The Buy to Let conundrum
Monevator posted a great article summarising the amount Brits have stashed in tax-exempt ISAs, questioning why there’s so little in there. The highest cluster of ISA saved amounts are in the £20k-50k range.
He’s got a point. Why so little? Well, whenever I hear middle-aged people talking about how to store wealth, there is one strategy that they focus on, that wouldn’t appear in the ISA tally. It stands head and shoulders above anything to do with shares, gold, or setting up a business, which is kind of strange for a country that has made finance its engine of growth in a post-industrial era.
I come across it time and time again, so often that it must either be a sure-fire winner, or there must be something else unusual about this radiant flame that is circled by an endless number of moths.
Most of these folk have had regular salaried jobs for a while, that pay a steady income, month in, month out. Until, that is, that fateful day when the backdraft of downsizing comes its way, or they come to pick up their carriage clock and sign out of the office for the last time.
So what they really, really, want is an income like that job, or that’s reliable as they used to remember. They want a steady monthly income. And to many, many people, the first things that springs to mind is a highly unusual investment, that has a typical capital value performance over time that looks like this in real (inflation adjusted) terms.
It’s residential housing, better known as buy to let. Now the good thing about this capital performance is that it’s generally on the up. The bad thing about it is that you can get slaughtered in it for ten years at a time. I should know, I’ve been there.
Buying your own house
Everybody needs to live somewhere, and if you are planning to stay in one place for a long time (> 10 years) then buying the residence you live in is generally a good move.That 10 year condition is a big ask in today’s job environment. If you’re going to move, then it’s best to be able to do it at a time of your choosing, and indeed some BTL owners are accidental landlords who couldn’t sell their house at a price they wanted when they needed to move elsewhere.
Even if you screw up like I did buying in 1989, after twenty odd years the slow uplift compensates somewhat. If the mortgage and house maintenance you pay is less than the rent you would be paying on the house you get a cumulative benefit from it. However, what you can guarantee with you own property is no occupancy voids, and hopefully the residents don’t trash the place either 
Even buying your own house isn’t risk-free, however – as well as market risk it is such a large undertaking that you can end up out of pocket if you fall on financial misfortune and become a forced seller or worse still a repossession.
You’re already highly exposed to the graph above through the value of your own house, though it isn’t as bad as it looks because once you own a decent amount of your house if you are selling at a low point you are buying at a low point too, which is what saved my tail in 1998.
Such a good deal, many people want to do it again!
So people then extrapolate, and want to own another house for other people to live in. There are two variants of this. Some, looking for somewhere for a store of wealth, simply want to buy and get the rental income. Others want to gear up, borrowing money using a BTL mortgage, using as little of their own money as possible, as advocated here. Your house is normally your largest asset if you own it outright, so doubling up your exposure to the same type of asset is a huge unbalancing of the asset classes you use to store your personal wealth. It so happens that this asset class has done pretty well over the last 20 years, though it’s taken a few hits of late.
Now there’s nothing fundamentally wrong with this, provided you have asked yourself if this reflects your particular attitude to risk. Maybe you have particular skills working with houses, or tenants, or renting to students. You can use other people’s money, in the form of a mortgage, at low interest rates to gear yourself up. Which is great when house prices rise or there is high inflation, but it’s hell when they fall. I know this from personal experience.
That was twenty years ago, so a generation has grown up to believe that house prices only ever go up, and those that know otherwise tend to keep schtum. Never underestimate the soulless feeling of paying hundreds of pounds towards a mortgage that is higher than what you sold the house for. At least if you throw tenners on the fire you’d get warm from them!
What’s so attractive about residential property as an investment, then?
On the plus side
- in principle it can give a regular income, voids excepted.
- profitability is helped by tax breaks on interest payments
- everybody has familiarity with the product.
On the downside
- the capital value is volatile
- This investment comes in big indivisible chunks
- There is no geographic diversification
- it is a high-maintenance operation showing people round and you have to get notice letters exactly right
- there are a lot of hidden costs like letting agents, repairs
Some of these downsides would be addressable by residential real-estate investment trusts but I don’t know of any. It is a shame, because it isn’t just prospective buy-to-letters that would be helped with residential REITs.
Such instruments would allow prospective house purchasers to save their deposits in an asset class which reflected the price of what they were saving for. This would tackle a frequent complaint, which is in the recent past as you save towards a 20% deposit on a house the price races away from you. Residential REITs would lift the value of your deposit as you save. At the moment the only way I know of to simulate this is with spread-betting. Obviously if house prices drop your REIT drops too, but if you are saving for a house that’s not as bad as it seems.
However, in the absence of residential REITs, which could fix the large lumpiness, intra-UK geographic concentration and maintenance, that’s a lot of downside, particularly when you take the shocking lack of asset class diversification into account, which begs the question
What’s wrong with the stock market?
Or, indeed, any other asset class, even if it’s bonds, oil futures, Apple shares, fine wines or tulip bulbs?
Two things are primarily wrong with the stock market. Everybody can see or touch a house, and provided they hold buildings insurance they feel it’s solid, reliable and will always hold value. Unlike some shares – in my earlier dotcom forays I held Videologic, Rage software, Ionica and Pace microtech. Rage software and Ionica went bust. You can’t argue with the logic that a house won’t go bust 
The second thing people feel is wrong with the stock market is that they can’t see how to get a reliable income out of it. There are various strategies you can use to get an income – a high-yield portfolio, High Income funds, an annuity if you’re old enough and don’t mind your capital eventually disappearing, but none of them offers the comforting constancy of income that a salary or that regular BTL rent cheque does.
You need to have a much higher, almost entrepreneurial risk appetite to deal with a varying income, and better money management skills, which usually involve having a large float of a couple of years’ worth of essential living expenses. Now that isn’t your typical Brit, who relies on standing in the firehose of income supplemented with a good dollop of consumer credit to smooth out the lumpiness of running costs.
The sort of people that are looking to BTL as a way of preserving as lump sum can cope with the variable income because they have capital. However, I know personally that it takes a huge wrench to contemplate a variable income if you aren’t used to it. I have several years worth of living expenses in cash and I still bottled it, so I have arranged my affairs so I have a fixed income that keeps the wolf from the door and a variable income that is entertainment and investment budget.
I’ve got every sympathy for the desire for a fixed income, but sometimes a fixed income comes with a high capital risk, as investors in Keydata know to their cost. BTL is nowhere near that risky, but the steadiness of the income is only steady if you close your eyes to the fact you can lose a big chunk of capital. A diversified HYP has the same sort of risk – the stock market can fall 50% in a bad year, but because you can strategically enter it over a period of about 5 years you’d be unlucky to take such a bath on your total investment, provided you invested in a diversified basket of index funds, or diversified bunch of shares in different sectors and geographies.
Someone who isn’t used to the principles of sector, temporal and geographical diversification may favour an investment they understand that pays a regular income in a way they can understand. Compared to regular rental income, the uncertain proceeds of a HYP and evaluating how stable that would be is a very big ask. Evaluating how you look at growth and income stocks and derive an annual income also takes a lot of research and understanding, and even then there are no guarantees.
It’s so much easier to look at your house, which worked well for you over the 25 year term of your mortgage. And think of doing the same again, with BTL.
Know thyself
It might well be the right investment for you. But you can only say that once you’ve taken the time out to understand the more accessible alternatives, and what their advantages and disadvantages are compared to BTL. You must have a very good reason to throw out the only free lunch in finance – portfolio diversification. Just knowing that ‘everybody needs to live somewhere’ isn’t good enough. Everybody needs oil, but that didn’t stop people taking a hit on BP a while ago, and nobody needs anything made by Apple, but they made a good investment of late.
Balancing the opportunity costs is one of the things that makes investing hard. When you buy an asset, you’re also making the decision to not buy a different asset. Diversification derisks this, by stopping you putting all your money in one type of asset.
BTL is emotive in Britain, carrying the hopes of the ageing baby boomers who tend to have a high cost lifestyle and are distrustful of the financial system because they’ve just seen a huge financial crisis and may not have been lifestyle profiling their investments. And conversely carrying the unrealised aspirations of the Gen Y/echo boomers who want to buy houses around now, and who are finding prices running away from them and mortgage funding harder to find.
It’s difficult to believe that BTL is right for so many people, with its toxic mix of illiquidity, gearing, lack of geographical and sector diversification and hard to quantify risks and opportunities. If I said I was going to take out a mortgage to invest on the stock market most people would say I’m nuts. It’s not that clear to me why the same doesn’t apply to speculating on the housing market. BTL makes sense if it’s 10% of a diversified portfolio. As 100% of someone’s retirement savings it looks like a recipe for disaster to me. It isn’t just the return on capital that matters. The return of capital also matters.
Retiring Early – a high-level view. It’s not all about the money
Most people think of the main issue in retirement as having enough money. By observation, there are two other main issues for people. One of them is retaining a social connection, and the other is health being a worry, though less so for early retirees You can do something to improve both, but they take time, measured in years, to get right. Many people, particularly guys, get a lot of their social connections through work. Talking to people who have retired from The Firm, this changes, absolutely and almost overnight.
Maintaining a connection with other people
Humans are social creatures, and isolation isn’t good for us. I’m less gregarious than many. Early Retirement Extreme had a view that early retirees tended in this direction being drawn from people on INTJ and ISTJ axes of the Myers-Briggs spectrum. I don’t have much idea of if he’s right. Perhaps early retirees who choose it as a life path are, but I’m met enough people who just get pig-sick of the rat-race and bail early who I wouldn’t describe as introverted. Anyway, even those INxJs need some connection with other people, and it’s something that many retirees get wrong, even if they retire at a typical retirement age. Early retirees will take a greater hit from this, because their friends and peers of a similar age are often still at work because they haven’t retired early!
I would have been more exposed to this a few years ago, but DW setting up a community supported agriculture scheme means I’ve met a number of people from various walks of life over this last couple of years. Some of these even work(ed) for The Firm, though most haven’t. I can’t claim any strategic direction here, growing thing has been one of DW’s passions for decades, and I’m simply taking advantage of the free ride here. But hey, why not It also comes with some activities that are working with others, after all it’s not really possible to raise a polytunnel on your own and it’s far more fun with a bunch of other people anyway.
raising a polytunnel - much more fun with other people
Building the frame is something you only need one or two people, DW and I constructed that beforehand rather than waste other people’s time. But skinning it needs more boots on the ground, and there is a feeling of satisfaction when it’s done!
I’ve also tried to maintain a toehold in interests, though this narrowed down greatly over the last three years, slightly from the reduced outgoings but mostly from the stress. But I kept a strategic view and low-level activity with interests and membership of societies. One of the keys to lowering costs is to be creative, originate, don’t consume. Things to do with the natural world in particular are often a modest cost, and living in an attractive part of the country is good. I’m not yet realising the upside of this investment, but I hope it will pay dividends, in quality of life, not in money. I’ll find out after I do finish work, and a period of convalescence perhaps.
Health
Yeah, it’s the big one, and I’ve been lucky so far in terms of physical health. Retiring early is a very good thing to do for ones health all round, provided you don’t fail on the human connection part, and don’t have the stress of being poor. I hope to avoid both of those. Eliminating the stress of working will be good for my long term health, as will drinking less.
No longer working in an office and spending some time in the open air will probably be good for my physical health. There’s a theory that willpower is something one only has limited resources of, and using it in one area depletes reserves to apply to another. Ending the working in a environment that isn’t suited to my values and saving heavily should give me some of these reserves back, and I will apply them to doing something about losing weight and getting more exercise, some of which will happen as a result of the change in lifestyle anyway. Cycling is a great way to reduce running costs for the small but frequent journeys. I’m not quite sure I will ever achieve MMM’s levels of badassity, but I can shift myself some distance along that axis. It’s made a lot more attractive by having more time.
What I eat is probably fine – we eat hardly any processed food and our veg is about as fresh as it’s going to be, within a couple of hours from field to kitchen. DW is a great fan of starting from the basics. In comparison with the typical modern Western diet we do fine.
There’s a lot to play for
If I die ten years earlier than my grandparents or indeed get as far as my parents are now then I have more of my adult life ahead of me than I have behind me. So staying interested in the world, connected to other people and in decent and hopefully better health is something worth playing for. And health of course gets a little bit harder as you get older, so while the best time to start sorting some of the strategy out with health was a decade or so ago, now is a good second-best.
Things I can learn from younger people
Quite a few people in the community supported agriculture scheme are in their twenties, and something that strikes me is how incredibly generous they are with their time, volunteering with things like the CAB and other interfaces wit hthe wider community. Particularly over the last three years, time has been exceptionally precious to me. I don’t understand the concept, I can’t ever imagine volunteering for anything that isn’t a specialised use of my skills.
However, I am struck by the blaze of energy and the remarkable generosity of spirit. Perhaps I never had this by nature. I used to think it was being a young adult in Thatcher’s Britain and joining the workforce in Thatcher’s first recession, but the situation with youth unemployment is probably worse now than it was then so this is no explanation of why I lacked that sort of generosity as a young person, and have become a miser with time now.
This isn’t the only thing I could learn from younger people, but it’s the one that is most obvious to me at the moment.
A finance detour
Though the most common concern is having enough money, reducing outgoings is a very good alternative. In the end it is the difference between spending and income that matters. DW and I have focused on reducing costs and winning self-sufficiency in some areas. Early retirement in particular is about spending less.
Looking ahead, there will be two obvious battlefields for everybody in trying to maintain living standards over the next four or five decades. These are the cost of fuel, a fight people are already losing, and the cost of food. Both are non-negotiable, and both of these DW has in particular applied herself to reducing. I have also tackled energy, reducing electrical power usage drastically, while we have used the wood resources of the hedgerows and our wood heater to eliminate using the gas central heating totally this winter. We do use the central heating boiler it to heat water, if we can achieve success with the heating then there are other approaches to water heating. We have a biomass willow plantation elsewhere in town that is four years into its rotation and we plant into the hedgerow more than we take out, as well as using Italian Alder for windbreaks and potential firewood in future.
Unfortunately since I switched to a fixed tariff EDF have been really slack on reading the meter. They already owe me several hundred pounds for electricity and I hope they will owe me a fair amount on gas, since they haven’t jumped to the change is usage.
Fuel is serious work. Mr Money Mustache probably wouldn’t approve but we use a chainsaw for harvesting wood. There’s enough grunt involved in moving it and splitting it with an axe. Which may help with the exercise and health stuff, but hand sawing wood is no fun at all. There’s a balance to be had here, and it’s not always in favour of muscle over motor!
The long view
I will have worked for a shade over thirty years, and just might see more ahead. The world will be very different. That much is clear looking back to what it was like when I started work. ET and Star Trek 2: wrath of Khan were in the cinema, and over the next few years Greed was Good for Michael Douglas a Gordon Gekko summed up the rising Yuppies. People feared being wiped out in total nuclear war rather than the environment and global warming. There were only three channels on TV, and people listened to portable music on Walkman tape players, and vinyl records at home.
The years to come will hold their own challenges for people and the economy. I don’t share this chipper view of the world in 2020, never mind the world in 2040. I think in particular the experience is going to be pretty rough for people in the West looking to retain never mind advancing their living standards. If we can get our heads round it all and stop living the consumerist lie then we may be able to salvage an improved quality of life; earning a living shouldn’t grind us out of the workforce in our fifties and sixties, particularly if people are going to start routinely living to 100.
Retiring from the workforce
I will retire from the workforce as far as earning an income from work – at least this is my current plan. I have paid far too much income tax. I’m not going to go all Ayn Rand – some contribution to society is fair enough, and I really do appreciate not having the stress of US-style healthcare insurance costs. But I’ve done my share. Last year, while saving furiously for retirement, I paid twice as much tax and NI as I was living on and a shade more than my pension will be. I’m pig-sick of paying for other people’s lifestyle, or indeed hard-done-by Guardianistas and high-rate taxpayers’ children.
I am not going to retire from adding value to projects, I am merely going to retire from working for other people and working for an income; the value-add will show in either increasing the capital value of an asset, its ability to do work or it will increase other people’s income which may reduce my costs. I still won’t be able to escape the demon of income tax on my pension, even after Nick Clegg and his merry men achieve their goals with the tax threshold. At least you don’t pay NI on a pension, and I’ve got more than my thirty years’ NI stamps paid now.
In my attempts to reduce taxation over the last three years I took my eye off the ball as to the damage NI does – for all the trumpeting of the aim to take low earners out of income tax I note wryly that the 12% NI tax still starts at £6000. Barstewards…
So I’m retiring from income, not from adding value to stuff. I’m not yet ready to hang up my soldering iron, keyboard and spanners for good
And on that note I am going to start with that health kick, get up off my ass and bike to work, so the fuel tanker drivers and the Government can stick it, too Tossers, the lot of them.
A very British fuel panic
On the way to work I spotted this very British fuel mini-panic (it was taken after the rush hour). Exactly what the Minister Francis Maude ordered. Panic, but only a little bit. Oh and on the topic of increasing fuel costs, that’s the last time you get to see a price of under £1.40 a litre. That’s up 40% from this time two and a half years ago.
Clearance at last to begin the Final Approach to early retirement
The birds are singing in the air, the sun is shining and the blackthorn is in bloom before the leaves come out.
Blackthorn in bloom - before the leaves appear
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Birds recorded in the cemetery on the way into town. I love the sonorous resonance of Woody Woodpecker
About three times a year The Firm invites staff to apply for voluntary redundancy. There’s usually an incentive of up to a year’s salary redundancy money, and I’ve put my hand up enough times in the last couple of years.
This time the stars are in alignment, it seems, and I have clearance to begin the final approach for the exit. HR spent a lot of time spitting bricks about that everybody has to be out by the 31st of March. However, I have a unique skillset for the Olympics work, and local management found a way to extend my leaving date to the end of June.
Which I’m absolutely cool with, though it confused the hell out of me when I received the confirmation with a leaving date contradicting everything else HR had said. Where there’s a will there’s a way, eh, guys Not only do I get the opportunity to finish the job, I get the opportunity of getting the year bonus just as I leave, I will only have earned half a tax year’s money so I have less tax exposure and I get to benefit from another load of Employee share schemes and Sharesave. Thank you Mr HR and line management.
Oh and I don’t exactly have to sweat the infernal performance management system because there’s nothing to play for. It gets back to how working used to be before a bunch of American HR twunts got a hold of the system. I didn’t realise that the punk Peter Drucker who is responisble for an awful lot of things that enable Digital Taylorism was the architect of Management By Objectives. The Firm seems to have explored pretty much all the avenues listed as Limitations in the Wikipedia article on this.
It seems W Edward Deming identified the thing that The Firm did wrong – in my area, which originally had a scientific and technical skill base, management was along Deming’s lines of leadership, which worked well. Only in the last seven years did they switch to MBO, which ended up destroying the esprit de corps. Indeed, the undesired outcomes of MBO seem to be rife in capitalism at the moment, with objectives causing our CEOs and bankers to run amok chasing short-term gains and hypercomplexity at the expense of the rest of us muppets.
Oh well. This isn’t my fight any more, though it does deeply hack me off that this damned performance management system and its abuse caused me to have the longest period off sick that I ever had in my working life.
Most people who take voluntary redundancy only get a window of about two weeks between when they hear if they’ve got it and getting to clear their desk, and to be honest that’s all I expected to have. The luxury of the extra time means I have more opportunity to set my financial affairs in order and take opportunities.
Joining the rentier class is a huge change from being an employee.
Living off capital is a massive change from living off a wage. I have always got the vast majority of my income from being an employee. This will change; my work pension is deferred pay of a little bit more than the NMW because I am a very early retiree, which fits conveniently with the aims for an increase in personal allowances from the Budget yesterday. Nevertheless, it is enough that I will probably always be a basic rate taxpayer as a result, which eliminates many otherwise useful ways of avoiding tax.
As far as the capital is concerned, to my employee-income-attuned eyes the numbers are enormous – and this often leads people into temptation. The AVC lump sums and redundancy money plus the savings I already have add up to the largest sum of money I have ever seen in my whole life, I could easily buy my house again, cash, and furnish it better than it is A friend of ours asked if I am going to blow the redundancy money on something nice.
No. That sort of thinking is madness. For a while I am not going to change any spending in any significant way, with one exception, I may go on holiday, but along the lines of The Accumulator’s staycation rather than a permanent Gap Yah. Other than one special occasion, I haven’t been on holiday since 2008, and this was one of the harder things about locking down spending while working. I came to this conclusion myself, however, the rationale is delivered with more vim and vigour by this writer
The one thing everyone must do the moment they get fired or quit is…
…NOTHING.
Don’t do a damn thing. Nothing at all. Got that?
So why no change? After all, though my total income will be less than half of my gross salary, that’s actually a hell of a lot more than what I have been living on these last three years, because I have been saving most of my salary. I could increase my lifestyle and not touch the capital
No change for several reasons. I only gained control of my spending after I had accumulated a lot of data on what it was. My spending will inevitably change – I lose the modest work-related costs, I will probably pick up some other costs. I need to know what these are before making any strategic changes. I have no experience, only a theoretical and intellectual understanding of what it is like to live off capital. This is eased in my case by having deferred income which is significantly more than my outgoings, so there really is no rush, and I have much to learn.
A signal received at the eleventh hour…
Just over three years ago I took the initial hit that started me on this path. So I decided I wanted out, and started making the calculations. This was in February 2009, and after loading a Cash ISA I started to look at more sustainable returns from saving, splitting between financial and non-financial investments. I read this on Monevator. These were among the darker days of the financial crisis.
Points of crisis magnify the power of small actions. It was clear that I was a long way away from financial independence, and I have a very dark view of the future of Western economies. And yet, I saw that combined with the power of a 41% tax saving on going into pension contributions, there was an opportunity highlighted in that article. It was time to take a chance like a Stagecoach bus driver, but with far better odds. At the time it did look to me like there was a very real risk of the entire financial system going titsup. I did know the ‘be greedy when everyone around you is fearful’ theory before but it took that article and some desperation to stiffen the spine to actually execute it then. I continued to invest in AVCs ever since, and have just issued the sell stock market funds to convert to cash fund command, at a 20% uplift (less about 5% inflation).
The echo of the initial hit still stayed with me, and so I saw these last three years as trying to manage the slow decline of energy as I fail to live my values for the sake of money. It is not necessarily the most motivational image, but it allowed focus. Sometimes it isn’t necessary to win, it is enough to lose less quickly.
I was ready to quit of my own without a redundancy package after August, by which time I will have run out of space to save 40% tax in my pension contributions to be able to take out as a pension commencement lump sum without having to take out an annuity, for which I am far too young. However, it was always good to roll the dice of voluntary redundancy if there’s an opportunity of a free win, and this time my number came up at the eleventh hour.
Retirement isn’t all about money, of course. I will probably not want for things to do, and the work, community and people at the Oak Tree will mean I won’t get to see too much of the attractions of daytime TV or the Jeremy Kyle show.
Though I chose a similar aviation metaphor to Salis Grano, I reversed the direction, I see the journey to early retirement as being on the final approach, where his is one of taking off. SG probably did the planning in the way you should do it, saving over many years. I started late, already from a weakened position and anticipated the three years would be the point where I was all out of energy from the enervating performance management system.
I’ve never had any actual trouble with it after the first hit, but I associate the whole procedure with a time when I felt I was within months of being run out of The Firm, and since it happens every quarter that is a lot of stress. I did wonder if I paid for psychotherapy then it might be possible to break the power of this association. However, in my view modern performance management systems are deeply screwed up. Some things should not be equalised or accommodated, they should be destroyed or eliminated from my life.
The Tribulations of Holding Lots of Cash
While I did a pretty good job of working out how to save the most while minimising my tax exposure, what is becoming patently clear is that I didn’t really pay enough attention to working out what to do afterwards. It transpires that the total sum of my AVC savings, redundancy and existing savings is far and away my largest asset, with the possible exception of my pension itself.
And it will appear as cash, and immediately start to decay in real terms in that unappealing way that only cash does. As soon as National Savings and Investments open their doors again for index-linked savings certificates I will double up my existing 15k holding with them. That I can leave as emergency fund. Unlike that cheeky pup Monevator who would like to make a profit on his cash holdings, I don’t have any aim to make money on cash. It’s quite enough for me to find all of it still there in real terms when I come back for it, I just don’t want to have it die away quietly into the night in order to pay for some Government largesse like Tarquin and Jemima’s school fees. And I don’t want to pay tax on it, either. However, in the grand scheme of things NS&I can’t really help me very much to stave off the rust of inflation for most of the capital, because of their savings limits.
The high-level aim is to invest most of the money, somewhat along the principles described here, and carry on on the general HYP lines my existing ISA operates on. I was also planning to hold a big wodge of The Firm’s shares unwrapped. The old principles of not holding shares in my employer kind of go away when The Firm is no longer my employer. It has a decent yield, reasonable prospects and I have totally avoided the sector in my shareholdings. However, this comment implies this will cause me problems with tax again. I had hoped to avoid paying tax as a retired Ermine by using ISAs but it will take me well over a decade to finish shovelling cash into ISAs.
The general issues of how to turn savings and a pension commencement lump sum into an income don’t seem to be addressed in any UK PF blog that I’ve found so far so this is a pathless land as far as I can see. The general principles of living off investment income are dealt with well, but migrating a large lump sum into tax-sheltered funds while avoiding the cash rotting away over time is a specialised requirement. The best source of information around the topic is MSE’s forum, however it needs sifting heavily. There are some people on there who believe it is reasonable to take out a loan of £4000 to have some pictures taken of themselves…
It appears I made a mistake paying down my mortgage early rather than investing using the mortgage as a low-cost loan, which would have given me many more years of ISA allowances, discharging the mrotgage at the end with the cash lump sum. However, I didn’t really have the brass neck for that sort of thing, so I have to eat the consequences of being risk-averse. My asset allocation and global diversification is now skewed horrendously to cash and to the UK, and it will take some time to fix that.
Retirement is about quality of life, that means hearing more of this sort of thing
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and less of the incessant babble of densely packed open plan offices and people talking loudly on their mobile phones in buzzword bingo phrases or the roar of datacentre cooling fans.
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Obama and Dave, what is it about peak oil that you don’t get?
Apparently Dave and Obama have decided that the price of oil is too high. So guess what? They are going to push down the price of oil. I could have titled this one don’t fight the tape but I’ve already used that for one of Dave’s previous wheezes. What has got into Cameron’s head? Has Samantha bought him a Superman costume or something, first he goes around encouraging people who can’t afford a house to overstretch themselves for a mortgage, and now he’s going to Do Something about the price of oil
So how can we do that? We could:
- increase supply – nope, the IEA says we can’t do that much longer
- reduce demand. Now there’s an idea, but it sits badly with rising global middle class aspirations
Hey, I know what we can do, says Obama. Let’s fudge option 1 and release a load of the US strategic reserves. That way American drivers don’t get pissed off in the Driving Season.
Oh good, says Dave. Tell you what, we’ll help you by releasing some of the UK strategic reserves to help you out, along with out Squeezed Middle. Presumably some Civil Service flack hurriedly whispered in Dave’s ear that the UK doesn’t actually have any strategic oil reserves. Thinking on his feet, he changes it to asking UK oil companies to hold less in reserve.
Great. That’s all sorted then. What part of ‘strategic’ was it that you guys didn’t understand, or should we send in the DEA to find out what you were smoking?
The high oil price is a signal. That signal is telling you that more people want oil than production can currently match, and the price will rise to shed demand until it matches supply. It’s also perhaps showing that the currencies of both the US and the UK have been debased in recent years.
Oh and by the way, guys, you haven’t got enough strategic reserve to deal with the probable war on Iran. They may be mad as a bag of spanners over there but the interruption to production will probably exceed the 40 days capacity of the US Strategic reserve. Just look at what happened next door in Iraq a few years ago.
personal finance rant: 95% mortgage support mortgage newbuy
by ermine
8 comments
Don’t fight the tape, Dave, the NewBuy Mortgage Guarantee will cause untold pain
The trouble sometimes with Government, is that it often gets itself into areas it shouldn’t touch. Such as meddling with the market, offering to guarantee home loans of half a million pounds to buy new houses. What on earth could go wrong?
So let’s take a step back and see what’s going on here. A putative homebuyer is looking to buy a house that they can’t afford. So Dave waves his magic wand to make lenders accept the risk by guaranteeing the money with taxpayers’ money. Now I would then suggest to the homebuyer they look for good value for money. With houses, like with many other durables, the best value is in the second-hand market. But no. Conflating the desire to help people buy stuff they can’t afford with some dirigiste industrial policy to support housebuilders, Dave makes them buy unnecessarily expensive houses – ie new-build.
Face the facts, Dave. You can’t make enough on the average income in the UK to buy a house in a lifetime. A middle class man on the average wage used to be able to buy a house on his own, my Dad did it on a blue collar wage. Then it took two people to do it when Thatcher sold off the council houses, meaning people who were too poor to buy a house themselves were robbed of the opportunity to have social housing, though a lucky bunch of 1980s tenants got their houses at knock-down prices to buy their votes.
I managed to buy a house on a single white-collar wage, but I lived somewhat below my means to do it. Nowadays if I were starting over I wouldn’t be able to afford even the interest on my current house on what my starting wage was in real terms.
And now another Tory government is going to dive into this frenetic marketplace with its hob-nailed boots and dance all over the face of the price mechanism in a capitalist society. Dave, the reason your middle class voters can’t buy a house these days is because we don’t make anything of significant value in Britain any more, and our standard of living is going to fall accordingly. You’re going to provide mortgage guarantees for houses priced at up to £500,000!!! I couldn’t even dream of buying a house for that much now, at the peak of my earning power and with a fully paid up house to defray some of the capital! What right do you have to buy your votes with the dreams of some daft young couple that is going to put themselves in hock for far more than they can afford in the long run?
Imagine a couple both with good jobs earning the average household post-tax income of £25,000 ish. Even if they paid no interest it would take them 20 years of their entire household income to pay that off. That’s assuming in those 20 years they eat nothing, have no kids, never go on holiday. It’s barmy. It is just so wrong, on so many fronts.
Dave, the price of houses is telling your middle class voters they cant afford a house. There is an old stock market adage from the 1930′s, ‘don’t fight the tape’. It means listen what the price signal is telling you. And for God’s sake, don’t fight that signal, because it will crush you.
Oh and to those putative homeowners – don’t do it to yourselves. Buying new-build is expensive, you’ll get more house for your money buying second-hand. I didn’t have enough money for the deposit on my house in the late 1980s. So I borrowed an interest-free from my MBNA credit card, and used a low-start mortgage to focus repayments to the credit card in the first year. It worked for me, I got my mortgage cheaper because I had a lower LTV and didn’t pay a bean for the loan. In those days you didn’t have the sneaky 3% handling charge on 0% cash advances. There are other ways of raising the deposit than having the government railroad you into buying an overpriced new-build house when you can least afford it.
living intentionally reflections simple living: quality of life standard of living
by ermine
11 comments
Your Standard of Living may take a hit, your Quality of Life doesn’t have to
Ben said something in a comment that made me think a bit
for the upper side of middle class these are brutal times with generation X ers significantly harder up than their baby-boomer parents. The desire they have to maintain the same lifestyle they were brought up with is almost certainly overpowering
There’s a lot in that. It’s hard to equate directly – I am probably tail end of the baby boom, DW is GenX and I had a better experience of work than she did. And work in general is getting less rewarding IMO. I’ve ascribed this to digital Taylorism before, although there is also the possibility that I am losing tolerance and adaptability to business trends through the usual process of getting more ornery and curmudgeonly as I get older.
Ben’s comment gave me a double-take. A lot of things are far better for GenX than they were for baby boomers, gone are the draughty coal-fire heated houses of the London I grew up in. TV is better, both in programming and in picture quality. Far more people have cars, though that has its downside too. Those cars are far more reliable now – I recall changing clutch cables and water pumps by the side of the road in the freezing winter a couple of decades ago. But I know what he means. Some of the important things in life, like accommodation and jobs early on, were commoner and easier to afford on typical wages than they are now. Britain paid its way in the world more, and had less global competition. More of our consumption was made locally in the mid-20th century than it is now. As a resut we had more jobs, relatively, but our stuff was of a poorer quality, hence the unreliable cars and TV sets
That decline in standard of living will progress and accelerate, as the West loses competitive edge to the East. Robert Peston had a programme ‘How The West went Bust‘ on TV last year and he pretty much laid this out with evidence. We’re overpaid compared to other people, and globalisation and improved communications will see to it that wages equalise. To see the level they will find themselves at, we are probably overpaid by five times relative to the Chinese by his reckoning. Split the difference and real wages will fall to about a third of their current real value, weight by population size and our pay will fall even further.
It’s not guaranteed, of course. There are some things that could happen that would forestall this sucker punch from globalisation. Peak Oil would put a major spanner in the works of those long supply chains and we’d have to make the stuff we use more locally again or do without. The Raspberry Pi could galvanise a generation of British kids to do something with the sticky grey stuff in their craniums rather than watching TOWIE and wanting to become a sleb.
However, the tragedy behind Ben’s comment is that each generation will have to strive harder to achieve some of the basics their parents had because of increasing global competition until that is assimilated, or the myth of continuous growth finally goes titsup, in which case it is Game Over for a lot of our standard of living.
Standard of Living ≠ Quality of Life
Just because we have an advertising industry hollering out that buying Stuff and Experiences is what makes a better quality of life doesn’t make it true, but unfortunately it makes it easy to believe that’s the case.
Obviously, at the bottom end of the standard of living scale it does directly influence quality of life. If you haven’t got enough to eat or you haven’t got a roof over your head then your quality of life isn’t great. However, one of the myths of British culture that causes a lot of misery is that you have to own that damned roof. At an early stage in your adult life you take on a huge financial risk and expose yourself to a big one-time purchase in a cyclical market. To make things worse, some of us don’t understand the repayment part of buying a house and get ourselves into a right pickle.
Other European countries manage better by having a working rental market with professional landlords rather than our motley crew of amateur buy-to-letters. It’s been a long time since I had dealings with landlords but the professionals always delivered a better experience than the amateur accidental landlords. It sounds like nothing has improved in the intervening quarter of a century.
That’s just one aspect, but there are many cases where we built non-negotiable costs into our lives. Each and every one of those binds the chains of wage and debt-slavery tighter. It doesn’t have to be this way.
You can separate Quality of Life from Standard of Living
Subject to a minimum standard, which you can achieve in Britain on benefits which is part of the financial problem we are in you can improve your quality of life separately to your standard of living. Ray has a much better quality of life than I currently have, though my standard of living is probably higher than his even after saving is taken out. Standard of living you influence by earning more, and/or eliminating debt costs. It is primarily about the amount of money you have in terms of income.
Quality of life is largely about how well your needs are met. Finance and society address the bottom two of Maslow’s hierachy of needs, after that it’s up to you and the people around you to work it out. Ray is living his values, and he’s comfortable. I am not living my values, so I have issues in the self-actualisation department. I am working towards fixing that, but I’m not there yet. Once I have sorted that, I will probably have a better standard of living and quality of life than Ray
It’s the job of the advertising industry to convince you that money will buy solutions to the top three levels. They do a very good job of it, and lead most of us into a continual epic fail. Let’s take a look at those top three levels.
You can’t buy Love
For a start most of us manage to break out of that fail in the love department, though there’s the oldest profession in the world for those that prefer to use cash rather than charm
To get anywhere with love you have to be a lovable person and to be able to give enough of yourself to love. That’s about how you are, not what you buy or what you own. However, the admen get in there too, with Valentine’s day, diamond rings, the wedding industry, almost anything to do with children, you get the picture. We are all social creatures to some extent, and again, lasting success in interacting with others is about who and how you are. You can take some shortcuts with what you have, but the sort of love and friendship money can buy tends not to stick around at times when you need it, or when the money runs out.
You can sort of buy Esteem
The Esteem level is absolutely rife with products to make you feel you are special by virtue of what you buy, and we fall for it every time.
The sort of esteem that money can buy you is shallow and impermanent – you achieve self esteem through self-knowledge, consistency, living your values and knowing what you stand for.
The sort of esteem you get from lowering your car suspension, fitting a loud sound system and detuning your engine with a bigger exhaust pipe is all about trying to dominate the ‘hood. It’s the same sort of esteem as the cock sparrow on the gutter dominating the area with his chirping. The self-esteem you get from what you own is all very well but it suffers from the ancient problem of the sound of a tree falling in the forest with nobody to hear it. If your self-esteem is dependent on other people looking at what you have and where you are then it will fail you in the dark night of your soul when you need it most. You can’t buy that, you have to grow it through hard work and self-knowledge, and even then there are no guarantees.
You can’t buy Self-Actualisation
It’s in the title. Doesn’t stop there being a huge industry being out there to separate potential self-acualisers from their money, but the Delphic Oracle had it spot-on, all those years ago.
'Know Thyself' in Greek in a stained glass window
Know Thyself. It’s something only you can do, and to achieve self-actualisation it’s something you have to do.
Quality Of life is about what you Are as well as what you Have
It took far too long for me to come to this realisation. Shona hasn’t got it yet, bless her, though she’s on a voyage of discovery. It is something that I found in a crisis point, I saw clearer, that I didn’t need another eight years of a decent middle class salary doing a middle class job.
So I started to make the biggest purchase in my life, of something no ad-man has ever offered me. In financial terms it is much more costly than my house and car. What I am buying cannot be held, or weighed, it is intangible by definition.
It is freedom and dominion over my time. No Stuff will be as good as Freedom from wage-slavery feels. It has no fixed price – Jacob in his ERE days won his freedom far earlier in his life than I and for a far lower price. There are other ways of doing it – Dolly Freed’s book Possum Living shows another way.
One of the things that saving towards buying financial independence showed me was I don’t need a lot more Stuff in my life, because my spending on Stuff dropped way down. I don’t miss it any more. Even if I had no independent savings if I drew my pension early I would have to increase my spending on Stuff to use it up. I do miss some things that I had to give up to shorten the period of saving to a minimum, and I’ll probably restart them. But more than half of my spending was a chimera from which I derived no lasting pleasure. To hell with that. I had to find that out the hard way, some times that is the only way; Nietzsche had some point with that which does not kill us makes us stronger.
Tyler Durden showed why it’s so hard to see this consumerist fallacy in Fight Club It’s only after we’ve lost everything that we’re free to do anything. Because he’s a movie the principle is overstated for dramatic effect, but far too many people cling to the inessentials of life as their standard of living falls only to lose the essentials because they are misallocating their resources.
Taking a controlled standard of living hit upfront means I haven’t had to give up anything really important to me
I was ‘lucky’ when I thought I was done for working three years ago. I first prioritised short term savings, along these lines, but what I percieved as an immediate hazard of having to leave work turned out to be less acute. At no time in the past three years have I attempted to recover my original standard of living. I simply aimed for a controlled crash-landing to a satisfactory standard of living, slowly surrendering disposable income to buy my future income, a reverse of the ‘borrowing from my future self‘ by saving to my future self.
I targeted half my income as a reasonable goal. I was more than halfway through the controlled crash landing when I realised that I was in danger of succeeding, despite not having the benefit of compound interest on my side. Some things make the job a lot easier for me than, say, ERE. I already own my house outright, and I have been saving in a good pension for nearly a quarter of a century. Against me, I want to retire early, which weakens the pension severely, combined with dastardly dealings from my employer which means even if I carry on working to 65 I can never realise the original target of half my salary with that pension now.
It is only now that I realise I have no need for half my current income, proven by the simple fact that I am saving well over half of it. This is largely as a result of taking the standard of living hit entirely under my control and in ways of my choosing. I will improve my quality of life once I have completed the path.
The Times They Are a Changing – Choose Quality of Life over Standard of Living
These challenges are coming to many of us in Britain, and Ben opined
The desire they have to maintain the same lifestyle they were brought up with is almost certainly overpowering
They need to kill that desire. The key to preserving your quality of life when your standard of living is going down is to get ahead of the curve and choosing where the dwindling resources will be allocated. Doing that reactively puts you in endless firefighting mode.
Choose your battles before they choose you. Live intentionally, know yourself, what your values are, what matters to you, what your resources are and what your potential is. Then deploy those resources, stay adaptable to changing circumstances, and live.
One good tip here is to engineer out as many fixed costs and long term commitments as you can from your life, things like Sky TV, long mobile phone contracts, any sort of contract like gyms. For elective spending it’s sometimes worth paying more for something to get that freedom from long-term lock-in. For things you must have, like mortgage/rent and fuel contracts are okay, but many people see the savings on elective contracts without seeing the invisible chains of spending that tie them down. And think long and hard before taking financial responsibility for anything that eats.
That’s where Shona screwed up. That family could either pay for school fees, or for their huge house. If the school fees mattered more, they would have downsized ages ago, when the first child went to public school, and not been caught on the hop. If the house were more important, then the school fees would go, and they’d still be living in their fancy house.
Prioritising worked for me, though I was already living within my means when I started, unlike Shona. I cut the holidays, the gadgets, the media buying. I’ve already bought myself a tax-free income of over a hundred pounds a month with my measly post tax savings, and a potential income of a lot more with pre-tax savings, which I will spring tax-free as a pension commencement lump sum. I also bought myself a stake in a business, three years’ index-linked living expenses with NS&I and a cash emergency fund.
It’s all about the choices you make, and I’ve chosen to surrender standard of living to buy a better quality of life. They’re not the same, whatever the admen want to have you believe. If it traps you in a job you don’t like or takes you away from seeing your children grow up, then a higher standard of living is often associated with a poorer quality of life. It’s the dirty underside of consumerism, and it needs to be called out every so often. Choose quality of life over standard of living. You’ll feel better for it
personal finance: Charlie Munger ESIP model thinking risk analysis
by ermine
2 comments
Employee Share Options, model theory and the Greek/Irish Default Conundrum
Looks like the Irish have gone and joined the Greeks in causing trouble in the Eurozone paradise. It’s coming up to the end of the tax year, and The Firm informs me I haven’t used my employee share options yet. Stands to reason as I didn’t expect to be working there in five years’ time. However, it’s come to my notice that if I retire I get to spring these ESIP shares free of tax and NI without holding for five years. Now I don’t know about you but I loathe paying tax, so I prick up my ears and wonder if I’m about to miss an opportunity to stop that B’stard George Osborne stealing some of the Ermine’s heard-earned cash.
So what’s the Employee Share Incentive Plan about then?
Somewhere in the distant past it was deemed A Good Thing if employees had skin in the game relative to the share price, that’s even lowly grunts like me that are about five layers of management down from The Board. And Hector the Taxman lets you buy these shares before tax and NI have been taken off. If you are a higher rate taxpayer then you save losing 42% of your salary. Now I would be a HRT payer but I hate people stealing my money so much I pay all the excess over the HRT threshold into my pension AVCs so I am a basic rate tax payer. So I get to save 32% on this. The catch is that you do actually get to buy the shares at the time of taking the decision, and the shares are then embargoed for 5 years, take ‘em out before then and you get tapped for the tax and NI you saved. You are also exposed to share price volatility, and you do get the dividends. Which is nice, as The Firm isn’t a bad divi payer at all.
What are the Risks and Rewards and How can I Mitigate them?
Let’s assume that The Firm is reasonably okay priced relative to its historical PE. The yield is about 3.5%, but I’m only aiming to hold the shares for sub a year, though I may change my mind once I am no longer working for them as they are a reasonable component for a HYP, and if The Firm is good enough for Neil Woodford’s High Income trust and I have no other exposure to its sector then perhaps I should just hold.
Rewards
Depending on how you look at it, I pay £1020 of post-tax income to buy £1500 worth of shares, a gain of 47%. Or as I look at it, I started out with £1500 and stopped the taxman stealing 1/3 of it. Either way, a gain of £480. I can’t buy any more than £1500 of shares, that’s the rules. If The Firm or the market takes this sort of viewpoint then I get to take a slice of the upside, and also some reasonably good dividend yield. The implicit yield of The Firm is upped from about 3.5% to about 4.5 by the tax discount on purchase price alone.
Risks
If The Firm screws up and the share price goes down the toilet. It’s been known, worst case is it has been about a third of what it is now, but that was an exceptional cock-up that was perpetrated by some directors who wanted to pump the SP to get their options, then left before the SHTF. Can’t guarantee that’s not about to happen again, but cooler heads seem to be prevailing.
Estimated Probability – 40:60 up 10% or down by 10%
The Greeks and/or the Irish cause a huge ruckus that destroys the Eurozone. Another form of the SP going down the toilet, let’s say this slaughters the UK stock market by 50% of its value, and The Firm gets caught in the crossfire.
These are the main risks we suffer from. I could also add general Black Swan risks, such as getting hit by a meteorite at 625 to 1 but that would be facetious There is, of course, a chance the stock market may go for a second near death experience as in 2007 but that might as well be lumped in with my estimate of the chance of the Greeks/Irish defaulting.
Estimated Probability of Eurozone crash (over the < 1 year holding period) 30%
Mitigation strategies
I could use IGIndex to short my shareholding, converting the volatile shareholding into a fixed cash holding (minus the cost of shorting, and the cost of dividends, but of course I would get the dividends to offset that)
I will represent this choice as a fixed cost of 5% of the holding, ie £75. I get rid of the risks of the Greeks, or The Firm screwing up, but I introduce some risk of IGIndex, the counterparty, going titsup.
Estimated Probability of IGIndex failing – 0.1%
Modelling My viewpoints
I joned the Model Thinking course called out by Monevator (vaguely at the behest of Charlie Munger ISTR). One of the lectures deal with Decision Trees, so I figured i would take this for a spin and see what it says I should do. My choices are to buy the ESIP shares or not, and to hedge them at IGIndex or not. There are three uncontrolled risks IMO – a Greek default halving the value of the shares (from analogy to what happened with the market in general with Lehmans), the possibly of The Firm being slightly overvalued IMO, modelled as a 40% change of the shares going up 10% as opposed to a 60% chance of them going down 10%, and the risk of IGIndex failing, which I put at 0.1%.
Go with my Gut or Model It?
My gut feeling was go for it, and probably don’t bother to short.
I ran all this lot into something called TreePlan, from www.treeplan.com. This is an add-on for Excel, and works okay, though it handles like a greased pig on an ice-rink; it is all too easy to blow away a branch of the tree at a stroke, there is no Undo with that. But it does the job.
The result was surprising
The results of the decision tree calculation. Computer says take branch 1 and 2. Buy the shares and short them.
So going with my gut would have sent me along the wrong track, slightly. Or I am not correctly quantifying my risk perception, either over-weighting the likelihood of failure or over-weighting the cost of failure. The costs of failure are pretty clear on this one, so I am probably either irrational or quantifying risk perception wrong.
Let me for a moment slough off my white pelt and pretend I am Ermevator, picking up some of Monevator‘s world-view. He tends to be more chipper about the stock market and the prospects for its investors even when being downbeat. He’d be more neutral to the Firm’s SP, if anything favouring a slight uptick, that I have represented by shortening the odds on a 10% uptick to 55% to 45%. And he probably wouldn’t let me get away with a 30% risk of Greek default, on the principle that the politicians will probably muddle through. So I’ve dropped that as low as I can go, to a 10% risk.
An Ermevator would probably buy the shares and find the 45% uplift provided by HMRC enough hedge against future downside risks.
Computer says buy the shares and wing it.
Interestingly, the difference in outcome isn’t all about the Greeks. Bear in mind that the time horizon for this exercise is less than a year, even I might concede that 10% is probably a better reflection of the Eurozone implosion risk over the next year than 30%. However, simply changing that in the top model doesn’t change the solution. It is only by being more optimistic all round, about both the Greeks and the Firm that the Ermevator’s path becomes favoured, ie hold the shares without shorting. So I need to reflect more on where I think The Firm’s SP is going to go, as well as collect more data on how much IG will charge to hedge this over about 9 months. I also need to refine my thinking inasmuch as it probably only makes sense to short the £1020 that I forego by taking ESIP, rather than the £1500 total stake. Which reduces my shorting costs by 30% and uncovers the value of 30% of the dividends.
All in all a surprising result from Model Thinking, which has taught me quite a lot about my worldview and its ramifications, and that this decision which looked fairly simple has more wrinkles than meets the eye. Whether it is worth so much mentation over £1500 worth of shares is a different matter, but it’s nice to actually apply something you’ve leanred at ‘vitual university’ to a real-world problem within a week of learning it. Charlie Munger was right, the old dog, and a hat tip to Charlie, Scott Page/UoM and Monevator for helping me think smarter
Middle Class Finances – Death by A Thousand Cuts
Another one in the complainypants section, but this one’s a more subtle object lesson in how not to lead a middle-class life. Perhaps the Ermine’s heart is softening as he gets older, or there’s a little bit of the there but for the grace of God since I screwed up with the toxic UK housing market too, though I don’t have 4 children
Let’s hear it for the Daily Mail’s Shona Sibary, who sold her house and considers herself now in the rent trap.
Shona and family, before they got into the rent trap
Now I was able to see her fundamental problem, just from looking at the picture. In Britain today, a middle class family with both parents working will find it hard to raise four children. We normally associate big families with the undeserving poor because of the headlines, but thankfully they are not the only section of society that has large families, otherwise we would long ago have succumbed to the premise of the movie Idiocracy. The unsung other sector of society that often has larger than normal families seem to be those with a bob or two. Like David and Samantha Cameron, who ain’t short of a bean, or even IDS and Nick Clegg. Other wealthy families include Victoria & David Beckham (4) and Boris Johnson (4)
I first noticed this with older colleagues at work. The Firm was a prestigious operation in the 1970s and 1980s, and pay was probably upper middle class (in the eighth or ninth decile of the IFS income scales). There is a surprising prevalence of three-child families there, which I had found particularly surprising when I joined nearly a quarter of a century ago.
It’s not surprising that nowadays it is the poor and the wealthy that can go beyond the one and two-child norm. The former get us all to pay for it, and the latter are presumably rich enough to pay for it themselves. Anyway, ’nuff about families. How did Shona screw up?
Shona’s financial red cards
By failing to watch her back. Shona had a couple of big red cards, I suspect that family was living way beyond its means for a long time.
Red flag #1 – they were remortgaging, not building equity in their home.
Look at how an old-skool repayment mortgage builds up equity in the house, by repaying some of the capital.
how a traditional mortgage builds equity
I pinched this from the excellent Mortgages Exposed website, which unfortunately uses infernal frames so I can’t link to the source itself, it’s under Capital Repayment in part 1. Now there are other ways of doing it. My original endowment mortgage was interest only, so in parallel with the mortgage there was an investment that should have been slowly rising to match the original loan. Either way, you should be building up equity, even if it takes the form of a separate asset.
Now the modern way to look at a mortgage is to take out an interest only loan, sit on your butt and whistle a dancing tune while the value of your house goes up. Voila, free money, you get equity without having to lift a finger. The catch is, of course, that the value of the house has to go up
Shona asserts that
After two decades of slogging to buy a house, maintain it and give our children security for the future
an ermine's inflation-adjusted income and mortgage stupidity
You see that by 1996 I had at least reduced the total, by about a fifth in real terms (this graph is inflation adjusted to a nominal salary of 10k in 1984). That underestimates my repayment as it doesn’t show the value of my endowment.
So what did you do Shona? You remortgaged. Taking that equity out, and spending it. Doing that once is a bad sign – nothing wrong with remortgaging per se, but spending the proceeds is bad. Doing it another two times is more than careless, it’s positively greedy.It’s a big red sign in your finances that says “Wrong Way, Do Not Enter, Turn Back NOW”.
Your house is a place to live, it is not an ATM. Over the 25 year span of a mortgage, you will probably see at least two housing booms and busts. I bought in a boom, ate a 10-year bust, and discharged my mortgage in the next boom, that has now turned to a bust (my mortgage would have finished in February 2014 had I not discharged it early)
It is the foreknowledge of that next bust that should make you say “I will not take the money I gain from remortgaging and use it for anything other than buying an investment which will go towards buying this house”. For most people that investment is reducing the total amount of the next mortgage, which is tantamount to saying “never withdraw equity from your house, unless you are trading down”. There are some people who can do better than that. They are few and far between. Otherwise that bust is just round the corner, waiting to bite you.
Red Flag # 2 – your house is not your biggest cost!
This is awesome. If you really are middle class, and buying your house, then that house is nearly always your biggest cost. If it isn’t, you are either not middle class, you are rich/wealthy. Or you are in deep, deep, trouble. Nowadays it’s pretty marginal for the ‘middle class’ to be able to afford the typical ‘middle class’ three or four bed detached family home in the ‘burbs. If your house isn’t your biggest cost and you’re not rich, you’re skint.
Let’s take a look at what Shona spent the money on.
In our defence, we weren’t spending the money on expensive designer clothes, luxurious holidays or flash cars.
So glad to hear it. So what exactly was it that you overspent on then?
Much of it was going on school fees and upkeep of the house.
If you’re withdrawing equity from your house to keep the damn thing standing then you have got too much house for your income. However, that’s not really your problem. It’s the school fees. According to the ISC the average termly fee at a day school is £3655, about 11 grand p.a. A cursory look at your family photo puts three of those kids in school, ie £33k p.a. Assuming for sibling rivalry you aim to do that for all of them, you are looking at paying 4 * 11000 * (18-11) = £308,000 if you just pay school fees for secondary school 11 to 18 and £572,000 if you pay from 5 to 18.
That’s more than your house was worth at the peak. The house is not your biggest problem. It’s a combination of having too many children and looking down on the sort of education that dragged up scumbags like me. So for all the mawkish whingeing about losing your home, Shona, you have failed to clock the real problem with your finances. ‘Tis the fruit of your loins and the style in which you’d like to keep them. With their own rooms, if you please, nothing else will do for Shona’s little ones Since humans come in two genders and it is apparently not acceptable for brothers and sisters to share a room these days you actually only need three bedrooms if the family is boracic lint, fixed that for ya.
Get real, Shona. You were on a middle class income but living a life not commensurate with your means. It’s hard enough for the middle class these days to buy one house in 25 years. To aim to do that and spend even more than that on the nice things in life on that middle class income is taking the piss. It cannae be done, and you’ve just found that out the hard way. To my eyes you’ve cut the wrong thing, but I respect it’s your call.
Shona shows me I need a financial Distant Early Warning Line
I learned something from Shona. Her family fell foul of slow changes that gradually overwhelmed them. Many things get imperceptibly worse day by day, as global imbalances right themselves but they’re resisted by the structures we have already built. The creeping rise of Digital Taylorism making the professional and technical job a stressful and unrewarding experience is an insidious change, little by little. I didn’t realise that until it became too much and my defences were overwelmed, hence the crash course over the last three years in becoming finacially independent as a counterattack.
In the 1950s the US instigated a distant early warning line to scan the northern skies at the 69th parallel north of the Arctic Circle. It was standing sentinel for the signs of incoming Russian nuclear bombers, and was located in the harsh North to give enough early warning to mount a counter-attack.
I need something analogous to stand watch for slow insidious creeping costs and sound the early warning. I plan to instigate an annual review of financial commitments as a percentage of resources. If I see a non-negotiable cost starting to rise proportionally I will consider that the alarm is sounding and it is time to attend to it. It is always easier to launch a counter-attack before it is upon you overwhelming your defences, and this annual review of commitments will be my distant early warning line against stealthy creeping costs.
Shona’s family could have used something like that. Okay, the alarm would probably have sounded as soon as it was set up, but certainly on the second child’s school fees. It would have been an easier call to make at that stage – do we want a big house, or do we believe in the value of public school education* makes it worth getting the girls to share a room?
While I am working I’ve generally lived sufficiently below my means that I didn’t need that sort of thing. Though I aim to have over 50% income in hand once I stop working, I’ve still got several decades, decades in which I believe living standards in the West will decline in a big way. Though I may be resistant to wages being eroded, I won’t be immune from inflation and its evil twin, rising prices and taxation. A financial DEWline will help me marshal resources ahead of time, and shift them to minimise taxation. Particularly with significant holdings in shares, it’s good to have as much advance warning if changes are needed, to average out the horrendous temporal volatility.
*NB for non UK readers, bizarrely schools that you pay fees for, those that Americans rationally call private schools are called ‘public schools’ in the UK, because we’re strange like that.
I was too poor to live in London, so I moved out. What’s so hard to understand?
The good old Grauniad had a bleeding heart article about the housing benefit cap squeezing the poor out of London.
I was there, once. I was born in London, grew up there, went to school there, and then went to university at Imperial College, in South Kensington (seriously upscale part of London for those who don’t know the city). I rented in sleazy dives in Earl’s Court, and for a while I rented a basement bedsit from a doctor which was behind Harrods, where I’d get my milk. Curiously enough, Harrods’ milk was a halfpennny cheaper than elsewhere in the neighbourhood, but it only lasted a couple of days without a fridge.
Then I looked for work. I worked in Beckenham, and then at the BBC in Television Centre. I shared a house with four other guys, then shared with two others, then settled on a bedsit in Ealing. London is probably even more damned expensive because it is holding the entire capital wealth of Greece embodied in its housing stock at the moment, but it was still dear way back in the 1980s.
It really, honestly, never occurred to me that what should happen is for the taxpayer to subsidise my rent. I looked around me, came to the conclusion that I couldn’t afford to buy a house, even on a reasonably okay wage. It was obvious to me, getting on for nearly a quarter of a century ago, that I would never be able to afford to buy a house or rent somewhere big enough to bring up a family. So guess what I did?
I moved out of London
It’s not hard, is it? 25 years ago it was obvious to me that Central/West London, where I’d have liked to live, somewhere near Bloomsbury, if you please, though Ealing would have done me too, was out of my reach. To be honest the place where my parents lived, 15 miles out and in sarf London, was out of my reach. I needed both a better paying job and cheaper houses. So why the hell are there any ordinary families at all in Westminster, which is a damned expensive part of the city? Not only are they competing with Greek shipowners, Russian plutocrats and general old money, the area is also prime commercial and office space. You don’t find ordinary Americans living in Beverley Hills or Manhattan, or ordinary Germans living in central Berlin.
And above all, why should the rest of us pay for people to live where it’s too dear for them? I wanted to live in London but it was too bloody expensive, so I moved out. Yes, in the end ordinary workers won’t be able to live in travelling distance of London, in which case the people that do live there will just have to stump up through their council tax to raise wages enough or pay for essential services privately. They are presumably rich enough to do that.
Look at some of the rents in the article. £812pw, £525 pw. Crikey, I couldn’t afford to pay that on rent right now, at the peak of my earning career, well, not if I wanted to do much else. Think about it. £812pw is £42,224 p.a. You have to earn £53,000+ to be able to pay that after tax. Why are we subsidising familes to the tune of twice the national average household pretax income to live in Westminster?
The whole benefits thing seems to have got out of hand, with presumptive rights accruing to people to mask organic change from them. It is the job of the parents to look around them and put their families in a place where they can afford the rent. Had they done this before they had lots of children, they wouldn’t have to disrupt their precious children’s education by moving when the taxpayer says enough is enough. If they were rich enough to be able to afford the rent, they wouldn’t have to move.
It’s hard to find any sympathy for people who didn’t look around them and move, but took the easy option. This change happened slowly, over time, and should have been adapted to. As a young man I could just about afford to rent a bedsit, it’s been obvious for years that London is out of the reach of someone on the average UK wage. Benefits are there to help people that suddenly fall on hard times due to a short-term (couple of years) change in circumstances. They are not there to enable people to improve their standard of living at the taxpayer’s expense. If you can’t afford to live in London, then move the hell out like I did!
At least the Graun showed us the logical conclusion of what they want to happen.
Ben Denton, Westminster’s strategic director of housing, regeneration and worklessness, said: “Is it fair for the state to provide subsidy for people to live in places that are the most expensive? Is it correct for the state to support anyone to live wherever they want to live? That’s the philosophical question. If the answer is, anyone can live anywhere, then the state and the taxpayer has to subsidise that.”
and the last word to Westminster Council
The philosophy behind the new cap seems to be “if you can’t afford to live here, don’t expect to live here”. “To live in Westminster is a privilege, not a right, because so many people want to live here,” a Westminster council press officer explains.
Too bloody right. There are lots of things I’d like to do, but can’t afford. What happened to making do, changing your expectations or doing without?
Why the Demise of the Interest-Only Mortgage isn’t a bad thing
So you walk into a shop, and spot that nice new flat-screen TV you want. £500 to you, sir, or you can buy it interest-only for £2 a month. Wouldn’t you smell a rat somewhere? The rat is, of course, the small print that says you’ll have to pay £500 at the end of the interest-only loan.
Now I know that some people, particularly in the United States, buy their cars like this. It is called leasing, and the name gives it away, you never get to own the car. It’s a long term rent. It looks absolutely and stupendously daft to me, but if the image of driving a nearly new car is that important to you, well, ‘you pays your money and you takes your choice‘.
So what the heck makes buying a house on an interest-only mortgage any different? You still never get to own the house. What it the point of that? The interest only mortgage was a clever wheeze to ramp up house prices and for banks to make more money. The beautiful part of this game is that the buyers go all gooey-eyed and think the mortgage company is doing them a favour by lending them more than they can afford. Hey, that Mr Interest Only Bank can lend me £200,000 whereas Mean Old Prudent Bank will only lend me £150,000. Isn’t Mr Interest Only Bank such a nice guy?
Two words. Northern Rock. It didn’t work out well, even for the lenders.
A history lesson
1960 – the Repayment mortgage
When my Dad borrowed his first £500 mortgage, way back in the early 1960s, it was simple. He told them his income, they looked up in a table what they could lend him, and armed with that knowledge he could look for a house. He borrowed the £500, and then paid them the interest plus a proportion of the price of the house, the latter proportion increasing with time.
Repayment mortgages were all that were available, based on the simple premise that you pay your instalments for 25 years and when the last one is paid the house is yours.
1990 – the Endowment Mortgage
Fast forward thirty years, and I get to go to the Abbey National, and bamboozled by the choice of endowment and repayment I foolishly go for an endowment mortgage. This is still on the principle that I pay interest only to the mortgage company, but simultaneously to a life-insurance policy which supposedly grows with time till after 25 years it is worth at least the price of the house. So although I was only servicing the interest on the mortgage, I was in parallel accumulating an asset that matched the cash price of the house, which when paid to the mortgage firm would discharge the debt. And the house would be mine. The mortgage company took a charge over the endowment, so I couldn’t sneakily stop paying it without them knowing.
2005 – The Interest Only Mortgage (Don’t Bother with the Capital, it’ll work out somehow)
Like an endowment, but endowments got a bad name, for not paying enough to match the price of the house. So just do away with the need for an endowment! How does that work? Well, you get to the end of your 25 year term, and you still owe for the house! Okay, so inflation hasd probably halved the real value of the debt, which is all to the good, but you still don’t owe your damn house at the end. It is a leasing arrangement. Why not just rent instead?
The assumption is that rampant house price inflation means that your house is worth so much at the end that the increase covers the total. But you still can’t sell off the chimney or your third bedroom to discharge the debt, and you are likely to be coming up for retirement. I wouldn’t want to have to stick my hand in my back pocket to come up with what I paid for my house over a decade years ago, though as it is I could just about do it.
increasing complexity, decreasing security and honesty
There’s a lot of bleating about interest only mortgages, because about a third of firt-time buyers bought their houses on an interest only basis.
Shockingly, I heard a father talking on Money Box about how it was so rotten that his son couldn’t find an interest only mortgage to buy his first house. David from Sussex said (13:45 on the iPlayer)
a bit surprised and disappointed to hear they’re only looking to offer capital repayment mortgages, and with my son’s circumstances, which I’m sure is the same for a lot of other first time buyers, the intention is not to stay in the property for that long
So how does that work, then, David? Are you saying your son doesn’t need the house after a while, can sell up, pay back the capital from the proceeds and stick a tent on the pavement? Or do you want him to be able to overpay for this house, so he doesnt’ spend the excess on booze and fast cars? Why exactly is it that you want him to borrow more money for a house he can’t afford the buy, only to lease? Do you realise, David, that your son is in an auction for houses, and if mortgage companies don’t let people borrow so much money then the auction price will fall?
It’s too late to save the people that did overpay for houses by going interest-only to the max, but we can at least not propagate the mistake. If you are going to buy a house, then buy the damn thing, don’t lease it for 25 years and then wonder why it isn’t yours…
Overall, look at the changing mortgage proposition over the years. My Dad was offered an honest and straightforward service. Pay this much for the next 25 years, and you will own your house.
I was offered a less honest service but at least one that in theory would end up with me owning the house. It didn’t work out that way because the complexity of a with-profits endowment hid untestable assumptions and I was stupid enough to buy a product that didn’t match my circumstances. In all fairness to my parents, they told me a repayment would be better for me, they told me why, and educated me well enough to be able to see why, but I was a damn fool and had eyes only for the potential gain, without the wisdom to look for the potential loss. That’s what being 28 did for me, I knew everything and nothing, so greed trumped wisdom.
Unlike my parents, David is failing his son in giving him only half the story. If he actually told his son, “look, you are taking a very serious risk here by going interest only, but you are in a profession where your pay will increase dramatically and as long as you start saving for the capital from then on you may consider this a calculated risk” then that would make all the difference.His son would still be taking a risk and would probably be just as cocky as I was, but at least David would have discharged his duty as a parent
He sort of alludes to the early years being hard, but wage profiles may be flatter nowadays and young people start out with more debt, so the assumption that money will be easier after five years probably doesn’t hold. David needs either to underwrite his son’s migration from interest-only to capital repayment with the Bank of Mum and Dad, or not encourage his son to overpay. Because it’s simple to summarise the issue
if you can only afford to pay an interest-only mortgage on your house, then you can’t afford to buy that house.
Although I think the demise of the interest-only mortgage has been exaggerated, its death would be no bad thing at all.