27 Jun 2015, 10:46am
living intentionally personal finance
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  • Don’t be in thrall to Total Return

    Poor old Greybeard over at Monevator has stuck his head above the parapet again saying he will use actively managed investment trusts to smooth his retirement income and make it easier to manage. Meanwhile Insourcelife has paid down his mortgage in his late 30s, some ten years earlier in his life cycle than I paid down mine in my late forties. 1. Paying off a mortgage early is an opportunity costThe Accumulator sensibly decided to invest instead. Here are two people giving up some Total Return, OMG, that’s nuts!!!

    The world of personal finance seems to be moving towards an intellectual materialist rationalism that favours Total Return over all else 2. Now if you are a 20-something with 35 plus years before you can get a hold of your pension savings then yes, I agree TR is what it’s all about in those pension savings taken in isolation. If you are a retiree who wants to featherbed your adult children because you think the robots are coming to take way their middle class jobs then TR is important too, because although you can’t take it with you they will and a little bit of you will live on, enabling you to do the whole terror management theory thing of living beyond death. Beats having your head frozen, I guess.

    The trouble is that life is a balance, and often maximising one aspect above all else has undesirable consequences. Money is crystallised power, a claim upon future work. You can prioritise one aspect of it like total return, but then you will have to deal with being exposed to massive volatility. It’s easy to sit back at 30 and say I’m cool with that but you need to have gone through a couple of stock market crashes to know if you are cool with that really. Maximising TR means you should run towards that sort of fire 🙂

    The Ermine is not a Total-Return maximising rationalist

    I have done some dumb things in personal finance. I retired 8 years early – the gross money I would have earned in the remaining eight years probably roughly equals my total networth 3. Oh no – hundreds of thousands of pounds kissed goodbye to-  how crazy is that? Well, I don’t know – the world of work was driving me round the bend with it’s stupid metrics and micromanagement – I am ERE craftsman, not gamesman. The view is a hell of a lot better, too:

    giving up a six-figure sum to see this

    giving up a six-figure sum to see this

    or this

    or this

    instead of this

    instead of this – hell yeah.

    I paid my mortgage off early – even at the time I knew this was a teeny bit irrational, and took a whole year with it dropped down to to about £1000 4 mulling over whether I should pay it off. Then I did, and although every so often I observe that I take an income suckout between leaving work and getting hold of my pension savings, faced with the same I’d do it again, because at that time I wanted peace of mind that if I got iced from work I could lock down and make it through.

    There’s a time to maximise your total return, and that’s probably when you’re young, because you aren’t usually putting much in. But as you go through life, beware of black-and-white thinking. Sometimes you have to consider throwing some red meat to The System and giving up some total return, particularly after you have retired, because it is about the ride, not just the money. Otherwise we are in the danger of becoming that “man who knows the price of everything and the value of nothing” Oscar Wilde warned of in Lady Windermere’s Fan.

    I’ve given up a very decent six-figure sum, pasting my potential Total Return by about 50 to 25%. I  did it because it is more important to live to see another few decades with health intact, and sometimes you have to take chances in life. It is nearly three years since I left work, and would I do it again if I had my time over? Hell yeah – because the aim of the game is to maximise Total Life Experience, not total return. It’s a balance thing, not a single variable.

    For sure, I’m poorer for it in money, but I am richer for it in Life. Money is not the only thing you can run out of…

    The Escape Artist put it this way

    Why behave as if this one life we get is just a dress rehearsal?  If you are one of those people and you carry on working in your all consuming City or Corporate job, then you are wasting your life.

    If maximising total return is stressing you out in retirement as you see your capital eroded which is reminding you of the Grim Reaper’s call then give up some total return. Use investment trusts, have a plan to annuitise at some stage/stages, give up the fight slowly for an easier ride.

     

    Notes:

    1. Insourcelife is American so paying off a mortgage may be an easier ask as houses are less expensive relative to wages I believe, certainly from looking at US real estate windows on a business trip in 2007 where I could have easily bought a house cash, but impressively Insourcelife has done this with children which probably more than offsets the difference!
    2. I’m projecting some of my own prejudice here, but passive investing is still a belief system IMO. Any belief system has axioms, and I am uncomfortable with some of them, in particular the ‘valuations don’t matter’ one. My perspective is different, however – I don’t have 30 years of investing without extracting returns ahead of me like a young Boglehead starting out would have
    3. the opportunity cost is in fact a fair bit lower, I was a HR taxpayer and couldn’t have extracted anywhere near the gross amount because of limitations on pension contributions introduced since I retired.
    4. it was a flexible mortgage so I could have ramped it back up at will up to the original repayment track

    There is a lot to be said for the peace of mind which comes from killing off your mortgage. I paid one off in the past and the feeling was brilliant.

    However, with low interest rates at present, I’m sticking with investing rather than chucking cash at my current mortgage.

    I want access to the money in case the looming threat of redundancy becomes a reality.

    27 Jun 2015, 8:21pm
    by Neverland

    reply

    Like you say money is crystallised freedom

    Making it involves toil and risk

    But your call on unimportance of the importance of the investment vehicle is dangerous thinking

    In a world of mid-single digit equity returns cost control is vitally important

    Let’s say you have £0.5m in FCIT the largest investment trust I can think of. The TER is 0.9%. Therefore every year you are paying £4,500 in management fees to some ******* in suits

    You withdraw maybe 4% a year in income and share sales – so that’s maybe £20,000 a year

    So you pay 22.5% of your income each year in fees

    So instead you invest in a cheap index tracker like VWRL from Vanguard. Now your TER is 0.25%. So on your £500k you pay £1,250 a year in fees to a similar but different set of suits

    You withdraw the same £20,000 a year but now your costs to do so are only c 6% income so it’s that important bit less likely you’ll be penniless at 85

    Look at it another way, with an investment trust you can end up paying 3-4x times as much in fees each year for pretty much the same performance just because you couldn’t be bothered to work out how many shared to sell every few months

    The big argument against investment trusts is just about costs, just like the argument against annuities. The reality with investment trust is just hidden until 15 years down the line

    I’ve finally done it – read every single post of Simple Living in Suffolk! I discovered your blog about a month ago and have been hooked ever since. I love your views on labour vs capital and how automation is going to give the middle class hell in the near future. We are now starting to ramp up automation in our firm and I think it will reduce our workforce and intake of new starters in years to come.

    As for paying off the mortgage early, we still have our mortgage but have it 100% offset with a linked cash account so that there is no interest. It still leaves us the flexibility to use the cash if we wish. I’m not sure if you have a similar product available in the UK but they are very common in Australia.

    I will be giving up a significant amount of future earnings when I exit the rat race at about 40, but I am focussed on quality of life and not total return. Not having to deal with the pressures of work should be enough for me – I won’t care about chasing the remaining million or two from working another 15 or 20 years if I have control of my own time!

    @Simon although I did pay my mortgage off while I was still working, I do agree that for someone in the workforce it is better to have a flexible/offset deal precisely because jobs are much less stable now. I already knew I was in the endgame, though without a doubt I would have smoothed my income profile retaining the mortgage and discharging the capital using some of my AVC lump sum at 55/60.

    @InsiderAccountant – Thanks – and gosh, that must have taken you a while 🙂 I fear that accountancy is also a field that will yield to some pressures of automation in the years to come. Looks like you’re seeing some of the straws i the wind 🙁

    The offset mortgage is also popular in the UK – I had an earlier form called a flexible mortgage that I could overpay and then draw down the overpayment.

    @Neverland I have absolutely no argument with your maths, and I’m not advocating insouciant ignorance. Once you have got to Enough, then there are tradeoffs to consider. I congratulate people when they cast the net wider – it is Life that should be optimised, not the bottom line once you have Enough. I could have sweated more years of sucky management to raise my total earnings – but why? We run out of time 24 hours every day, and money is not everything. My perspective may be privileged – when I claim my pension it will provide notably more than my current outgoings, so my investment returns are purely in the department of wants, not needs. At one time I believed otherwise, which is why I put such a lot of effort into investing.

    I don’t need to leave a legacy to children so as I get older once the return on annuities rises above the return I am getting on equities there is a strong case to part go that way, perhaps staged across a couple of providers and ages. It is unlikely to cramp my lifestyle, although of course we can’t know what the future holds. It’s the same as the choice of whether to paint my house or get someone else to do it – cheaper to DIY, but heck, do I really want that job?

    For people who haven’t saved enough, yes, they will need to take optimise TR. Your proposed VWRL approach isn’t bad, and to be honest I will probably add a component of exactly that technique to my HYP for exactly your reasons for the next couple of decades when I get my AVCs, even though I have Enough. It’s rude to leave money on the table if doing so doesn’t cost you anything, but as I get older I will change.

    I’ve seen the converse. A family member is living in a London house with investment income built up over a working life and only living off the divi and a FSP (she has no SP for various reasons). I’ve suggested seeking independent FI and arguably take the annuity route if only to simplify life, and to have more money to ease the process of daily living. Yes, it consumes the capital, but so what – there aren’t any pockets in a shroud. Even if she sells it all up and simply peels off banknotes from the top of the roll on an ongoing basis I doubt she’ll get through half of it before the final bell tolls. If you aren’t aiming at a legacy what’s the point of piddling about maximising TR when you’re past 70 when easier, and yes, dearer, options are available?

    The biggest win I found in personal finance was finding out what Enough looked like. I discovered I valued time and autonomy more than money, and that Enough lay in my past, not my future. Yes, there are risks that society may become more troubled as fewer people manage to earn enough for the basics and in particular provide for children, but I could never have earned enough to protect myself from that – that involves gated communities, flight to Switzerland etc. I surrendered a quarter to a half of lifetime earnings to retire early. Perhaps I’ll regret that one day, but I’m okay with the risk, compared to cowering in fear of all the things that could go wrong. I’m not a teenager going YOLO – there are more things to life than maximising a single financial variable. I agree one should be able to estimate the amount being given up along the lines of your illustration and the consider – am I prepared to pay this cost for simplicity? For me it hasn’t got to that point yet, but should I be fortunate enough to get to 70 that point will very definitely be reached for ITs and probably for annuities too, depending on rates at the time.

    I respect other people may need more money, have legacy desires or may have saved less – that’s why there’s a personal in personal finance 🙂 TR shouldn’t blind those who are well-off enough to consider other aspects of retirement. Greybeard explicitly cited declining intellectual capacity as one reason to shift to an easier route – I hope I’m not shit-for-brains at 70 or 80 but it’s nice to have the option of thinking about other things than TR in the time remaining then!

    @ermine As stated previously my wife and I worked diligently to pay off our mortgage before we reached our 40s and then saved just as diligently for retirement. At the time we paid the mortgage off interest rates were around 15 % in Canada so it seemed like a good idea. My employment situation was not good either so having a place to live free and clear was a nice security blanket.
    By the time we reached our late 50s our company and teacher pensions were ready to kick in and we were in good enough financial shape to retire. So we did. Our pensions cover our needs and our savings are icing on the cake or a legacy for the grandchildren.
    I’ve heard it said that DB pensions are like bonds so we could be extremely aggressive with the savings we have. But my wife and I would not feel comfortable with that so we go 50/50 equities and fixed income in our savings portfolio.
    I understand the concern about costs but as you get older you perhaps don’t want all the investment decisions all the time. It certainly would be a burden I would not want to leave my wife if and when I exit the play.

    @Ray I envy cheaper Canadian house prices relative to earnings that makes it possible to pay down a house before 40 🙂 I was 29 when I bought a house and 49 when I discharged the mortgage.

    I definitely take the bond line on DB pensions – I don’t have any bonds although I use cash in the current low-inflation times as a proxy. You have great options with the pension covering needs – that is a great comfort against the slings and arrows of the stock market!

    I guess one thing is that we are lucky to have is working in an era when labour was more valuable to companies than it is today and they had to offer pension benefits for retention of professional staff. Although today’s talented young have wider opportunities and their earnings ramp seems precociously fast to me (reaching high-water marks in the 30s to 40s) they have to manage a much less stable jobs background. I probably would have screwed that up. I am amazed at the financial wisdom of many of the younger PF bloggers compared to my earlier self – the greatest gift my parents gave me was the principle of “don’t spend more than you earn, son”

    If we carry on the way we are we would have enough to pay off our current mortgage in 3-4 years.

    With a low interest rates it seems that equity would be expected to earn more than I would save by paying off the mortgage early. But the mortgage balance is what it is and equity valuation is whimsical. The draw to pay off the mortgage would be pretty strong at that point, even if it not the best approach for total return in the long term.

    @Mr Zombie – paying off the mortgage or not is a devilishy tough call if you’re in a position to do it in your mid thirties, congratulations on getting to tackle this tough problem 🙂

    There’s the whole security/opportunity playoff, but the logic of paying into a SIPP and discharging the mortgage with that at 57 is dented by a lot of years of paying interest batting on the pay down early side. Pity you don’t get mortgages offset against a SIPP, but I guess the bank doesn’t get to lend your SIPP out as it does the offset bit of an offset mortgage.

    28 Jun 2015, 8:35pm
    by Passive Investor

    reply

    @ermine – really liked your work / life balance musings on maximising life-experience and sacrificing financial returns. Very few people in my world really seem to get the point on that. As they earn more they get used to a more expensive life-style – so many seem to end up “running to stand still”.

    Also liked the points re annuities. They get a bed press at the moment but there is a lot to be said for the security and simplicity they offer and the insurance they provide against out-living savings.

    I am with @neverland on ITs though. Foregoing 20-25% of income for a modest amount of psychological security doesn’t seem good value to me. Each to his own on that…

    Imagine having a mortgage in a country where the banks are closed for a week…

    Yeah, there are good reasons to pay off a mortgage early and to have cash instead of bank cards.

    29 Jun 2015, 1:49am
    by less4success

    reply

    The title caught me off-guard. I was worried this was going to be an article about how focusing on income/dividends was somehow superior to focusing on total return. Instead this article was about seizing your time and your sanity, rather than endlessly building your wealth–a great goal I think we should all aspire to.

    I wanted to point out one issue with paying down a mortgage early: if your job situation is not absolutely secure (and usually it is not secure–despite outside appearances), your mortgage payment is fixed, and you can’t easily access your equity, I think it only makes sense to pay off a mortgage in a lump sum (and not paying it down as you go).

    Based on your comments, I suspect your mortgage arrangement was different, but most mortgages I’ve heard of don’t allow you to directly withdraw prepayments (except, perhaps, against higher interest home equity lines of credit) and fixed mortgages often don’t result in lower payments after paying down additional principal (they just shorten the term of the loan). If you’ve been throwing all your extra money at your mortgage, but then suddenly find yourself jobless, you may not have enough cash to comfortably squeak by.

    My reaction to a similar experience was to set money (and investments) aside, but not actually pay down the mortgage until there are sufficient funds to eliminate it completely. This gives you flexibility if your income vanishes but still holds the door open to annihilating your mortgage.

    Ermine you are at your timeless best when you talk about these deeper philosophical/values topics. Even the Jungian stuff (which I used to be deeply in to but now, not so much) about transition and stages of life just reads so nicely.

    You had a mortgage for 20 years?! The horror. I had a mortgage for one year and then decided it wasn’t my scene. My apartment was featured in design magazines and people used to come over and compliment me on my good taste and nice things. Boy did that piss me off after a (short) while; being complimented for STUFF you have BOUGHT because you happen to have money in your pocket and there is lots of nice stuff to buy, art, objects from a life well traveled, an eclectic collection of books. Balls!

    I sold up, downsized BIG TIME and sold/gave away most of my stuff. Moving from a 160 sq m apartment to a 44 sq m walk-up apartment seemed scary at times but I thought what the heck, just do it and see what happens.

    “Claustrophobia” is, of course, the word which many people would think of under such circumstances. I found it was the exact opposite. The physical space was unimportant. What was important was the feeling of freedom from being all paid off and having less stuff. It was the process of downsizing itself that was as transitionally important for my growth as was the end result.

    I sold and moved from the small apartment after a few years (the area became too noisy as it changed from a slum to a trendy area full of bars and restaurants) in to an even smaller rental for a few more years but am now in a bigger rental but with the knowledge that it really doesn’t matter how big the place is. Books are still my great weakness and I have too many of them. It’s easy to look at books as somehow special and in a different category from other objects but they too are only just things.

    Right now I’m just in a sort of countdown for another nine months before quitting my job. I could go now but feel this irrational need to make it to the finishing tape, even though I’ve already shortened the course I need to run by a considerable amount.

    “But for this dull tick of time which chides my ear…”

    @Passive Investor By a long, long chalk (even worse than buying a house at a high) the worst financial decision I’ve ever made was retiring early. But eight extra years of Life – that’s the personal in personal finance. Sometimes the personal outweighs the finance. Similar for annuities really – on a TR angle they stink. But they give something non-financial – ease and peace of mind.

    I kind of view ITs as somewhere along the continuum from Neverland’s purist angle that needs balls of steel to implement at one end to the annuity at the other. One end gives up no TR but the ride is harsh, the other consumes it all in the search for comfort. Maybe I have something wrong there, I’ll ponder given both your angles!

    @less4success My mortgage was a flexible mortgage where I could drawdown the overpayments – I did that when a previous relationship failed to buy out DxGFs stake. After that ramp up I pushed it down again. All these events happened towards the end of my working life. I fear that I was not as prudent as most current PF writers, I paid the minimum (though I did have an endowment to address the capital).

    There’s something to be said for your approach of investing towards paying the capital at the end – for a short while there used to be ISA mortgages where a S&S ISA played the capital repayment role running with an interest only mortgage. Unlike an offset mortgage you had a stab at equity return…

    @Jim – thanks – and impressive to be able to squeeze into 44m2! I’ve inflated lifestyle a bit and haven’t got minimalism cracked that much, although setting the brakes on acquisition eases it a bit.
    Interesting (and dare I say it Jungian stages of life 🙂 although perhaps equally the hero’s journey shortened) intro to Wilfred Blunt’s anthology

    No life is perfect that has not been lived – youth in feeling – manhood in battle – old age in meditation

     

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