will be resilient even if capital values fall.

Commitment

Source: Pixabay

If you want to achieve financial freedom or financial independence, and you have a vision of achieving that, then you need to have a commitment to getting there. It can’t just be a wish. This commitment will involve time and money and will be reflected in your actions in working, saving and investing.


You will need to commit some time to this effort. It can take time to understand what your financial position and starting point is. What are your financial assets and liabilities? What is your annual income and expenditure? What changes do you expect in these? If necessary, you will need to improve your financial record keeping so you can answer these questions when you start and throughout your journey. You can use paper records as I did from the early 1980’s up until 1996 or you can use computer records as I have done since getting my first home PC in 1996. It will take commitment to continually maintain these records. You need enough information to know at any point where you are and where you are headed. This can help with spending and investing choices and can strengthen your commitment as you see progress being made.


You will need to commit time to learning about personal financial and investment matters. Finding this interesting will really help with this challenge, as so many people claim or say that this is boring. There is, however, nothing boring about being poor in your old age when you are less able to work to earn money. The money pages in the newspapers provided my starting point for this learning. I also read a select few books. Nowadays there are many blogs and other websites where one can also learn. Back in the 1980’s I avidly read the Telegraph money pages and sampled other papers and magazines occasionally. Nowadays there are a range of sources that I use: newspapers, magazines, newsletters, blogs, and websites.


You will need to bring your commitment to bear in the world of working and earning. Being committed to progressing in your chosen field and taking up opportunities and maximising earnings will all help. In my time I pursued further studies, I took up promotion and job opportunities, and later on I worked with an eye on maximising earnings. This should help both your career and your progress to financial independence. As you gain rises in pay, and bonuses, these should be allocated to additional savings ahead of additional consumption. In addition, you should seek to understand and probably to join any company pension in order to gain the company’s pension contribution. You can benefit from tax relief on your own contributions, and many companies will match your contributions. In an early role I contributed 7.5% of my salary (4.5% after tax relief) and gained a company contribution of 7.5%. In a later role I contributed 5% (3% after tax relief) and gained an additional 9.5% from my employer. Where these are defined contribution schemes then you can usually transfer these into a plan of your choice after you have left the relevant job.


You will need a strong commitment to saving money. Without spending less than they earn even the highest paid will not become financially independent before they draw their pension. In order to make good progress you need to look to save 20% of your take home pay. You need to pay yourself first, for instance by means of a direct debit from your bank account just after pay day. It is best to develop this habit early on before higher earnings translates straight into higher spending. I have heard people talk of saving what is left at the end of the month or year after their spending has been done, but that is not a commitment.


If you gain a financial windfall such as an inheritance, or an insurance pay-out, or a redundancy payment where you quickly get another job, then you should be committed to saving all or most of this money. If your inclination is always to spend pay rises, bonuses, and such windfalls on lifestyle improvements or additional consumption, e.g. houses, cars, holidays, then you probably lack the commitment required for early financial independence.


You will need a commitment to invest your savings in equities. This should maximise your long term returns as cash and bonds have generally returned less than equities. I have been mostly 80% or more invested in equities over the past thirty-three years and have benefited from compound growth of over 8% per annum.


These levels of commitment need to be sustained over the years and decades to get the required result. You need to be able to live a bit outside the consumer society to maintain your progress. This is all a bit prescriptive but this is the medicine I have found to be beneficial.

A path to financial freedom

Source: Pixabay

Having attained a measure of financial freedom for myself I would like to outline my thoughts on how to reach this point. The path I will discuss is informed by the actual one I followed. When I set out on my journey through the world of work and earning, saving and investing over thirty years ago, I did not have any route map to read or to follow, but over that time my experience has enabled me to devise one. My writing here on this blog is intended to include providing the route map I didn’t have but would have liked to have had.


Key factors include vision, commitment, planning, earning, spending, saving, investing and time.


Once you have seen the vision and embraced the objective of financial freedom then you need to make the commitment to follow a path, and be disciplined in staying on it, so you can reach that destination.


Some planning is needed and is useful when considering the necessary ingredients of earnings, spending, saving, investing and time. The past may not be a perfect guide to the future but it may be a useful guide when planning. An interest in financial matters and an attitude and approach of trying to handle these areas of life in an effective manner is key.


In your early years it will be key to maximise your earnings as soon as possible. Above average or double the average earnings will make this journey easier. A commitment to achieving success in the workplace so as to maximise earnings is useful, but so also is the ability to consider things from one’s own perspective and not always from the employer’s or the job’s perspectives.


At this time, it will also be important to think carefully about spending habits and “lifestyle management” and how you approach the consumer society. The idea of living below your means by a significant margin, such as only spending 80% of your take home earnings, is important. An ability to stand back from the consumer society and make choices so as to maximise savings is also key.


The cost of housing and the issue of house prices will need special consideration of both the past and the future possibilities.


If you have achieved above average earnings, and have your spending under control, then you should have the savings to proceed. These will need to be deployed carefully towards eliminating any debts, dealing with housing, and setting up planned savings. A ready cash reserve is useful and necessary but in my view most of your available savings should then be deployed in growth investments where a real above inflation total return can be obtained.


A preparedness to invest so as to grow one’s savings at a rate above inflation despite the perceived risks of losing money will be critical to growing one’s wealth. My preferred investment is equities and the vehicles to be used include investment accounts, ISA’s, and pensions. It is important to establish a pension plan in order to gain any employer contribution and to gain any available tax relief. As pensions are not accessible until the age of 55 or later at present and as current and recent governments are prone to changing the rules then one should proceed carefully.


The main investment plan after pensions should be ISA’s because of their tax privileges. If you are fortunate enough to have savings that are surplus to the ISA limits and to any pension commitments, then an ordinary investment account can be used.


Various investment approaches can be utilised, such as the permanent portfolio, and passive equity index tracking. My current preferred approach is investing in income and growth equities using investment trusts.


Finally, one can consider the importance of time and timing and the influence of luck. I think you will be pleasantly surprised by the financial position you can reach after a long time following this path.

Holding your nerve during a stock market tumble

Source: Pixabay

It has been reported that “only 18 per cent of investors said they stuck with their investment plans during the volatile three-month period at the end of 2018” when “the MSCI World index fell 13.9 per cent, the 11th worst quarterly fall since 1970”. The Schroders Global Investor Study 2019 added that “In the final three months of 2018, when the MSCI World index of global equities fell sharply, only 18% of people kept their investments the same, and a further 9% made changes to their portfolio but kept the risk profile the same.” According to this report in the UK we stay invested in an investment product for only 2.9 years on average.


I read that and decided to review my own experience of this situation. At the time I noticed the drop in the market in that quarter and especially in October but I didn’t feel any inclination to react to it. My only transactions during the quarter were automatic and manual dividend re-investments already decided upon, a fund switch within my ISA, and a drawdown sale of dealing account assets. The switch was a minor one concerned with adjusting the relative sizes of a global fund (increased) and an Asia Pacific fund (reduced). The asset sale was also a routine one that I carry out every three months at present.


My total return during the full 2018 year was a fall of 6.45%. My total return during the final quarter of 2018 was a fall of 5.91%. October 2018 was my highest losing month since beginning drawdown in January 2014 but was not much worse than some other months in 2014, 2015 or 2016.

I follow the markets and the news affecting the markets and aim to be informed but I also aim to be sceptical of commentaries on the market situation and of “noise” in the markets. News of Trump, trade wars, USA versus China, interest rates and Brexit may be interesting and may influence market activity or may provide an explanation for market moves, but it doesn’t give me a reason to trade.


Rather than considering the market situation I try to stay focussed on my own situation. I’m broadly happy with my portfolio allocations to equities in the UK income, global income, and Asia Pacific income sectors, and to UK real estate and UK bonds, and to be almost fully invested. I might switch between assets to adjust position sizes or to increase my ISA and reduce my dealing account, but otherwise I am just re-investing dividends and selling down assets in my dealing account to fund my expenditure. In 2018 my portfolio turnover was about 7%. My current holdings have been held for an average of 9.76 years.


I began investing in equities in 1986. In thirty-three years, I have had nine losing years of which four were worse than 2018. So, I regarded 2018 as a disappointing year but it didn’t compare with 2001-2002 (-27%) or 2008 (-23%).


My first experience of a loss in the markets was in October 1987 when I remember my £3,000 invested fell to be £2,000 in only a few days. It happened so quickly that I didn’t have a real opportunity to react. These were all certificated unit trusts or privatisation shares and my dealings then were by post. Fortunately, I didn’t need to access these funds and not having any desire to recognise this loss I stayed invested. My losses were recovered by the end of 1989. Interestingly the full 1987 year isn’t a loss year for me or for the UK market. The October fall was a correction to gains made earlier in that year.


I now prefer to take a one-year view or a calendar year view of stock market moves so as to put short term volatility in perspective. I now regard it as very useful to have had that experience of loss in my second year of being invested and when I only had £3,000 invested. It prepared me to deal with similar percentage losses on much bigger numbers in both 2001-2002 and 2008. In both cases I stayed invested, and invested more when possible. I held my nerve and with hindsight I think that was the right thing to do.