On seeking Income – 2010 review

Having made the bold assertion that the aim of my ISA is to seek income, rather than the usual aim of seeking to increase my net worth, I then go and review 2010 in terms of net worth. Which is all nice, and party time as it so happens, but how did that income go?

It turns out to be incredibly hard to unscramble the egg and work out how that went. It’s probably easier if you are an accountant, but I’m not, so I had to do the best I can.

The issues are that I haven’t straightened out the targeting of my ISA properly, since at the moment it serves several masters in terms of my hopes and fears. The rationalists at The Accumulator and RIT would titter softly into their tea and mutter I told you so, and to some extent rightly so. To go anywhere you have to know where you’re going, and perhaps why.

However, it isn’t unreasonable for parts of one’s budget to get allocated to different things in real life. Not all your money goes on insurance, or hedonism, or rent, or tea and biscuits.

There’s a fair case to be made that where I screwed up was in not deciding in January 2010 how much ISA budget I was going to allocate to income seeking, how much to asset protection. However, being an opinionated SOB I say that Emerson was right,

A foolish consistency is the hobgoblin of little minds, adored by little statesmen and philosophers and divines. With consistency a great soul has simply nothing to do.

Okay, I’ll steady on in claiming to be a great soul.  I’m not that arrogant a SOB, though I’m working on it… However, my belief system does not assume that Western economies are paragons of stability, and at times I will seek shelter from the storms in golden and silvery ports, at times surf out into calmer waters. In the background I am trying to build an income.

You are only allowed to contribute ~£10,000 a year into an ISA, and I don’t do non-tax-sheltered investing so I have to do most of my saving in pension AVCs. Once I retire  I will spring the tax-free lump sum and probably shovel it into ISAs over a few years. Assuming, that is, that in five years there still are tax free lump sums, ISAs and a £ that is worth more than a grain of rice…

So I have classified my ISA components as ‘income’ and ‘other’, other being balanced in hope (= emerging markets and growth stocks) and fear (= gold and silver)

2010 ISA stake versus income

So taking the income section, I plot the money I have spent on achieving an income on the left-hand axis, and the income I have received from that on the right-hand axis, conveniently scaled at 1/20th of the LH axis. If the maroon bars were to reach the same level as the blue bars, over than year I would have achieved my 5% target (5%=1/20th). So I fell short this year, my dividend return on a stake of £5500 purchase cost is £208, thus a 3.8% return. However, if I take into account that I only really pumped up my stake in July, my average stake over the year was £3800, so my return on actual stake is 5%. It’s a bit rude to expect people pay me the dividends in January for what I was about to buy in July :)

UK RPI in 2012

UK RPI has rolled in at 5% this year. Not being a lying bastard politician I don’t do CPI so I have got my income, however, the value of my stake had better have improved by 5% otherwise I will slowly be destroyed. I guess this is where I can’t afford to ignore net worth. The capital value of these income-yielding investments has appreciated by 15%, so I take off the 5% RPI loss leaving me with a stake at 110% of its real cost to me. So far so good, I can eat another two years of 5% inflation and still come good, assuming the capital value of the stakes don’t fall in numerical terms.

I feel okay about this as a strategy though I fully expect to see much more than 5% inflation in the next five years, this is where I hope the theory that equities track inflation over the long run holds up, otherwise I am in trouble.

So there’s much handwaving to get the answer there, either qualifying an income-targeted approach analytically is hard or I have made a particular dog’s dinner of it.

The other conclusion is that I have spent £5500 to get an annual income equivalent to three weeks Jobseeker’s Allowance. Assuming I sharpen up my act and target 100% of future ISA contributions, in six years I will have spent £70,000 to get the same annual income as going on the dole ;) This doesn’t surprise me – you need about 20-25 times the annual income as a stake, so if I want 52*£65=£3380 then it stands to reason I need a stake of at least £70,000. But now you know how much savings you need if you can’t face the smirking questions from the spotty youths behind the desks at the Labour Exchange inquiring “what efforts you’ve made to find yourself a job in the last two weeks, Sir?”

So I think the conclusion of all that was I fall into the ‘did OK’ part of the annual report, though probably with a ‘could do better’ in terms of not chasing other goals. Next year I will focus on this income targeted approach as I think I have enough evidence that it works in principle broadly in keeping with theory. I need a jolly good stock market crash so I can get to buy ITs or income yielding shares at a 5% yield rather than 4% or less. I can see why people focus on net worth to see how they’ve done over a year – it is so much easier.

REITS scream out to me old. Land Securities and British Land are both pretty diversified, and they’ve done rights issues to shore up their balance sheets. The latter yielded over 5% when I last looked. They’re building again, too.

I’d buy for the long-term dividend growth, which is how you’re meant to hold property as I wrote in my post, and let the capital fluctuate.

On that score, I think comparing valuation to RPI over a year is a dangerous game. How will you feel if your portfolio is down 20% next year?

With your profile (a buyer of income) you should want your portfolio to be covered in red! More chance to buy cheap! :)

As I know you know, anything can happen over the short-term. The inflation proofing of equities is a long-term operation.

Sorry if a bit preachy, and just IMHO. ;)

(Er, I meant “old chap” in the first sentence. In the vernacular sense, not the numerical, of course! ;) )

Thanks for picking up the fallacy :) Much appreciated, it would have been a shame to kick off my tracking spreadsheet with a underlying cock-up! What I should account for, and rebase relative to inflation is the cost of my stake over any given year. i.e. next year I should mark up the nominal cost of this year’s purchases by RPI to see what my yield is. That way I can ignore net worth, rather than trying to split off some of it to account for RPI. And save myself from the stress of worrying about net worth falls :)

At the moment I want my portfolio to be coverd in red, but on steady state it would be good to have them tempered with blue years. Just not in the next few years, please – bring on those PIIGS, though not all at once…

I’m coming round to REITs from a study of the Big Two – Doesn’t seem worth paying the ETF premium where BLND and LAND dominate the holdings. I’d prefer to be able to split off the London side from the retail side, which I suspect will get a pasting in 2011-12. Lots of London opportunities however…

For the American audience (only me?), what’s the difference between the three inflation measures?

@George – many thanks for your question! RPI stands for Retail Prices Index and is the oldest one, designed in more innocent days, when inflation included the things people spent money on, inclduing mortgage interest payments, property taxes (these are much lower in the UK than it seems from US commentators, mine is about USD 2000 per annum), house maintenace and some vehicle purchase and running costs, as well as consumer goods.

RPI-X is RPI without mortgage interest payments. Arguably as a house owner free and clear I experience RPI-X.

Mortgage interest rates were very high when George Soros bet against the Bank of England in 1992 – I was paying 14% p.a. around then, so the Government of the day was looking for a meaure that would downplay mortgage interest rates in the inflation figures. Enter the Consumer Prices Index, CPI – by excluding the costs of housing the inflation figures suddenly become lower.

There has recently been a fuss because the Government has switched the indexation of pensions and benefits from RPI to CPI, since the latter represents mroe accurately the inflation that people experience, because we all know that nobody needs a house in the UK ;)

That’s a rough summary of the differences – the ONS has a more detailed description but the reason for my disdain is the elimination of many of the fixed costs of operating a household in the UK from CPI…

Yes, the revised annual RPI strategy makes more sense, I think. Re REITs, I’ll be giving everyone the benefit of my highly limited experience of them in a few days.

@George, There are really two main measures in the UK and I’ve tangentially discussed them briefly in my latest blog.

@Ermine, Apologies for the shameless plug!

One of the issues I have at the moment with financial planning is deciding what my income needs are. I mean at present I know I need approx £1,200 to live off per month, but that is now, and I dont know what my medium to long term plans are, will I buy property in this country? because you cant rent forever? Will I move to rural portugal buy property outright and slash my COL by at least 50%?

I really dont know how much capital I will need in the next 5 – 10 years so I have to keep a lot of it freed up and so I am losing income. you see in the past I have changed my mind about where I want to be every few years, I need a bit of plan.

So I am curious about your own situation, do you know what you will do after early retirement? I dont mean that in the sense of how will you fill your time but more in the sense of how do you know what your capital and income needs will be?

@Dreamer my outgoings are probably more determined than yours, as I will continue to live in the same house, and I have 10 years experience of the bills. My housing will be lower than yours as it is essentially maintenance, people usually rate that at ~2% of the price, but for me a run rate of about £2k a year is plenty. I may do a post on running costs, but your £1200 budget does not strike me as unreasonable. It is higher than mine by the rent I don’t pay, and my power bill is less (gas + electricity is < £1000 but I have a woodburning stove and usually free wood). My costs will be broadly the same in retirement, though I will have more disposable income despite a much lower income because I will be out of the aggressive savings mode.

One observation I might make on your situation if I may be so bold is that you've spent a lot of time in work which perhaps wasn't congruent with your aims and values in life, and courageously you've taken action to fix that. You've made the break (what, jealous? me? good for you!!!) but I do wonder if you have given yourself enough time to decompress from the old 9 to 5 life. Perhaps you will weave a new dream of a live lived according to your own values; imagine your life in five or ten years time, who will be in it and where you want to be.

So be gentle with yourself, sketch out your future and where you need money and for what will follow from that. You’ll need some sort of income for day to day needs, some capital for housing and some contingency. Take the time to sketch these details in and breathe life into them, and the finance plan will follow ;)

It has taken me over a year to take the rough outline sketches of my future aims and colour in the basics, shade in the details. Some of that journey is outined on here, for instance at the start I was blinded by the net-worth-centric philosophy of many PF bloggers. That’s right for many of them, particularly younger people still working looking to establish a retirement/escape fund, but it wasn’t right for me. I maintained my savings rate, but have adjusted my investment profile to match my hopes and expectations of the future. At the moment you’re probably in a holding position on your capital, you can probably afford to keep that until you have had the chance to fill out the details of your future life path. I am overweight cash at 42% partly as a result of taking time out to settle my strategy, and experiment with an income-based approach. I am losing money on some of that cash, but as long as I only do it for a year or so it’s no great loss if it means I can get my thinking straight.

Thanks ermine, and be as bold as you want. Honestly it is great to have some feedback from someone as moneysavy and wise as yourself. One of the problems with this situation is finding like minded people to bounce ideas off, no one talks about money really these days, apart from on the internet!

I do need a bit of a plan, and you are right and others have said the same that I need to sit back for a bit and just be. I think I will not get too stressed out about locking money away for a year, I am cash holding at the moment but not all of it, some is locked away for a few years and the income pays about 80% of my monthly outgoings, so there is some drawdown just for basics.

I go back and forth about income as opposed to capital growth, I think that the reality is that being 37 I do need more capital growth, but the stock market scares me.

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