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
 Net SalarySpentSavedGrowthNet Worth

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

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.
Debt - Loans & Bonds8.427.391.037.65

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

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.

The house of Woodford

I invest in funds and therefore I invest my hopes in fund managers and their investment performance. I am therefore glad to not be invested with the well-known fund manager Neil Woodford as his well won investment reputation has turned to ruin.

Despite being a fund investor for around the same time as Neil Woodford has been a manager of funds, I did not invest in his funds for over twenty years as he built his reputation. He managed UK income and high-income unit trusts for Invesco Perpetual from around 1988 until 2014. He exceeded the index by avoiding the worst of both the dot com bust of 2001 and the financial crisis of 2008. Instead of investing in the dot com firms in 2001 and the banks in 2008 he favored tobacco companies. After he took over the management of a UK equity income investment trust for the first time, in 2008, I saw that as a good opportunity to invest. My investment in Edinburgh IT (EDIN) coincided with his management for the five years ended on 31 January 2014. During that time the share price total return of £217.80 on an investment of £100.00, exceeded that of my benchmark the FTSE All Share Total Return which returned £200.90. It was, however, below the sector average of £239.20, and below all my other holdings in the sector. At the time I was satisfied with the performance.

His leaving Invesco Perpetual after twenty-six years to set up his own business was a big news story. I followed this with interest but was not too keen to invest in his new venture. This was for several reasons. I aim to buy and hold for the long term. I had a positive view on his successor at Invesco Perpetual, Mark Barnett, who now took on Edinburgh IT. I don’t favor new issue investments and prefer those with a long history. I don’t like to follow hype or over-promotion. I prefer investment trusts to unit trusts. Woodford’s first new fund was the Woodford Equity Income unit trust. I didn’t invest.

His second new fund was the Woodford Patient Capital IT. Although it was an investment trust all my other reservations applied. Also, this fund aimed to invest in new start up and unquoted ventures which was not something I was looking for. I didn’t invest. His third fund was the Woodford Income Focus unit trust. All my original reservations also applied to this one. I didn’t invest.

Initially in it’s first year Woodford Equity Income performed well. Woodford Patient Capital raised more money than it was expecting and, at first, the share price rose to be higher than the asset value. Subsequently, however, some problems surfaced. The Woodford Equity Income unit trust was investing not just in FTSE 100 companies paying above average dividends as expected, but it was also investing in unquoted companies that didn’t pay dividends. This has meant that it has not fully paid the dividends promised at outset. More importantly as a unit trust it was unsuited to holding unquoted companies that it could not sell to pay-out to investors selling out. This became a problem as performance deteriorated and investors sold and the fund came to be increasingly populated by unquoted holdings. Various controversial things were done in order to attempt to address this issue as the unit trust was supposedly limited in the percentage of illiquid assets it could hold. Eventually a significant shareholder requested a large sale and the unit trust was forced to stop all sales and purchases. Without it having re-opened it has now been announced that it will be closed and liquidated and the investors will be paid back what can be realised. The Woodford Patient Capital IT is looking for a new manager and may also close down. The Income Focus unit trust has now also had to stop all sales and purchases and seems likely to close.

My impression of these events suggests to me that Neil Woodford didn’t invest as he was expected to, and maybe not as he promised too. This was no usual UK equity income fund. He invested in unquoted companies which was not the area in which he had built his previous reputation. Such illiquid holdings were entirely unsuited to a unit trust, and especially one which had been heavily promoted, or hyped, to small investors. He persevered with this approach rather than bail out earlier and take a loss on these holdings. The regulators appear to have failed to manage the unfolding situation. He would have done better to have had one genuine income fund and one separate unquoted fund rather than create a hybrid fund that has dragged all three of his funds down.

This story reinforces to me the importance of portfolio management. I aim to have no more than around 10% in any one fund so as to limit manager risk. I hold less in more specialist funds. I also diversify by fund house, by fund sector, by geography and by asset type. I still hold a relatively small number of funds but I aim to watch them carefully so as to avoid the next such problem.

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

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

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

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 %
Global Equity Income37.001.7135.293.96
Asia Pacific Income27.000.6026.404.77

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.