Investment Strategy Statement – Part 4 – Accounts, Funds, Taxes & Rebalancing

Wrapping up my ISS with the mechanical stuff.
Taxes

Exploit tax-free allowances where possible

MrsShrink and I are both UK resident fully compliant UK taxpayers. 2018/19 I have been on the cusp of higher rate tax, and will need to review once I get my year end P60 for the three (actually sort of four) jobs I’ve been on PAYE (1). From 2019/20 onward it looks like I’ll be in the higher rate 40% bracket.

I plan to exploit four tax-sheltering methods:

1. Interest from cash savings and emergency funds will stay within my Personal Savings Allowance

This latest weapon in the public’s tax armory allows for £1,000 tax-free savings for basic rate tax payers and £500 for higher rate (2, 3). Interest from our high interest current accounts holding our cash emergency fund will aim to be held within this limit.

2. Filling up ISA allowances

Once our emergency fund is topped off we will contribute to ISAs (4, 5). In the short term all my stock market purchases will fit within the £20k/year wrapper (6). MrsShrink is likely to use Cash ISAs (7). We will utilise the Marriage Allowance if such circumstances arise (8).

We are considering using LISAs as well, but their benefit appears limited to the government bonus (9). We’re not first time buyers, so such an account would be for the long-haul and intended to supplement our income post-60. They’re a complex product and I’m not sure I’m happy with the lack of flexibility, so this will be another area to think about in the future (10).

tax efficiency

3. Pensions Contributions

I will maximise my tax relief on my pension contributions. I’m in the enviable position of having pensions held in two of the most generous funds left in the country; the NHS Pension Scheme and the Universities Superannuation Scheme. Both are sort of defined benefit schemes. The NHS Pension Scheme functions as a career average revalued earnings (CARE) scheme (11). The USS is a hybrid defined benefit and contribution scheme, where DB is paid on salaries up to £57,216.50 and DC over that figure (12, 13). I will detail both schemes in separate future posts. I shouldn’t really have both (this has happened due to some HR oddness) and so I need to sit down and unpick. The complexities of my professional life mean that I am likely to be bouncing between services for the foreseeable future, so this will remain a headache.

The secondary headache in this is that both pensions may be hard up against the lifetime allowance cap (14, 15). As a defined benefit scheme my NHS pension is multiplied by 20 and added to any lump sum to give a capital value (16). Many of my senior colleagues have been hit with substantial (five-figure) unexpected tax bills since the reduction in the lifetime allowance. It’s therefore not clear to me yet if making further contributions will be tax effective, or which pension scheme will be the most advantageous for a potential early retirement (17, 18, 19, 20). A matter for future reading.

4. Other investment structures

Longer term areas of interest:

  • Venture Capital Trusts
  • Enterprise Investment Schemes
  • Seed Enterprise Investment Schemes (21, 22)
  • Premium Bonds (I dared to speak thy name!) (23, 24)
  • Property (25, 26, 27, 28)

Accounts and Funds

Split holdings across multiple providers and platforms to reduce risk

We will use the bank account savings website (or similar if superseded) to maximise returns on liquid cash holdings (29). This will be split across multiple accounts to remain within the FCSC £85,000 limit (30). Tax-free accounts will be the preferred method for holding passive equities, bonds and stock.

Assets will be allocated across investment accounts to reduce costs, provide further security and reduce platform risk (31, 32). Initially I will aim to keep investments within the £50,000 FCSC protection limit (33). As stated in my ISS part 3, I intend to allocate ETFs across fund holders to meet allocation targets. No provider will hold more than 25% of my holdings after year five (to give me time to actually build the damn thing up!).
Rebalancing

Rebalance quarterly using Swedroe’s 5/25 through purchases

A basic tenant of my investment plan is to sell rarely, if ever. My stock purchases are for the long haul. Therefore I aim to check and buy back to allocation each quarter through purchases (34, 35). Boundaries for this are set using Larry Swedroe’s 5/25 rule; 5% absolute or 25% relative percentage variance (36). If this implicates selling I will wait until year end to optimise Capital Gains Tax. Allocations will be balanced annually against global markets plus my own weighting. On the active naughty step portfolio investments are free to do their own thing but will be re-evaluated against the overall portfolio yearly at the 10% stocks, 10% active target.

I’ll revisit this and update periodically, but for now that about wraps it up.

Take care,

The Shrink

References:

  1. https://www.gov.uk/income-tax-rates
  2. https://www.gov.uk/apply-tax-free-interest-on-savings
  3. https://www.moneysavingexpert.com/savings/personal-savings-allowance/
  4. https://www.gov.uk/individual-savings-accounts
  5. https://www.moneyadviceservice.org.uk/en/articles/isas-and-other-tax-efficient-ways-to-save-or-invest
  6. https://www.fool.co.uk/investing-basics/isas-and-investment-funds/stocks-and-shares-isas/
  7. https://www.fool.co.uk/investing-basics/isas-and-investment-funds/isa-basics/
  8. https://www.gov.uk/marriage-allowance
  9. https://www.fool.co.uk/investing-basics/isas-and-investment-funds/lifetime-isas/
  10. https://youngfiguy.com/why-the-lifetime-isa-is-not-a-simple-to-understand-product/
  11. https://www.moneywise.co.uk/managing-your-pension/pensions/the-lowdown-nhs-pensions
  12. https://www.imperial.ac.uk/human-resources/working-at-imperial/pension-schemes/uss—universities-superannuation-scheme/changes/pension-schemes-explained/
  13. https://www.uss.co.uk/members/members-home/the-uss-scheme
  14. https://www.gov.uk/tax-on-your-private-pension/lifetime-allowance
  15. https://www.pensionsadvisoryservice.org.uk/about-pensions/saving-into-a-pension/pensions-and-tax/the-lifetime-allowance
  16. https://www.bma.org.uk/advice/employment/pensions/lifetime-allowance
  17. http://www.legalandmedical.co.uk/3-reasons-to-have-a-pension-pot-that-is-over-the-allowed-limit/
  18. https://chasedeveremedical.co.uk/2018/02/22/beware-the-lifetime-allowance-charge/
  19. https://www.telegraph.co.uk/money/special-reports/should-i-retire-at-55-because-of-my-125m-nhs-pension/
  20. https://www.uss.co.uk/members/members-home/retirement-articles/2018/the-easy-way-to-keep-track-of-your-annual-and-lifetime-allowances
  21. https://www.moneyobserver.com/how-to-invest/how-to-invest-tax-efficiently-beginners-guide
  22. https://www.fool.co.uk/investing-basics/how-shares-are-taxed-2/tax-efficient-investing/
  23. https://www.moneysavingexpert.com/savings/premium-bonds/
  24. https://www.nsandi.com/premium-bonds
  25. https://www.moneyadviceservice.org.uk/en/articles/tax-and-property-investment
  26. https://www.out-law.com/topics/tax/property-tax-/tax-treatment-of-reits/
  27. https://www.investorschronicle.co.uk/tax/2017/08/31/how-farmland-is-taxed/
  28. https://www.whatinvestment.co.uk/how-to-invest-in-forestry-2134293/
  29. https://www.bankaccountsavings.co.uk/calculator
  30. https://www.fscs.org.uk/what-we-cover/
  31. https://www.bogleheads.org/wiki/Asset_allocation_in_multiple_accounts
  32. https://www.thisismoney.co.uk/money/experts/article-2553851/How-I-know-DIY-investing-platform-safe.html
  33. https://www.fscs.org.uk/what-we-cover/investments/
  34. https://www.investopedia.com/articles/stocks/11/rebalancing-strategies.asp
  35. https://www.bogleheads.org/wiki/Rebalancing
  36. https://awealthofcommonsense.com/2014/03/larry-swedroe-525-rebalancing-rule/
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Investment Strategy Statement – Part 3 – Allocation

So here’s the guts of my ISS, which may or may not ruffle feathers.

Asset Allocation

My timescale is long, my employment is (in theory) secure and my pension scheme is (supposedly) generous. All money going into my portfolio is that which I can afford to lose. My current lifestyle, while not extravagant, is comfortable and by limiting lifestyle inflation I hope to increasingly channel spare cash into investments. I’m happy to take a reasonable amount of risk in my portfolio on this basis.

In choosing my asset allocation split I’ve tried to read widely, including the usual Smarter Investing 3rd edn – Tim Hale, Monevator etc (1, 2, 3). There’s an argument that given my timeline is 15+ years I could go wholly into equities, however I’m going to try and include my whole net worth in the picture.

Allocation will initially be set at 70% equities, 15% cash, 10% alternative or exotic assets, 5% property (4, 5, 6). Equities are split between a core 80% passive tracker portfolio and a testbed active portfolio (10% active funds, 10% stocks) aimed for growth. Allocations will be reviewed and re-balanced quarterly. Re-balancing will be covered in Part 4. Cash holdings will target high interest and liquidity, through usage of high interest current and savings accounts with FSCS cover. Alternative and exotic assets will be covered separately. Property is currently equity in our own home, but will encompass owned property plus REITs.

Fund/Brokerage Allocation

I intend to allocate across ETF/ fund providers. Rules here are loose, but the intention is that no provider will hold more than 25% of my holdings. To minimise risk I’ll also allocate across brokers, with the intention of simultaneously reducing TER and minimising tax burden (7).

World Allocation

It would be very simple to put all my money in a LifeStrategy 100 and be done with it, but I’m a contrarian at heart. As fits a diversified passive-focus portfolio the central core of my global equity allocation will mirror world markets, using all world tracker funds and ETFs (8). Beyond this statement and with caveats for other sections of my portfolio I diverge from the norm.

Testbed Active Portfolio

This section of my portfolio is largely UK-based, and a mixture of 10% stocks and 10% active funds I find interesting. Themes here are disruptive companies, and early investing and venture capital, counterbalanced with commodities. I will explain more about this in a separate post.

Core Passive Portfolio

My global allocation aligns to two main beliefs:

  1. Broadly match global market capitalisation (so far so normal)
  2. Global market capitalisation reflects top-heavy population demographics (… que?)

I understand the broad investment logic behind investing in your own country, and holding trackers to your domestic market. The protection against inflation a home market affords (9, 10). I too feel the deep rooted psychological reasons for supporting UK industry.

But much of my active testbed, cash, property and other assets are in the UK. I’m already 40-50% UK inflation vulnerable/protected before even looking at passive equities. I’m therefore ex-UK in my passive section. The sensible answer would be an Ex-UK All-World Tracker. But then how do you slice your pie? Contribution to Gross World Product? Global market capitalisation? If global cap whose data do you use?

My figures are a blend of the above taken from a seeking alpha blogpost, the PWC yearly report plus the Credit Suisse Yearbook (11, 12, 13, 14). Factoring in ex-UK active investments with the passive core I aim to hold:

  • 40% US
  • 35% Emerging Markets
  • 15% Developed Ex-US/ Ex-Euro
  • 10% Euro

Standard All-World trackers hold heavily in the US, which I consider to be over-valued for a number of reasons I won’t go into here. China ranks second in PWC and third in Bloomberg Global Market Caps, with India closing the gap (11, 12) . I aim to capture these as part of a quite aggressive 35% emerging market weighting (15, 16). Emerging markets appeal for a number of reasons, but one I really favour is young demographics. This is also the reasoning behind my 15% targeting Developed Ex-US and Ex-Euro markets. Here, like Firevlondon, I’m looking at English-language Commonwealth nations with expat potential, favouring Australia and Canada (17). These markets also have a sector mix which balances the tech and service heavy US/ Eurozone.

In summary

Despite all my waffling, it’s probably a fairly stock allocation profile. 40-odd percent in the UK, 20-30% in the US, with the rest scattered about the developed and emerging markets. I’ll review this yearly with new world data to see what changes need to be made.

In Part 4 – Funds, Accounts and Rebalancing.

References:

  1. https://amzn.to/2Sthjtv
  2. https://monevator.com/asset-allocation-construct/
  3. https://www.bogleheads.org/wiki/Asset_allocation
  4. https://monevator.com/asset-classes/
  5. https://youngfiguy.com/how-i-invest-my-money/
  6. https://en.wikipedia.org/wiki/Alternative_investment
  7. https://www.bogleheads.org/wiki/Asset_allocation_in_multiple_accounts
  8. https://monevator.com/investing-for-beginners-the-global-stock-market/
  9. https://www.investopedia.com/articles/basics/10/protect-yourself-from-inflation.asp
  10. https://youngfiguy.com/how-i-invest-my-money/
  11. https://seekingalpha.com/article/4202768-u-s-percent-world-stock-market-cap-tops-40-percent
  12. https://www.pwc.com/gx/en/audit-services/assets/pdf/global-top-100-companies-2017-final.pdf
  13. https://monevator.com/world-stock-markets-data/
  14. https://indeedably.com/home-market-bias/
  15. https://monevator.com/emerging-markets-index-fund/
  16. https://www.investopedia.com/terms/e/emergingmarketeconomy.asp
  17. https://firevlondon.com/2015/06/17/my-ips-2-of-5-asset-allocation/

Investment Strategy Statement – Part 2 – Goals

When I first started writing this blog I set out a very brief goal:

Financial independence for myself and MrsFireShrink.

But beyond that, the aim is to save a sufficient amount to create a self-sustaining portfolio. The dream goal being to create a portfolio sufficient to support my family in the future and continue to grow (1).

Which is all a bit wishy-washy. Over the course of the year I’ve realised that I need to firm up my yearly goals, and also articulate more clearly my long term dream. This was put into sharp focus by a few recent blog posts, including indeedably’s goals, strategy and tactics (2). Elsewhere in life I’m fairly SMART in my goals, with monthly and yearly targets.

“Sound tactics bring victory” – Shaxx

So here’s the current goals list with steps already taken and timescale for target/ dream (a-la indeedably) (3). (Last updated Jan 2019).

  • Complete medical degree. Achieve Royal College Membership.
  • Find a girl. Get married. Have kids (2028). Have good kids.
  • Publish a paper (2018). Get a fellowship (2019). Get another fellowship. Get a Phd. Get a lectureship. 
  • Get a job. Get a job I enjoy. Get a job which doesn’t feel like work (2020). Be in a position to retire in 15 years (2033).
  • Have an emergency fund of three months income (2019). Save £1000/month (2020). Have a net worth of £100k.
  • Own a home. Have £100k in equity (2023). Own our dream home in 10 years (2028). Own a self-sustaining estate.
  • Learn to drive. Own a car. Own a six-cylinder car. Own an eight-cylinder car (2028).
  • Race in a motorsport. Win a race (no timescale).
  • Start a martial art. Start gradeing. Get to sho dan (no timescale).
  • Learn to ride a motor bike.
  • Learn to fly a plane.
  • Do 50 press-ups. Do a pull-up (again) (2019). Get back to 15 stone (2019). Do a hand-stand press-up (again). Do a ring muscle-up.

The numbers

Most of the maths in this section is rough and dirty. I’m not going to make complex predictions or models. Life itself is too unpredictable (even if the money isn’t), and some recent health concerns have demonstrated the fallacy of trying to predict the future. I’ll review my household expenses more formally in a couple of years, and may come back and model timescales then.

  • Be in a position to retire in 15 years (2033).

A review of the 10 months I’ve tracked so far shows my personal yearly expenditure (minus credit card payments and one-offs for this year) to be around £10k. To this I’ll add £2.5k to cover lifestyle inflation. Our joint account also goes through around £10k a year in running costs for the house, groceries, energy etc. I conservatively therefore need around £22.5k a year to maintain our current lifestyle if I didn’t work. This fits nicely with what the fun Standard Life calculator reckons for our current lifestyle (~£23,000) (4).

Plugging that into a simple interest calculator suggests I need to have around £650,000 saved to be able to withdraw £22,752/year at a reasonable 3.5% interest rate with no erosion of capital. This presumes the savings will be tax-sheltered. This seems pretty unachievable from a standing start, but I love a moonshot (5). I’ve selected 3.5% as a conservative blend of cash interest rates (currently 1.5%) and the average annual return of the FTSE All-Share over the last 100 years (+7.0%) (6). It’s also conveniently the mythical Perpetual Withdrawal Rate (7, 8).

You say: “Why are you not interested in drawdown? You’d get to retirement a lot quicker.”

This seems to be a fundamental schism in the investing/ FI community. I think it’s highly personal, and relates among other things to your optimism for your life expectancy, number of dependents and general approach to lifestyle. The figure above would replace my current salary (9). I have a pipe dream goal relating to my families history and future inheritance, and therefore I’ve no interest in drawdown.

  • Have an emergency fund of three months income (2019). Save £1000/month (2020). Have a net worth of £100k.

These are all stepping stones on the route to the previous bullet point. Plugging that £650,000 into Money Advice Service’s savings calculator suggests I need to be saving £2300/month at 6% interest to achieve retirement by 2033 (10, 11). Yikes. 110% of my current take home. Thankfully my income should ramp up in the next few years, and while I’m quite a way from £2300/month now, it’s probable that I will reach that in the next 10 years. Just in time to miss my target.

  • Have £100k in equity (2023). Own our dream home in 10 years (2028). Own a self-sustaining estate.

Currently our dream homes cost around £500k. Difficult to say what that will be in 10 years time. Historically the yearly trend has been c2.9% (12). More recently it’s closer to 2%, comparable to the OECD 2.0% long-range inflation forecasts (13, 14). Inflating the £500k at 2% brings us to £610k in 2028. Our feet are on the ladder, which mean we also benefit from that inflation to an extent.

We envisage another move in 5 years time, and I’m not averse to value-adding property renovation. I’m therefore aiming for some stepping stones to a solid deposit for the move to a dream home in 10 years.

Summary:

  • Have an emergency fund of three months income (2019)
  • Save £1000/month (2020)
  • Be worth £100k (2022)
  • Have £100k in equity (2023)
  • Be in a position to retire in 15 years (2033)

In the next post I’ll cover my asset allocation.

Take care,

The Shrink

References:

  1. https://thefireshrink.wordpress.com/about-me/
  2. https://indeedably.com/goals-strategy-and-tactics/
  3. https://indeedably.com/i-will/
  4. https://www.standardlife.co.uk/c1/guides-and-calculators/retirement-how-much-may-i-need.page
  5. https://singularityhub.com/2016/11/15/this-is-how-to-invent-radical-solutions-to-huge-problems/#sm.000003z7yn60ncsavol2a9f74o5he
  6. http://stockmarketalmanac.co.uk/2016/12/100-years-of-the-ftse-all-share-index-since-1917/
  7. https://youngfiguy.com/safe-withdrawal-rate/
  8. https://portfoliocharts.com/2016/12/09/perpetual-withdrawal-rates-are-the-runway-to-a-long-retirement/
  9. http://monevator.com/try-saving-enough-to-replace-your-salary/
  10. https://www.moneyadviceservice.org.uk/en/tools/savings-calculator/
  11. http://candidmoney.com/calculators/investment-target-calculator
  12. http://monevator.com/historical-uk-house-prices/
  13. https://www.bbc.co.uk/news/business-44736472
  14. https://knoema.com/rwbagv/uk-inflation-forecast-2018-2020-and-up-to-2060-data-and-charts

 

Investment Strategy Statement – Part 1- Investment Philosophy

Inspired by Firevlondon, Weenie et al and as advised in Smarter Investing, over the course of a few posts I’ll aim to set out my Investment Strategy (1, 2, 3). To an extent I am concerned about the face validity of such a series, as my current investment experience runs to a Fidelity fund up to 2007 and cash savings. I aim to have a strategy in place for commencement of my portfolio, rather than changing my portfolio to fit a later strategy; “if you don’t know where you are going, you’ll end up someplace else”. As recommended by the textbooks and others I’ll be starting with my investment philosophy, and the rest of my statement will be set out in line with that suggested on Bogleheads (4).

Core philosophy:

“Buy-and-hold, long-term, all-market-index strategies, implemented at rock-bottom cost, are the surest of all routes to the accumulation of wealth” – John C. Bogle

Tenet 1: Diversification

Diversification, as wide as possible, as advised by Modern portfolio theory etc (5, 6, 7). Holdings will be diversified across global markets, ultimately in multiple accounts held with multiple companies. Property, cash accounts and tangible assets (cars, art, books) will further diversify my portfolio.

Tenet 2: Passive-focus

I will accept market returns, and will not change funds based on timing. I won’t rehash the evidence that passive investing is a superior strategy for long term returns (1, 8, 9). I lack the time and luck to ‘beat the market’ with active selection of stocks. In the past I held an active investment which did rather well in the run up to 2008, when I sold pre-crash by sheer blind luck. As my investment timeframe is 20+ years I am not interested in short term gains, so passive will work fine.

N.B. The exception to this rule is where active funds offer access to investments (i.e. unlisted companies) I’m targeting for growth in an experimental corner of my portfolio which I’ll go into in more detail at a later date.

Tenet 3: Reduce costs, taxes and fees

Maximise the % growth by minimising the amount I’m paying out for it. Minimise tax expenses through the use of ISAs and tax-free savings (10, 11).  I’ll use calculators like Monevator’s to select the cheapest platform available for my portfolio mix. (12) I’ll track expenses across all my investment and produce expense ratios.

Tenet 4: Grow and hold

My investment timescale is long, and my ultimate goal is not to use my portfolio for drawdown (discussed in Part 2 – Investment Goals) (13). I continue to earn and am in a (relatively) secure job. Therefore the aim is to accumulate diversified holdings for the long term. Preference for Acc funds and reinvestment. Preference for growth over dividends, for expansion and (in the experimental corner) for disruptive companies. Preference for physical assets, avoiding derivatives, synthetic or other complex financial products; I am beginning to understand these, and while I comprehend the theory I don’t feel comfortable with the additional counterparty risk (14, 15). Physical assets are to be a theme throughout my portfolio.

Tenet 5: Stick to allocation

As fits a diversified passive-focus portfolio my global allocation will mirror world markets, using all world tracker funds and ETFs (16). I’ll review world market data yearly, and set re-balancing targets based on global market cap weightings as the market  moves (16, 17). Since my timescale is long, my employment is (in theory) secure and my pension scheme is (supposedly) generous, I’m happy to take a reasonable amount of risk for my portfolio. Allocation will initially be set at 70% equities, 15% cash, 10% alternative assets, 5% property (18, 19) . Equities are split between a core 80% passive tracker portfolio and a testbed active portfolio (10% active funds, 10% stocks) aimed for growth. Allocations will be reviewed and re-balanced quarterly. Re-balancing will be through purchasing with new income where possible.

In summary:

  • Tenet 1: Diversification across world markets, and through multiple asset classes, held with multiple companies
  • Tenet 2: Predominantly passive focus to portfolio
  • Tenet 3: Reduce fees and maximise tax efficiency through use of ISAs and tax-free savings accounts
  • Tenet 4: Hold and grow investments through re-accumulation and compound investing in simpler financial products
  • Tenet 5: Monitor mix of investments against target allocation quarterly, investing to rebalance

In the next post in this series I cover my goals.

The Shrink

References

  1. Smarter Investing 3rd edn – Tim Hale
  2. https://firevlondon.com/my-investment-policy-statement
  3. http://quietlysaving.co.uk/2017/06/08/investment-strategy-updated/
  4. https://www.bogleheads.org/wiki/Investment_policy_statement
  5. https://seekingalpha.com/article/151352-portfolio-diversification-and-risk-the-basics-of-beta
  6. https://en.wikipedia.org/wiki/Modern_portfolio_theory
  7. https://youngfiguy.com/asset-allocation-and-the-uk-efficient-frontier/
  8. http://monevator.com/category/investing/passive-investing-investing/
  9. http://monevator.com/why-a-total-world-equity-index-tracker-is-the-only-index-fund-you-need/
  10. https://www.gov.uk/apply-tax-free-interest-on-savings
  11. https://youngfiguy.com/pensions-isas-the-basics/
  12. https://www.gov.uk/marriage-allowance
  13. http://monevator.com/commit-to-investing-strategy-for-the-long-term/
  14. http://monevator.com/types-of-investing-risks/
  15. http://www.morningstar.co.uk/uk/news/108970/understanding-the-risks-of-different-etf-structures.aspx/
  16. http://monevator.com/investing-for-beginners-the-global-stock-market/
  17. http://monevator.com/world-stock-markets-data/
  18. https://en.wikipedia.org/wiki/Alternative_investment
  19. https://youngfiguy.com/how-i-invest-my-money/