Property Renovation Lessons I

Gather ye round students.

It’s a peculiarly British fascination that we own our homes. Your home is your castle.

The default setting for those with spare-cash in their middle-years appears to be adding to your castle, working up the property ladder or buy-to-let. Yet it’s a route full of pitfalls, and BTL is fast becoming a mug’s game. MrsShrink and I have been fortuitous in turning a £20k deposit in 2014 into a £52k deposit this year (~38% annual return). We did this by buying a fixer-upper and working our socks off in our spare time. MrsShrink comes from a family of serial renovators, and spent some time learning painting and decorating with a professional family member. I come from building trade stock, and have plied the hod and trowel. I know which end to hold a hammer. So here’s the lessons from along the way that we applied to our second house purchase and renovation.

Location Location Location

  • Buy the worst house on the best street in the best neighbourhood you can afford

Classic Sarah Beeny this one. Waiting for the rough looking house to come up can pay dividends, however there’s plenty of property developers also looking to do this who probably have cash on hand to swoop quickly (1). As an alternative look at what has been on the market a long time, work out why and knock them down for it if it’s overpriced. That unappealing quality avocado bathroom could be £15k off the asking price for a fed-up seller. The primary issue here is that due to Sarah Beeny, DIY SOS, The Renovation Game etc every man and his dog thinks they’re a property developer by ripping out a 30 year old fitted kitchen and banging in a Wickes’ budget MDF job (2). Shame that.

  • Check the location using Rightmove’s school checker, look for local shops and public services like bus stops, libraries, parks etc (3).

This again is partly straightforward. Even if you don’t have kids being in a good school catchment improves resale, although worth bearing in mind that schools can turn around quickly. Less thought about are bus stops; schoolkids yelling outside your house can pretty quickly turn a night shift worker potty. Likewise parks and outdoor sports areas.

  • Check the local streets on your councils planning portal and local area development plan

Is your neighbour about to be converted to an HMO? Is that spot of derelict land at the end of the road turning into a block of flats with no parking allocated. This is exactly what is happening a few streets over from us, and the next-door owner is currently selling up as their current uninterrupted view over the city is due to be replaced by six stories of students. Those planning applications may be the prompt for the sale. Also check your councils local area development plan (or equivalent). This may suggest (as for our current location) there are planned infrastructure, zoning or conservation changes which could dramatically impact the appeal of an area.

  • Check long term floodrisk maps

Published by the government, this shortcuts going through the purchase process only to find on your surveys that your new dream home floods any time we get fair-middling drizzle. For England see here, Wales here, Scotland here (4, 5, 6).

  • Google Streetview is your friend

Check the roof, neighbours gardens for a sense of upkeep of the local area, evidence of building work and other nearby extensions. Four doors up may have a single storey extension that makes getting your planning permission in five years time that much easier. What’s the rear access like? Does Streetview show the rear lane blocked by idle taxi drivers?

  • Check the street at rush hour and mid-evening.

This is a bit involved, hell some people buy houses without seeing them! However if you go to a house viewing at 2pm on a Saturday the quiet tree-lined street with great school access may be a different picture to the school-run mummy-chariot car park. Likewise mid-afternoon could get very different to mid-evening if your excellent local gastropub has less than polite clientele.

Kerb appeal

It’s not just about from this (1):

to this:

Though that first impression counts. If the house looks down at the heel then a clean and a coat of paint may do wonders. Here’s a short list of what else to look for:

  • Doors and windows – wood/ PVC/ aluminium?

Is the wood rotten? Is the PVC discoloured or warped? Is the aluminium corroded? Are the windows double glazed and if so what state are they in? If there is misting inside the windows, like below, it suggests the double glazing has ‘blown’, and is no longer sealed (7). This will still be warmer than single glazing, but lets less light in and obscures your view! Budget at least £500/window for decent replacements (8). Sash windows and wooden casements will cost more, but sash are more desirable and wood will last a lot longer if maintained. On older properties original sash windows can be retrofitted with double-glazing by specialist companies, and this can work out cheaper than having new units made (9). Finally, check the state of the external locks, as many insurance companies will give you better rates for a BS-standard 5 lever deadlock.

  • External walls – clad/ brickwork/ render/ pebble-dash/ stone/ other?

We’ll start with brickwork as in many ways it’s simplest, and most of it also applies to stone. Older and underburnt bricks can suffer from years of frost damage and degrade, a process called spalling, so check for evidence of failure like below (10). Stone will also erode over time (particularly limestone in acid rain, and sandstone mislaid with a vertical grain) (11)

Check for evidence of degradation of the mortar in joints which will require re-pointing (12).

Look for external cracking. In previous centuries lime mortar was used which allowed a degree of flex in the joints due to it’s softness, but as building has moved to stronger and easier concrete/ cement the joints have become inflexible and unyielding. Cracking can have multiple causes but it usually down to building settlement. A degree of settlement is normal over the course of a properties lifetime, and particularly after periods of heavy rain or prolonged drought when the soil underlying the foundations moves. Small cracks are nothing to worry about, but bigger ones may suggest faults with the foundations which can require costly underpinning work. When next to gable walls it may suggest the wall is pulling away from the rest of the house, requiring insertion of wall ties and structural work. If around windows/doors then it may suggest rotting, movement or inadequacy of the sill. If in doubt get a professional survey.

 (13) (14)

Render can have similar issues with cracking as above, but is utilised to offer a layer of protection to the underlying stonework. This was traditionally used where unfinished structural stonework was rougher/ cosmetically poor, or in exposed areas – coastal etc. Breathable lime-based renders were used on older buildings, and replacement with concrete can cause damp issues. Newer buildings have concrete render, which will usually last about 20 years. Certain areas of the country (in my experience Cornwall particularly) have issues with render staining which requires cleaning (15). Budget a couple of thousand pounds, plus VAT and scaffolding costs for a re-render (16, 17).

Pebbledash and roughcast are essentially a different form of render where pebbles are sprayed on or added into the render. It came to be used during the Arts and Crafts Movement, but is often associated with ’20s and ’30s housing where it was used to cover cheap and quick brickwork (structurally sound but not aesthetically pleasing) (18). It offers a greater degree of weather protection than standard render. Don’t write off a pebbledash home. Removal is time-consuming (read expensive), but painting can make a huge difference (16)

Cladding is it’s whole other separate post. Replacing cladding is a good way to bring an out-of-fashion exterior bang up to date. Cladding may require planning permission under permitted development rules, or further consideration in conservation or national park areas (19).

  • Check for cavity wall injection points

Cavity walls, where there is an air gap between the inner and outer skins of the wall, became mainstream in the 1920s (20). The two skins are tied together either with bricks placed perpendicular across them, stones, or now with metal ties. The original usage was to prevent the passage of moisture into the building from outside. Insulation in the cavity became compulsory in the 1990s. In older houses is became common to use an injection method to insert insulation into the pre-existing cavity, leaving behind tell-tale holes where drilled (21). Cavity wall insulation divides opinion. The added insulation can in principal save a fair amount on heating. I dislike retro-fitted cavity wall insulation due to the potential for air and moisture-bridging, especially across damp courses lower down in the wall. This allows moisture to track across where there was previously an air gap, or through osmosis past the damp proof course. In modern houses the damp proof course sits below the insulation as it is inserted during construction, and with the use of modern backed insulation boarding it is less of an issue. Do your own research.

What lies above?

  • Check the roof

I won’t go into different roof materials, again it would be a whole other post. Stand on the other side of the street and look at as many elevations as you can see. Are there any slipped slates/ tiles? Any missing ridge tiles? These can all be sources of leaks if the roof lacks underlay (22). Most tile roofs can last 50 years if maintained, while slates can last a hundred (23). Budget £5000+ for new roof. This could escalate if the underlying joists and rafters are warped, damaged or rotten, indicated by a sagging area of roof. If the whole roof appears bowed under weight then it may be less of a worry; this is usually the result of replacement tiles being heavier than the originals, gradual settlement over time, or the effect of weight following a period of heavy snow (24).

Damaged or degraded flashing is a common cause of a leaky roof. I would bring binoculars to look at the roof when I was viewing a house. Lead is generally used and is very durable, but can fatigue or come loose. More rarely zinc, copper, aluminium or galvanised steel has been used. Budget £1000-1500 as a minimum for remedial work including labour, materials and scaffold (25, 26).

Chimneys… where to even start? Apply all of the brickwork damage section here, particularly spalling. The heat expansion and freeze/thaw effects combine to result in rapid degradation. Check for mortar breakdown around flashing at the base, a common source of ‘falling damp’ which is water leaking down the chimney breast. Check for vertical cracks in the chimney, vegetation, nesting animals, degraded cement caps and loose chimney pots or cowls. All can cause problems (27, 28). We’re currently trying to have our chimney repaired as preventative maintenance, with quotes between £1500-2500. Getting the agreement of our neighbour as it is a party wall has proved troublesome (rented property). We can’t go ahead until we have their agreement, but hopefully they’ll go half.

  • Check the gutters, soffits and fascias

Again a multitude of materials and a cause for ‘falling damp’. Traditionally gutters were cast iron and painted. These with maintenance can last many, many years. For a short period there were asbestos and fibre gutters, before moving over to PVC or plastic forms. These don’t last as long but don’t need the maintenance (and are cheaper).

Firstly, check for vegetation or any signs of blockages in the gutters themselves. This causes rainwater to overflow (a cause of damp), but is easily remedied with a ladder (or if you really fancy get a bloke with a pressure washer). Then check downpipes and ground-level drains (gullys). Are they securely attached and are they all connected. Again a common cause of internal damp is a leaking external downpipe (29). I hired an aluminium scaffold tower for a week for £120 this summer and had a great old time digging years of rotting vegetation and a few carcasses out of our blocked gutters, before rodding out the downpipe and running new ground-level pipes. I also took the opportunity to repaint our soffits and fascias. Cheap fixes and maintenance preventing future problems.

Your guttering will be attached to the fascia, with the soffit covering the underhang (30). These used to be made of wood, which would need to be periodically painted. In more recent years they’ve been replaced with PVC. Sometimes this covers and is fixed to a wood board, or is fixed to the older fascia or soffit. Watch out for where people have covered a rotting old fascia with PVC to hide it, as it will continue to rot and the guttering will fall out.

The hidden costs

  • Check utilities services

What do I mean by this? Check where the stopcock and meter are externally if it’s obvious. Check where phonelines enter the building. Both can be a pain to track down. More importantly – check the drains! Where does the external surface water drain to? Are there obvious access hatches to inspection chambers? Learn from my error, when I spent a wintry December week breaking up our concrete yard and digging down two feet to expose a broken salt-glaze pipe containing 12 foot of backed-up liquid faeces. If you’re planning to rework a property then knowing where the utilities is essential for plumbing planning.

  • Check the garden for Japanese Knotweed & other pests.

Look for the plant below, Japanese Knotweed. The effect on the value of the property is massive. It’s an invasive non-native species which is classed as hazardous waste, and any land containing it is counted as contaminated. It’s difficult to get rid of, spreads like wildfire and grows up to 10cm a day (28). A survey by YouGov and Environet UK estimates that 5% of UK homes have Japanese Knotweed (31). Finding Japanese Knotweed will knock 10% off that value of the property (31, 32, 33). Also take the opportunity to spot for evidence of wasps nests, bats, rats or mice.

Finalement

So that’s outdoors briefly covered. In part two I’ll cover indoors, reflecting on what to look for in your first and second viewings when considering a house, and the mistakes we did and didn’t make.

The Shrink

 

References:

  1. https://www.telegraph.co.uk/property/buy/should-buy-worst-house-best-street-turn-ugly-duckling-swan/
  2. https://www.dailymail.co.uk/news/article-3114485/Want-make-money-property-Buy-house-avocado-bathroom-Artex-ceilings-quadruple-investment.html
  3. https://www.rightmove.co.uk/schools.html
  4. https://flood-map-for-planning.service.gov.uk/
  5. https://naturalresources.wales/evidence-and-data/maps/long-term-flood-risk/?lang=en
  6. https://www.sepa.org.uk/environment/water/flooding
  7. https://www.eygwindows.co.uk/lifestyle-blog/why-does-double-glazing-mist-up
  8. https://www.theecoexperts.co.uk/double-glazing-costs
  9. https://www.renovategreen.co.uk/building-fabric/retrofitting-double-glazing-into-old-windows/
  10. https://www.designingbuildings.co.uk/wiki/Defects_in_brickwork
  11. https://www.heritage-house.org/damp-and-condensation/types-of-damp-what-have-i-got/damp-problems-caused-by-cement-pointing-of-brick-or-stone.html
  12. http://www.loughboroughproperty.com/repointing/
  13. https://www.diydoctor.org.uk/projects/settlement.htm
  14. https://gharpedia.com/diagonal-cracks-brick-walls/
  15. http://www.colinsquire.co.uk/red-stained-walls/
  16. https://www.homebuilding.co.uk/render-faqs/
  17. https://www.thegreenage.co.uk/cost-of-external-render/
  18. https://en.wikipedia.org/wiki/Roughcast
  19. https://www.homebuilding.co.uk/cladding-new-facades-for-ugly-homes
  20. https://en.wikipedia.org/wiki/Cavity_wall
  21. https://www.fixmyroof.co.uk/videos-and-guides/pitched-roof/repair-a-slate-roof/
  22. https://www.roof-stores.co.uk/guides/tiles-and-slates/roofing-tiles-slates-lifespan/
  23. https://www.designingbuildings.co.uk/wiki/Flashing_in_building_construction
  24. https://www.homebuilding.co.uk/roof-repairs/
  25. http://essexroofingandfascias.co.uk/portfolio-items/damaged-chimney/
  26. https://www.karnakcorp.com/roof-conditions/damaged-flashing/
  27. https://www.homebuilding.co.uk/repairing-gutters/
  28. https://www.jjroofingsupplies.co.uk/blog/what-are-soffits-and-fascias/
  29. http://surveyingproperty.blogspot.com/2018/#.XAATl9v7SM8
  30. https://www.independent.co.uk/news/business/news/japanese-knotweed-house-prices-property-value-mortgage-insurance-how-to-treat-a8557971.html
  31. https://www.telegraph.co.uk/property/uk/property-buyers-sue-50000-japanese-knotweed-problem-homeowners/
  32. https://www.moneywise.co.uk/news/2018-09-28/japanese-knotweed-blight-has-slashed-uk-house-prices-20bn

 

 

 

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Musing On… Motivation: Are you running from or running to?

What motivates your financial choices?

Reading a variety of FI and finance writers, it has occurred that those who blog are a rag-tag bunch. You have to be a bit different to move away from the credit-to-the-eyeballs herd. The reasons to go down the various financial paths, and then write about it are even more nebulous. A scientific mind led to attempts to discern some patterns among the noise. One such pattern is the writers motivation, and where the drive to save/ live frugally/ be financially independent arises.

Running from

For some, it seems the drive to be frugal is innate, inherited, learnt behaviours from early childhood. LittleMissFire talks about it as leaving the ‘shop floor mentality’, the mindset of a household living week-to-week, month-to-month, without financial planning (1). The crux of her post about the ‘shop floor mentality’ is the drive to better oneself, and leave behind the stress, envy, anguish and heartache of poverty (1). Understanding financial planning and making frugal life choices are just a short psychological hop from FI, and there seems a lot of overlap between frugal living and so-called ‘lean-FI’.

This drive to leave behind an unpleasant situation also appears prevalent on the FI forums I frequent, but here it’s less about a memory or experience of struggling for money, and more miserable working environments. For example (2):

And an example reply (2):

Small talk, alarm clocks, office politics, performance reviews, managers talking about you behind your back, tracking metrics, spreadsheets, deadlines, cubicles, dress code, meetings, daily existential crises, passive aggressiveness, emails with manager cc’d, scrum meetings, being taken advantage of, erosion of self esteem, etc. Etc.

I assume it was among those so miserable in their work that the term “Fuck You Money” arose (3). You’ve built up enough cash to say “Fuck You” to that miserable environment and walk away… but what then? How do you adapt your austere lifestyle out of work, with it’s focus on minimising all outgoings, to your new-found freedom (4):

Running towards

I sort of class myself amongst the running towards school-of-thought. I enjoy my job, to the extent that I am happy to go into work every day to perform it (especially after a slight change into a less front-facing role). I would probably keep doing it to some extent even if I wasn’t paid, because it is my ‘ikagai’ – a Japanese word whose closest translation is ‘the reason for which you get up in the morning’ (5, 6). Despite this I think the world is full of wonder, and I could spend whole other lifetimes doing different things. There are too many things to do and not enough time to experience them all whilst also working to support myself. FI, as The Frugal Cottage puts it, “gives you the option of spending your limited time however you want” (7, 8).

Just enjoying the run

This seems to be the final stage in FI nirvana fulfillment. Some suggest that by it’s nature, being frugal has a sort of contrarian cool (9). An echo of the counter-culture in a rejection of consumerism (10)More hippy than hipster I hope. Some bloggers, like TEA, enjoy the journey to FI and beyond because they developed an enjoyment of “the process of wealth building” (11) TEA writes about learning to enjoy these things by using conditional rewards; a big juicy carrot for the FI stick, training your brain to associate putting the financial graft in for a reward (11). Or writers like FIREvLondon, who enjoy the writing about their process, discussing ideas, commenting on experiences (12). This is a far better path to happiness, where any goal you set or any target you make can bring you fulfillment. Enjoying the process of blogging, the sharing of knowledge and community.

Why does it matter?

Understanding your motivation is inherently tied to your ability to complete the goals you set yourself for financial independence and frugal living. If your goal is off from what you truly want you’ll lack motivation, and if you’re motivated for only a specific purpose you may find yourself unfulfilled and lost when you reach that goal, or unable to reach it altogether. As I’m setting my goals, I’ve been noticing many are around things I’d do after being FI. I risk that there will always be one more goal or target. It’s time to think about my enjoyment of the pursuit, and I would urge others to ask, why do I want FI?

References:

  1. https://littlemissfireblog.wordpress.com/2018/03/24/do-you-have-the-shopfloor-money-mentality/
  2. https://www.reddit.com/r/financialindependence/comments/8ogyp8/people_who_are_trying_to_reach_fi_because_they/
  3. https://theescapeartist.me/2018/07/24/the-art-of-wealth-preservation/
  4. https://www.reddit.com/r/financialindependence/comments/94kmku/first_day_of_retirement_at_40_yo
  5. https://www.telegraph.co.uk/health-fitness/mind/finding-ikigai-japanese-secret-health-happiness/
  6. http://monevator.com/weekend-reading-what-is-your-reason-for-being/
  7. http://www.thefrugalcottage.com/everyone-early-retirement/
  8. http://thefirestarter.co.uk/early-retirement-in-5-years-in-the-uk-is-it-possible/
  9. https://www.psychologytoday.com/gb/blog/the-eclectic-professor/201102/the-psychology-thrift-why-not-frugal-cool
  10. http://thefirestarter.co.uk/about-me/
  11. https://theescapeartist.me/2018/02/13/get-rich-with-the-process/
  12. https://firevlondon.com/about/

 

 

The Full English Accompaniment – On Brexit, social psychology and market timing

What’s piqued my interest this week?
I’ve been reading Tim Hales Smarter Investing over the last couple of weeks, which appears considered essential reading by most FI/ passive investment sources (1). It has prompted me to write down a philosophy and a draft set of goals for my investment plans. One of the cautions is against market timing, because it’s very statistically difficult to be good at it, incorporating not a small amount of luck. Much better to go Bogle, and buy then hold a low cost tracker (2). So far, so sold.
There’s another section of the book which documents how one of the most important, most overlooked parts to a portfolio decision is target country allocation. This is where I’m currently stuck, as Brexit presents a big hit of unknown outcomes, and is turning my market timing milk sour. Oh look, another r/UKPersonalFinance post triggered me (I’ll cut out all the Reddit relevant-only bits)…

Everyone, put on your tin-foil hats and join me on a journey considering a Brexit scenario…

I’ve personally suspected that Brexit is being pushed along despite it outwardly, appearing to be in no-one’s interests perhaps as a textbook example of Naomi Klein’s ‘Disaster Capitalism’ but maybe just as a way for massive money to be made from the lurches in exchange rate and FTSE etc.

So one outcome I suspect is that the pound will stay relatively weak to the EUR/USD etc, keeping the FTSE reasonably high, until we suddenly hit a point where it gets revealed we’ll basically stay in the EU (or EEA), perhaps after a 2nd referendum, so…

If the timeline of this is the next 6 months, how will the politicians and their chums be looking to maximise the person financial benefit to themselves? Assuming a, say, 15% increase in the value of the pound, and 10% drop in the FTSE 100, would they be looking to sell most investments, have cash and then be ready to re-invest after the correction?

What would you do in this scenario if you had this inside information? (3)

This is a little tinfoil hat brigade, although the murmuring the Nigel Farage shorted the value of the £ when he found out the result of Brexit before it was officially released could provide some evidence (4). An ex-investment banker wouldn’t call up his mates still in the industry with privy information would he? The main issue I have with the above is that it appears to go against the political wind and public opinion polls. The Conservatives and Labour are both loath to go back on the stated plan to exit (would be seen as weak?), and YouGov’s last poll in July found that a fraction greater percentage thought Brexit was the wrong decision than didn’t (5). Opinion polls may be a pretty poor judge, but they’re not so bad as to miss half the nation suddenly decided they do want to stay in the EU, after all (6).
Brexit therefore represents a challenge to the efficient market hypothesis (7). Pre-Brexit vote, a commentator in Forbes discussed how the referendum would represent an excellent testbed for efficient markets (8). It truly did, as the unexpected (to the city) voter decision was integrated into share prices in a number of hours. The fact that the referendum result was unexpected and therefore prompted such a dramatic shift in the markets challenges the efficient market hypothesis, and specifically what makes it efficient. The efficiency relies upon the sum of all the traders individual access to information. To bring it round to psychological terms, it is a form of social Gestalt theory, where the individual chaotic pieces of information/ action contributes to a total pattern (9, 10). Market traders were unaware of the depth of feeling in favour of Brexit prior to the vote (those pesky polls again), and were suddenly exposed to it and integrated it into the markets on referendum day.
But why were market traders so unaware? I wonder that the possibility of a Leave vote did not comply with the collective conscience of market traders and ‘the city’ and therefore was not appropriately considered by the markets (11). To go back to Durkheim’s original use of collective consciousness (very separate from Jungian collective unconsciousness), it is the ‘general feeling’ towards a position, experienced and perceived by the individuals in the collective (11). A shared unconscious understanding of social norms. In the city, it was a social norm to be pro-EU. In the general populace, not so much. Therefore the true risk of a Leave vote to the markets was a Rumsfeldian ‘unknown unknown’. To be pro-Leave in London pre-Brexit went against social norms, it didn’t fit with the social reality constructed in that environment, even if it did fit with the social norms and social reality of the wider UK (12).
Which brings me to my market timing and allocation conundrum. The market is efficient when it is integrating information which makes sense within it’s system; IPOs, sales data, quarterly returns etc. It appears less efficient at integrating popular opinion and behaviour. The market is vulnerable to collective psychological effects (herd behaviour etc), and changes in the market are made by people. The people who change the market (traders etc) operate in a different social world (‘social reality’) to the general populace, by nature of their social interactions. Yours is visible in day-to-day life in your twitter or social media sphere, which may differ from general public opinion. The markets will therefore be generally running on the market traders social reality, whilst the rest of us live in a slightly different social reality. Politicians span the divide, but take their lauded mandate from the general populace’s social reality. The difference comes to the fore when the market has to integrate decisions which are made by the wider populace that didn’t fit with it’s reality, e.g. Brexit. The reddit comment quoted above appears to sit well within the market reality bubble; we’ll stay in the EU in the end, it’s all a sideshow. My concern is that the general populace appears fairly relaxed about a ‘No-deal’ Brexit. Knowing that we’re a few short months out of formal Brexit, do I choose allocations based on that worry which insulate against this outcome. Does even thinking about this represent market-timing, and I should just bung my cash ‘somewhere’ and sit it out. Your opinion welcome here…
Have a great week,

 

The Shrink

 

Side Orders

Other News

Opinion/ blogs:

What I’m reading:

Smarter Investing by Tim Hale – essential reading

Religio Medici by Sir Thomas Browne – the theological and psychological reflections of a C17th doctor. This is turning out to be real heavy-going.

Enchiridion by Epictetus – Bedside reading for a bad day

 

References:

  1. https://www.amazon.co.uk/Smarter-Investing-Simpler-Decisions-Financial/dp/0273785370/
  2. https://www.bogleheads.org/wiki/Getting_started
  3. http://www.reddit.com/r/UKPersonalFinance/comments/9cnsqj/the_potential_effect_of_a_massive_shift_in
  4. https://www.theguardian.com/politics/2018/jun/25/nigel-farage-denies-shorting-value-of-sterling-on-night-of-brexit-vote
  5. https://yougov.co.uk/news/2018/06/23/eu-referendum-two-years/
  6. https://www.nature.com/articles/s41562-018-0330-7
  7. https://www.investopedia.com/terms/e/efficientmarkethypothesis.asp
  8. https://www.forbes.com/sites/timworstall/2016/02/22/brexit-uk-financial-markets-and-the-efficient-markets-hypothesis/#31ab82161667
  9. https://www.britannica.com/science/Gestalt-psychology
  10. https://en.wikipedia.org/wiki/Gestalt_psychology
  11. https://en.wikipedia.org/wiki/Collective_consciousness
  12. https://en.wikipedia.org/wiki/Social_reality
  13. https://www.thisismoney.co.uk/money/pensions/article-6130445/Will-council-force-sell-house-cover-dads-care-bills.html
  14. https://www.thisismoney.co.uk/money/cars/article-6138267/A-1979-Lada-Niva-estimated-sell-75-000-goes-just-4K.html
  15. https://www.theguardian.com/money/2018/sep/07/house-prices-rose-at-fastest-rate-in-almost-year-says-halifax-august-north-south
  16. https://www.theguardian.com/uk-news/2018/sep/05/thinktank-calls-for-major-overhaul-of-britains-economy
  17. https://www.thisismoney.co.uk/property/article-6106049/A-downstairs-family-bathroom-lowers-property-value-6.html
  18. https://www.thisismoney.co.uk/money/news/article-6080099/Are-Monzo-Revolut-Starling-Transferwise-safe-bank-with.html
  19. http://monevator.com/10-things-you-can-do-today-to-reset-your-life/
  20. http://monevator.com/weekend-reading-what-is-your-reason-for-being/
  21. http://thefirestarter.co.uk/my-5-years-are-up-how-did-i-do/
  22. http://thefirestarter.co.uk/august-income-expenses-report-a-bit-of-an-odd-one/
  23. https://thefireeng.com/net-worth-update-august-2018/
  24. http://www.msziyou.com/yes-i-am-rich-now/
  25. http://www.msziyou.com/net-worth-updates-august-2018/
  26. http://www.mrmoneymustache.com/2018/09/05/what-really-goes-on-at-mmm-headquarters/
  27. http://theirrelevantinvestor.com/2018/09/04/gold-what-is-it-good-for/
  28. https://www.ukvalueinvestor.com/2018/09/sold-senior-plc-after-recent-share-price-gains.html/

The Full English Accompaniment – The neuroscience of a frugal mindset

What’s piqued my interest this week?

In a throwaway conversation this week MrsShrink said something which I’ve subsequently been ruminating on. In running our household I do most of the shopping, but MrsShrink does the toiletries. She remarked that she actively enjoyed going to browse in Savers, Home Bargains etc, as she enjoyed spending money she knows she has to. She’s learnt to be frugal, to penny-pinch, and spending is a treat. She gets a hit out of buying things most of us wouldn’t think twice about because to her it’s a forbidden joy.

Attitudes and behaviour towards money are learnt in childhood by observing your parents. On a structural level, the dopaminergic mesolimbic ‘reward’ pathway develops through your childhood and adolescence (1). This is the time when your brain is most sensitive to it’s reward system, and is setting down the pathways for a lifetimes use (2). The way I explain behavioural modelling to patients is to think of it as a parallel to learning your first language. As a toddler you observe your parents using sounds as language, try it out, see what works, gradually accumulating your understanding without consciously being aware of the process. Other behavioural processes also follow this unconscious accumulation process, including financial attitude. If you model your child’s behaviour at this time (consciously and unconsciously) you lay down the pathways for a lifetime of reward processing.

Hundreds of websites and blogs have signed onto this, offering to teach us the ways we can consciously train our children to be better financially. This doesn’t have to be as intense as paying your child through an investment account, or making them buy fractional shares in Netflix as some would recommend (3). The piggy bank, pocket money, weekend job development path will work just fine (4). I clearly remember learning the value of money calculating how many penny sweets I could buy with my 50p pocket money. The pre-frontal and frontal cortex projections of these pathways continue to develop into your teens and early 20s, forming your conscious awareness of pleasurable responses as you grow into adulthood.

The unconscious processes are far harder to model, alter or change. These are the deep cortex projections close to the archaic midbrain structures, projections which develop during early childhood through modelling. These are learnt through observation of those around you. This is why teaching your child to be a spendthrift can only go so far if your own approach is spending all you have to keep up with the Joneses. This is also why, in my opinion, people such as Little Miss Fire struggle with her Shop Floor Mentality (5). If you have grown up in an environment of thrift as a necessity of poverty the rewards from saving, investing and watching wealth grow are not hard-wired in your cortex. There is no unconscious drive for these goals. The Stanford Marshmallow experiment on delayed gratification is a case in point example, and potentially a way of teaching your child the benefits of patience (6).

Which is where I bring things full circle. Many rich people are innately frugal; look at Warren Buffett (7, 8). These winners derive their pleasure from the process not the outcome. MrsShrink is innately frugal as she was brought up in an environment where frugality was a necessity. She observed her mother being able to afford the things they wanted by saving wherever possible. I secretly suspect she is much more likely to become FI than I because of this innate drive, but will be hampered by her mistrust of investment vehicles. She has no desire and gains no pleasure from making non-frugal choices. Consciously training thought processes to be the same way is far harder.

Have a great week,

The Shrink

N.B. There won’t be a Full English Accompaniment next week as I’m on holiday AFK.

Side Orders

Other News:

Opinion/ blogs:

What I’m reading:

An exam textbook

Religio Medici by Sir Thomas Browne – the theological and psychological reflections of a C17th doctor

Enchiridion by Epictetus – Bedside reading for a bad day

References:

  1. Walker et al. Adolescence and Reward: Making Sense of Neural and Behavioral Changes Amid the Chaos. The Journal of Neuroscience (2017)
  2. Galvan, A. Adolescent Development of the Reward System. Frontiers In Human Neuroscience (2010)
  3. https://www.marketwatch.com/story/how-to-teach-your-kids-to-be-better-with-money-than-you-are-2017-07-26
  4. https://www.independent.co.uk/money/spend-save/how-to-teach-money-children-kids-personal-finance-tips-guidelines-property-a7789381.html
  5. https://littlemissfireblog.wordpress.com/2018/03/24/do-you-have-the-shopfloor-money-mentality/
  6. https://en.wikipedia.org/wiki/Stanford_marshmallow_experiment
  7. https://www.psychologytoday.com/gb/blog/how-do-life/201503/why-many-rich-people-are-frugal
  8. http://time.com/money/4861261/billionaires-spending-habits-frugal/
  9. https://www.bbc.co.uk/news/business-45194019
  10. https://www.bbc.co.uk/news/business-45201155
  11. https://www.theguardian.com/technology/2018/aug/17/elon-musk-says-past-year-has-been-excruciating-and-worst-is-yet-to-come
  12. https://www.bbc.co.uk/news/business-45216551
  13. https://www.bbc.co.uk/news/world-asia-45199034
  14. http://www.thisismoney.co.uk/news/article-6064685/Fears-grow-house-prices-fall-fastest-rate-financial-crisis.html
  15. https://www.ig.com/uk/shares-news/mining-in-the-uk-and-ireland-is-well-and-truly-alive-180815
  16. http://thefirestarter.co.uk/can-we-afford-an-electric-vehicle-lets-run-the-numbers/
  17. https://www.bbc.co.uk/news/business-44953607
  18. https://www.ukvalueinvestor.com/2018/08/ted-baker-dividend-growth-stock.html/
  19. https://www.ig.com/uk/commodities-news/is-investment-in-renewable-energy-drying-up-180809
  20. https://www.etf.com/sections/index-investor-corner/swedroe-determining-esgs-nature
  21. https://firevlondon.com/2018/08/13/recalibrating-my-portfolio/
  22. https://firevlondon.com/2018/08/09/july-2018-the-trade-news-sweetens/
  23. https://simplelivingsomerset.wordpress.com/2018/08/13/there-be-a-rumbling-and-a-sound-of-clucking-chickens-in-the-air/
  24. http://eaglesfeartoperch.blogspot.com/2018/08/garden-gate-repair-and-new-fence.html
  25. http://monevator.com/weekend-reading-funny-money/
  26. http://monevator.com/taking-more-risk-does-not-guarantee-more-reward/
  27. https://deliberatelivinguk.wordpress.com/2018/08/13/savings-rate-revisited/
  28. http://quietlysaving.co.uk/2018/08/12/phone-free-day/
  29. https://www.mrmoneymustache.com/2018/07/25/the-twenty-dollar-swim/
  30. https://www.theatlantic.com/magazine/archive/2018/09/cognitive-bias/565775/

Musing on… Long-term care costs and financial savings

This post has been mulled over for a long time, trying to discern and distil a direction. It began (as these trains of thought often do) with an idle r/financialindependence post. If you’re not familiar with that, it’s a subreddit for FI-types, predominantly populated by Yanks (Reddit being a sort of forum-cum-meta-aggregator of internet waffle). In this post a group of our ex-colonial cousins were discussing long-term costs (1):

So far, so not our problem. The UK may have significantly higher tax rates (ignoring ISAs etc), but it pays for (in theory) the NHS and social care, the cradle-to-grave support system for when times are bad. The NHS and social care system are what makes FIRE and any sort of fuck-you to working possible in the UK. Check out the video and post TEA and Rhik Samadder did on the matter (2).

National, personal cover

As we celebrate the NHS’ 70th birthday, it’s worth reflecting on where this all came from. Before the birth of the NHS all doctors services were private in the UK. If you needed something, you went to your local doctor, hoped they had been trained adequately, paid your money, got your treatment, hoped it worked. There were no guidelines. There was no standardisation. This worked fine for the wealthy, who could afford the best, but for the poor would die from an inability to pay the doctor. You can find plenty of stories from that time, but if you read one, I recommend the recollections of the wonderful Harry Leslie Smith (3). He remembers a doctors visit costing half-a-weeks wages, which they sadly did not have (3). This private price has scaled with inflation. A 15 minute private GP consultation will set you back £70 (4). As a profession we remain a rare commodity, and on an open market our hourly rate is such. The NHS affords the government a position of power and collective contractual employment which, despite press vilification, means we still come relatively cheap.

In the days before the NHS, workers would club together to pay for ‘self-help’ organisations, to provide medical care for one another. Beginning in the late 1800s, the Tredegar Workmen’s Medical Aid Society was one such successful organisation (5):

By the 1920s, the society employed the services of five doctors, one surgeon, two pharmacists, a physiotherapist, a dentist, and a district nurse. For an extra sum each week, members could also benefit from hospital treatment.

During the inter-war depression, the society continued to provide services to unemployed people, even though they could no longer afford to pay a subscription. By the mid-1940s, the society was providing medical care for 22,800 of the town’s 24,000 inhabitants.

Aneurin Bevan, who was born in Tredegar, took the Workmen’s Medical Aid Society as his inspiration for the NHS, saying: “All I am doing is extending to the entire population of Britain the benefits we had in Tredegar for a generation or more. We are going to ‘Tredegarise’ you.” (5)

The fragmentation of the NHS, gradual privatisation and reduction in care available deserves a separate post. For now, with a sense of perspective, we can look across the pond and be smug about our NHS (6). Cradle to grave cover, in our most frail years, maternity and care home. Isn’t it marvellous. Except… have you ever been in an NHS care home? And how much do you think that care home costs?

Who wants to live forever?

Time and again bloggers discuss their financial plans, how they’re 50 now, and they see themselves having 30 more good years. They fall into a common trap, recent research shows 8/10 of those over 50 underestimate their life expectancy (7). Most people guess they’ll live to 82-ish, whereas the data says more like 88 for men, and 90 for women*. We have got much better at keeping people alive for longer. Those aren’t necessarily going to be good years though, and so people trot out those bleak jokes; “oh just roll me off a cliff at 80”; “I’ll just head off to Switzerland”; “I’ll just pop my clogs then”. Except those are all to varying degrees illegal/ unethical. We doctors can’t just settle you off in a dignified way when you decide you’re not much use or aren’t enjoying things anymore. How do you decide when that is? Death is so very final. As a culture we have developed a fear of discussing or even considering our own mortality.

(*N.B. You can’t actually use ONS life expectancy at birth figures for this. Infancy through to teenage years (and early adulthood for young men) still have higher mortality. Once you pass your mid-20s your life expectancy actually statistically increases to accommodate for this.)

So for our friends the FIRE-savers, that’s an extra half decade of savings to account for. Suddenly retiring at 55 with a 4% SWR estimating a 30 year retirement isn’t quite enough (8). Life expectancy has increased in the 20 years since the Trinity study was published (9). A 45 year-old sitting down now and estimating for a 4% withdrawal starting at age 55 may well have a good 40 years ahead of them. It’s not just the %withdrawal that’s a variable in this calculation, it’s the duration too. For some really interesting drawdown calculations, check out RIT’s recent post (10).

The final splurge

How much do you think your living costs will be too? The common practice appears to be to take roughly your current living expenses, and times that out for the number of years you need. Some people estimate less, as they figure their homes will be paid off. An interesting piece of research by investment firm Schroders casts doubt on that. It found that savers underestimated their living costs in retirement by 15% (11). Only half of people surveyed had enough to live on comfortably (11).

Coming back to people facing their own mortality, and a decline into frailty, did you include the care home fees in that cost? The answer to the previous question is that the average care home price per year in the UK is £29,270 for a residential home, £39,300 for a nursing home (12). That’s average too, as with everything the South is more expensive, and we all like to imagine ourselves in our twilight years in a beautiful peaceful home, and not being roughly manhandled by someone on minimum-wage with no dignity or care, before being hauled up on a CQC newspaper expose (13). If you want to see what it’s like in your area, the UK Care Guide has a number cruncher and area analysis (14). You can decide to stay in your own home, but there the costs can mount up too. 24 hour care can be more than £150,000/year (13). And again for perspective, your life expectancy from a diagnosis of dementia in your 60s – 6.7 years, in your 90s – 1.9 years (15).

Where’s my cradle to grave?

Too right, where’s the NHS and social care system in all of this? Broke, that’s where. Historically there were jobs that provided care and nursing homes for their retired workers as part of their payment plan (although I can’t imagine anything worse). Now the burden falls on the social care system. The boomer population is ageing, and everyone is living longer. Social care reform remains a political football as no side wants to try to tell people that their lifetime of NI contributions and tax wasn’t enough to pay for their care (16). The “squeezed middle” baby boomers (le sigh) are already paying up to £10k a year to look after their ageing parents, and this will only get worse (17).

To try and at least partially cover care home fees, the central and local Govs have created an Orwellian masterpiece of committees with opaque criteria to make decisions about who gets support and who doesn’t. It’s called NHS Continuing Healthcare when the NHS is involved, i.e. if there is ‘sufficient medical need’ (17). If you can’t qualify for that you get means tested by the local social care trust/ provider (18). AgeUK make a fair stab at explaining it on their website (19). I’ve seen people die before any decision on who will pay has been reached.

http_com.ft.imagepublish.upp-prod-eu.s3.amazonaws

The final stretch of this little essay is about the means testing that social care can use. It’s not actually free at point of care. The system used is fairly complicated in it’s own right, but the Money Advice Service has a good page breaking it down (18). Your income and capital are assessed. If you live alone, and in certain other circumstances, your home will be counted as part of your capital (18). The local authority can and will sell your home to pay for the fees, even if you don’t want them to (20. 21).

If the local authority deems you have deliberately disposed of assets, for example by gifting your child your home, to avoid paying means tested fees, it can claim them back. This quietly introduced piece of legislation is called Deprivation of Assets (22). The rules have subsequently got much tighter around gifting any asset; housing, jewellery, money, objects (23). As always, do your own research.

We can’t take it with us

To summarise, as a culture we fear death and avoid considering our own mortality or old age due to the association. This is a shame, as people are more active in their old age and living longer than ever before. We underestimate the costs and expenditure we will have in retirement. Old age will cost more than we collectively think. The last few years cost A LOT MORE. Don’t ignore your final years, embrace those calculations, and spend them in luxury if you can.

Have a morbid time!

The Shrink

References

  1. https://www.reddit.com/r/financialindependence/comments/8fyu65/do_longterm_care_costs_factor_into_your_fire_plans/
  2. https://www.millennial-revolution.com/freedom/early-retire-uk/
  3. https://www.newstatesman.com/politics/2014/10/hunger-filth-fear-and-death-remembering-life-nhs
  4. https://www.bupa.co.uk/health/bupa-on-demand/gp-services
  5. https://www.theguardian.com/healthcare-network/2018/may/22/south-wales-town-forged-nhs-points-future-tredegar
  6. https://www.reddit.com/r/financialindependence/comments/8zx7iq/health_insurance_as_a_barrier_to_fire_in_the_usa/
  7. https://www.ftadviser.com/pensions/2017/11/28/most-over-50s-underestimate-life-expectancy/
  8. https://www.madfientist.com/safe-withdrawal-rate/
  9. https://en.wikipedia.org/wiki/Trinity_study
  10. http://www.retirementinvestingtoday.com/2018/07/sobering-retirement-income-drawdown.html
  11. https://www.moneywise.co.uk/news/2018-07-03/savers-vastly-underestimate-the-cost-retirement
  12. https://www.moneyadviceservice.org.uk/en/articles/care-home-or-home-care
  13. https://bit.ly/2OiBuIN
  14. https://ukcareguide.co.uk/care-home-costs/
  15. https://www.bmj.com/content/341/bmj.c3584
  16. https://www.independent.co.uk/life-style/health-and-families/nhs-social-care-uk-reform-aneurin-bevan-health-poverty-andy-burnham-a8429571.html
  17. https://www.moneyadviceservice.org.uk/en/articles/are-you-eligible-for-nhs-continuing-care-funding
  18. https://www.moneyadviceservice.org.uk/en/articles/means-tests-for-help-with-care-costs-how-they-work
  19. https://www.ageuk.org.uk/information-advice/care/paying-for-care/paying-for-a-care-home/
  20. https://www.ft.com/content/34c336e8-3e5c-11e8-b7e0-52972418fec4
  21. https://www.telegraph.co.uk/finance/personalfinance/insurance/longtermcare/11441163/Why-you-WILL-have-to-sell-your-home-to-pay-for-care.html
  22. https://www.ageuk.org.uk/information-advice/care/paying-for-care/paying-for-a-care-home/deprivation-of-assets/
  23. https://www.which.co.uk/elderly-care/financing-care/gifting-assets-and-property/343063-what-are-the-rules-for-gifting-assets

Musing on… the future’s bright, the future’s green

A recent Grauniad article got me musing on energy futures (1).

MrsShrink works in sustainable energy and has had various roles from industrial purchasing to consultancy in the last 10 years. It’s probably the only thing she’d blog about on here, but for now I’ll lay some opinions on you with a big statement. Offshore power could be Britain’s next north sea oil. However, currently it is mainly overseas company investing, creating jobs and getting stuff done on the ground. See the massive investment by Siemens in the Humber region, which has made it ‘the envy of the world’ (2, 3). MrsShrink finds it barmy that as an island nation we can’t be energy independent using the resources around us. For a nice AV update, here’s a recent episode of Fully Charged News that covers some of the current investment:

I’m a great fan of Fully Charged, and plan to become a Patreon for all the hard work Jonny and Robert are doing (4).

The nuclear conundrum

This makes the recent decision by the government to invest massively in new nuclear power stations a bit bizarre. The new Wylfa power station on Anglesey will be built by Hitachi for >£15billion, requiring at least £5billion, but more like £9billion, of UK government money (5, 6). This is on top of the recent strike price of £92.50/MWh and investment in Hinkley Point C, run by EDF, which has been dubbed “the dreadful deal” (7, 8). This is not an argument against nuclear, per se. There is a defence argument for maintaining a number of active nuclear reactors to have the ability to produce military grade munitions (don’t let MrsShrink here me saying that). Hot off the press is commendable investment into new nuclear technology, to the tune of £200m (9). This includes £86m into a UK fusion programme (probably to replace our investment in the EU ITER, ejits), £32m for advance R&D for construction, £30m for supply chain, and commitment to clean up ‘legacy’ sites (10). Intriguingly, it will also see £56m for R&D into ‘advanced modular reactors’, seen by many as a move toward U-batteries; small reactors designed to operate intermittently or independently to decentralise supply (11, 12)

MrsFIREShrink deals with plenty of civil servants who are aware of and pushing for a decentralised grid. She was involved in recent R&D funding pushing the current decrease seen in wind cost /kwh to the grid, with a strike price of £50/MWh achieved (13). While this is likely a temporary artificial low, it follows a decreasing curve in renewable energy prices /kwh and cost for installation. International R&D is driving this. The losers here are UK based ‘big-6’ energy companies, who are mainly invested in traditional power supply methods and only now coming round to renewable sources. Interestingly ‘the city’ is fairly evenly split, probably due to the split of UK-based and world-based investment. The disconnect at a political level is between the current politicians in power and the civil servants. I wonder why…

The issue of baseload is often touted as reasons for energy not to be fully renewable. Hydro and pumped storage are one element of the reply. Building pumped storage plants like Dinorwig will provide robust, large-scale storage back-up (13). More of these are being built in abandoned industrial quarries and workings (14, 15). However this continues to follow a traditional power supply train of thought working with a centralised grid. The energy infrastructure and supply field is changing tremendously quickly, and so 10 year old articles don’t cut the mustard.

The current focus of R&D and rapid development is battery storage to solve the cyclic demand for power. Tesla have opened a massive powerbank in Aus (16), however Tesla gets lots of fanboi hype despite being considered the world leader in energy density for batteries. This work is also going on in California, and with more energy dense Li-ion and potentially solid state batteries in the pipeline, the technology is moving as fast as it can be installed (17). The grid and suppliers are struggling to keep up.

Bring the system down

The wider move to decentralise the grid, utilising the smart grid and home/ industrial supply makes sense from cost to the consumer/ company, and from a strategic point of view. Hard to blow up the power supply to an area if every home and factory is contributing. The top end consumer market is moving to home PV and wind coupled to battery storage. Again the excellent Fully Charged show covers this (18):

It’s difficult to find a clear graph to demonstrate just how fast PV costs have reduced. Most data is based on US, Asian or Australian costs, which says something about uptake. These graphs are taken from submissions made by Friends of the Earth to the old Department of Energy and Climate Change (19). Biased, but the data they’re based on is factually correct:

1605vw06.gif

1605vw07.gif

Wind:

REW_Chart3.png

What’s the picture on the ground?

The actual amount in use is again difficult to calculate. The graphs below run to 2016, and since then the Government has been playing around with the feed-in tariff, reducing and dis-incentivising (20). Capacity can be assessed on the amount of feed-in tariff being utilised and the supply being provided to the grid (21, 22):

As prices come down it will make increasing sense to have a bit of solar PV on your roof and a battery in your house to decrease your energy cost from the grid. This is limited but not prevented somewhat by our old house stock. Industrial energy use is changing more rapidly. To briefly summarise it is currently cheaper for many offices to retrofit solar PV and wind, with a hookup to the grid for peak demand, than to just buy from the grid at standard rates. For larger consumers, Combined Heat and Power (CHP) and microCHP plants running off natural gas with grid electricity sell-back is cheaper and more efficient.

The future?

So to get back to the original point, we are reaching a crossroads where either the ‘big 6’ or others recognise that offshore wind coupled to onshore solar PV and battery storage are most cost effective over lifetime of installation than traditional power plants for supplying grid baseload. The cost cross-over is nicely demonstrated when looking at long-term solar PV changes (23):

To date experts have been astonishingly bad at predicting the uptake and use of renewable energy (24):

IEA Solar Predictions for Global Installations

I like graphs

What we find interesting is who is going to invest in this and when; is it the ‘big 6’ (E.On are starting to), is it foreign energy companies, or will it be a smaller network of UK based suppliers (25). The government can’t seem to decide, but is erring on the big companies side; vis Hinkley C’s strike cost of £92.50/MWh for EDF vs solar PVs £50/MWh strike cost and offshore winds £57.50/MWh (8, 12, 26). Big oil companies like Shell are starting to clue up and get in as a way of surviving the death of fossil fuels (27). We’re looking at using a small renewable-only energy supplier for our home. It’s a time of huge change and potential for the energy industry, with lots of great opportunities for investors and new companies. We just hope the UK can find a way to lead the change again.

Have a great week,

The Shrink

References

  1. https://www.theguardian.com/environment/2018/jun/19/huge-mistake-britain-throwing-away-lead-in-tidal-energy-say-developers
  2. https://www.bbc.co.uk/news/uk-england-humber-43808806
  3. https://www.hulldailymail.co.uk/news/business/siemens-boss-says-humber-become-1513169
  4. https://www.youtube.com/watch?v=HYr7aGf0-wA
  5. https://www.thetimes.co.uk/article/taxpayer-bankrolls-15bn-nuclear-plant-at-wylfa-in-wales-0p7dnxfhq
  6. https://www.theguardian.com/environment/2018/jun/04/uk-takes-5bn-stake-in-welsh-nuclear-power-station-in-policy-u-turn
  7. https://www.ft.com/content/00be1bc4-64c2-11e8-90c2-9563a0613e56
  8. https://www.theguardian.com/news/2017/dec/21/hinkley-point-c-dreadful-deal-behind-worlds-most-expensive-power-plant
  9. https://www.gov.uk/government/news/new-deal-with-industry-to-secure-uk-civil-nuclear-future-and-drive-down-cost-of-energy-for-customers
  10. https://www.bbc.co.uk/news/uk-wales-politics-44634580
  11. https://www.theengineer.co.uk/nuclear-industry-sector-deal/
  12. https://renewablesnow.com/news/solar-pv-gets-lowest-strike-prices-in-uks-cfd-auction-465462/
  13. https://en.wikipedia.org/wiki/Dinorwig_Power_Station
  14. https://www.theengineer.co.uk/first-new-uk-pumped-hydro-scheme-for-30-years-given-go-ahead/
  15. https://www.theengineer.co.uk/pumped-hydro-storage/
  16. https://www.bbc.co.uk/news/world-australia-42190358
  17. https://www.theguardian.com/sustainable-business/2017/sep/15/californias-big-battery-experiment-a-turning-point-for-energy-storage
  18. https://www.youtube.com/watch?v=Ym8emBsYdMs
  19. https://publications.parliament.uk/pa/cm201012/cmselect/cmenergy/1605/1605vw34.htm
  20. https://www.theguardian.com/environment/2018/jun/27/uk-home-solar-power-subsidies-costs-battery-technology
  21. https://www.r-e-a.net/member/uk-solar/feed-in-tariff
  22. https://www.solarpowerportal.co.uk/news/exclusive_uk_installed_1.553gw_in_q1_2016
  23. http://ramblingsdc.net/Australia/SolarPower2.html
  24. http://www.visualcapitalist.com/experts-bad-forecasting-solar/
  25. https://uk.reuters.com/article/uk-rwe-renewables/rwe-ceo-eyes-15-billion-euros-annual-investment-in-green-energy-idUKKBN1JJ00R
  26. https://utilityweek.co.uk/orsted-orders-turbines-record-breaking-offshore-wind-project/
  27. https://www.edie.net/news/10/Shell-collaborates-with-Carbon-Trust-to-drive-lower-offshore-wind-costs/

Musing on… Mortgages, what’s your risk tolerance?

I’ve recently been thinking a lot about mortgages, because I’m getting a new one. At the same time I’ve been educating myself about investment risk tolerance (1,2). I’ve done lots of online questionnaire’s to evaluate mine, which broadly show I’m willing to tolerate a lot of risk; I’m youngish, can wait most storms out and have a background in a profession where I have to manage risk daily. I also have the capacity to tolerate that risk; I make a good, secure salary and I won’t be investing money I can’t afford to lose. That’s not the case for my mortgage though, the single last purchase/ cost I’ll probably ever make. A post last week on r/UKPersonalFinance got me thinking:

Stick or twist?

Are you mad Shrink? You need to fix, fix, fix, before the rates go up. Everyone says they will: the BBC (3,4), Newspapers (5,6,7,8), lots of blogs (9,10).

Is what everyone was saying when I was looking last week. Except the rates didn’t go up. We had crappier than anticipated economic results, and the BoE said no (11). It cut it’s growth forecast and interest rates remained on hold at 0.5%.

Well they can’t stay that way!

No, they probably won’t. But they could do, pollsters and pundits have been off before. They said Lehman Brothers, Northern Rock etc were too big to fail. They said Brexit wouldn’t happen. Predicting the future is Mystic Meg’s domain.

Carney  
Mark Carney – will the last one out please turn off the lights.

 

Opportunity cost

Four years ago MrsFIREShrink and I were looking at putting our hard-earned deposit down. As 20-something millenials we were pretty unusual to be in that position. We leveraged a 90% LTV on a do-er-upper in the area we both loved, worked and intended on staying in. In those pre-Brexit, pre-May/Corbyn, pre-economic flatline days everything pointed to fixing for as long as we could. 4.29% fixed for 5 years was the best we could manage. That was ok as when we bought we planned to renovate and stay there for 5-10 years.

Fast-forward four years and we’ve moved 150 miles for job opportunities we couldn’t pass up but never anticipated. Our old house is for sale, and we’re trying to port our mortgage to save paying our eye-watering (5%!) exit fee. We’ve learnt that long fixed rates have their downsides (12). We look at others fixing for 10 years, who have no plans to move, and think about their flexibility (13,14).  Going back to those trackers *affix hindsight glasses* had we selected a three year tracker rather than fixing we would have saved thousands in interest. This time we’ve taken information from a number of different sources, and used online calculators to think about our best financial options (15). Cardinal rule learnt: Always consult multiple sources, references and opinions before purchasing.

Where’s the risk?

Why didn’t we go for a tracker 4 years ago? We wanted to minimise our risk to a rising base rate. Despite being tolerant of risk in work and in cash/ stock investments in the past, I’m not for my housing. I started to think about why, and where the risk lay:

  1. LTV – How much you’re willing (or the bank is) to leverage your cash against future earnings.
  2. Monthly repayment figure – How much you’ll be paying back a month, and if you can afford it.

The two are obviously inextricably linked. Our LTV has improved to 80%, which looks to be optimal for interest rate offers. Risks/ costs worth considering:

  • Under-leverage – borrow less, with LTV 60-80%, and pay less on interest due to better rates and lower value. Buy a smaller property, but risk missing out on the extra equity caused by a potential increase in house prices.
  • Over-leverage – borrow more, with LTV 80-95%, and pay more interest due to higher rates. Buy a larger property, put more money in monthly, so more equity in the long run. Greater exposure if there is a house price falls resulting in more negative equity.

The tolerance for this definitely varies amongst my friends and acquaintances. The common theme amongst blogs I’ve read has been to leverage to your max, 90% at least, as long as you have a good duration (25 years+) of work-life human capital left. This seems to be driven by the view that property remains a good long-term investment option. Monevator does an excellent piece on this, although as it’s 2012 it’s a bit out of date (16). Just look at the long term trends below to get the picture:

house-prices

real-house-prices

Anecdotal evidence; I have a close friend who bought on a 85% LTV five years ago. He bought a property in an up-and-coming commuter belt, and the house value increased by about 25% (good on him). He took this and leveraged at 90% LTV on a thumping great Barratt executive home (le sigh), so in his early-30s is sat in a half-million pound house. He’s willing to tolerate the exposure because it’s their dream home and they intend to stay there 10+ years.

Historic Value

Digging a bit deeper into those trends to understand whether now is a good time to go max-LTV is difficult. The question; Have property prices always been a good investment? Could be a whole separate post in itself, but suffice to say it’s difficult to answer. Most property prior to the post-war housing boom was owned by landlords and rented out (are we heading back that way?). The British obsession with owning your own home is a new one. UK house price index data only reliably starts in the 1950s, but this LSE blog looks at land prices going back to 1892 (which helpfully are no longer published) (17).

Cheshire-fig-1

To unpick this data note that the value of the home is made up of the value of the structure and the value of the land combined. This blog by James Gleeson summarises dis-aggregating house price value (18). From it I take this graph:

test2

So, we see that the value of the structure increased slightly once inflation-adjusted, but residual values, i.e. that value of the land, is the source of most of the increase. This is also visible in the price of undeveloped land. Review the historic trends from the former LSE graph and we see that the increase in value is a modern phenomenon, and the long-term investment strategy of property is not so long term.

Short-term LTV Outlook

Again, another whole post in itself. In 2016 the UK Value Investor reckoned that UK house price forecasts weren’t looking good (19). Two years on and the market, as discussed in recent Full English Accompaniments, looks to be stodgy. Back then, UK Value Investor reckoned that house prices were in a bubble and due a crash. This was based on price to earning ratio data:

UK-house-price-chart-2016-11

From UK Value Investor (19)

Here’s a quick description of what that chart shows:

  • The black line – The average house price in each year
  • The red zone – Where the average house price would have been if houses were historically expensive, i.e. if the PE ratio had been between 5.5 and 6
  • The yellow zone – Where the average house price would have been if houses were at historically average valuations, i.e. if the PE ratio was between 3.8 and 4.5
  • The green zone – Where the average house price would have been if houses were cheap, i.e. if the PE ratio had been between 3 and 3.3″

The whole article is worth a read if you haven’t before. John predicts:

Expected capital gains from UK housing are zero over the next ten years

Which two years on looks pretty fair. His assumptions hold that house prices won’t crash, but will stay relatively flat while wages catch up. Worth considering if you’re buying now expecting a 10-20% increase in the value of your holding. Why waffle about this – it nullifies one of the arguments for a 95% LTV.

2. Monthly Repayment Figure

Back to our original list and the monthly repayment figure. A function of mortgage duration, principal sum and interest rate. I’m not going to go into duration so much, as this appears to be more a personal choice and dependent on how much human capital you have left. Opting to pay a short duration means more/ month, a long duration = less. People modulate their monthly repayment on big houses with high LTVs by going longer on their duration. The risk here is about what % of your earnings you’re going to be spending on your mortgage. Lenders set their affordability calculators on earnings, up to 4.5x, but this has got stricter. There have been concerns that borrowers who were previously approved will now struggle to remortgage due to the affordability rules (20, 21, 22).

The traditional model argues to aim for 35% of your pretax income to go on your mortgage, 45% at a push (23). Dave Ramsey advocates a conservative 25% of take-home (24). UK-wide this is on a downward trend, with Halifax reporting it’s dipped to around 29% in 2017/18, but with massive regional variability (25, 26). This has a complex interplay with affordability and price-earning ratio.

Mortgage Payment as %

4A420BC000000578-0-image-a-1_1521210565456

Bottom line – you don’t want to be paying so much on a mortgage you can’t afford other day to day activities. Money Advice Service and Money Saving Expert have good tools to work this out (15,27). The balance between fixing or tracking affects interest rate. Generally go for a tracker and it’ll be closer to the BoE base rate, go for a fixed rate and you’ll pay some percentage for the choice. Money Saving Expert also includes tools to compare trackers, or calculate if paying out of a fixed rate mortgage could be better value (28). People are fixing to avoid a base rate rise, and there’s various calculators available to help with this too, allowing you to calculate how much extra you would pay (27,29,30). The risk if you don’t fix – the BoE base rate skyrockets and repayments become un-affordable.

Anecdotal evidence; I have a colleague who’s a bit of a flash git. At 28-29, he owns 3 properties (from a standing start) and drives a new LR Discovery (on PCP/ lease). He achieved this by buying a small property straight out of university, sub-letting rooms, using the cash created for a second BTL property, and then leveraging that for a flat. All on about 80% LTVs. He works full time 48 hours a week in the medical profession, then does another 20 hours on top overtime to pay his mortgages. Just thinking about it gives me the collywobbles.

What have I learnt?

My risk tolerance for my mortgage is substantially lower than for investments. Our LTV is now 80%, we’ve opted for a shorter (2 year) fixed rate on our extension while our other fixed rate runs out, and combined these make up 39% of our take-home income. Once burnt, twice shy. We’re hoping to fix next year on the other larger principal, and that rates remain low. This seems likely looking at conditioning paths (31). Even if it rises to the long run UK average of 5-6% we’re comfortable. In face we’ve calculated that we can tolerate up to a 10% BoE base rate and still be ok. Those would be days of property price collapse, repossessions, defaulting and as Ermine over at Simply Living in Somerset teaches us the hooded figure of negative equity (32,33). We’re not at the 15% of the the mid-’80s, and it seems unlikely we will be any time soon, but my tolerance for the chance of losing my home is minimal (34,35). But if you have the stomach and the wallet for it, then maybe a tracker is a decent current option. Ultimately I’ve learnt I’m not willing to gamble my home or my family, and I’m not so gung ho after all.

The Fire Shrink

References:

  1. https://www.forbes.com/sites/mitchelltuchman/2014/03/14/understanding-your-own-investment-risk-tolerance/#7f0edac140f5
  2. https://www.thebalance.com/what-is-risk-tolerance-2466649
  3. http://www.bbc.co.uk/news/business-44055400
  4. http://www.bbc.co.uk/news/business-41831777
  5. https://www.theguardian.com/money/2018/mar/05/mortgages-fixed-rate-loans
  6. https://www.theguardian.com/money/2018/apr/21/mortgage-rate-highest-two-years
  7. https://www.standard.co.uk/news/uk/rush-for-fixed-mortgages-as-bank-of-england-rate-rise-looms-a3816071.html
  8. https://www.thesun.co.uk/money/6120079/interest-rates-could-go-up-twice-this-year-but-how-will-it-affect-you/
  9. https://moneytothemasses.com/owning-a-home/interest-rate-forecasts/latest-interest-rate-predictions-when-will-rates-rise
  10. https://mortgageadvisers.which.co.uk/about/blogs/
  11. http://www.bbc.co.uk/news/business-44065472
  12. https://www.ftadviser.com/mortgages/2018/01/18/downsides-to-long-term-mortgage-fixes/
  13. https://www.independent.co.uk/money/mortgages/is-a-10-year-mortgage-deal-a-fix-too-far-10237879.html
  14. https://www.moneyadviceservice.org.uk/blog/how-long-should-you-fix-your-mortgage-for
  15. https://www.moneysavingexpert.com/mortgages/mortgage-rate-calculator
  16. http://monevator.com/historical-uk-house-prices/
  17. http://blogs.lse.ac.uk/politicsandpolicy/land-prices-the-dog-thats-lost-its-bark/
  18. https://jamesjgleeson.wordpress.com/2017/04/03/historical-housing-and-land-values-in-the-uk/comment-page-1/
  19. https://www.ukvalueinvestor.com/2016/11/uk-house-price-forecast.html/
  20. https://www.theguardian.com/money/2014/apr/12/need-mortgage-new-rules-lenders-check
  21. https://www.telegraph.co.uk/finance/personalfinance/borrowing/mortgages/10787446/How-to-pass-the-new-mortgage-affordability-tests.html
  22. https://www.mortgagestrategy.co.uk/borrowers-lose-tightened-mortgage-affordability/
  23. https://www.moneyunder30.com/percentage-income-mortgage-payments
  24. https://www.moneyunder30.com/dave-ramsey-financial-peace-university-review
  25. http://www.thisismoney.co.uk/money/mortgageshome/article-5510061/Mortgage-payments-compared-disposable-income-region.html
  26. http://www.thisismoney.co.uk/money/mortgageshome/article-5510061/Mortgage-payments-compared-disposable-income-region.html
  27. https://www.moneyadviceservice.org.uk/en/tools/house-buying/mortgage-affordability-calculator
  28. https://www.moneysavingexpert.com/mortgages/fixed-mortgage-calculator
  29. https://www.which.co.uk/money/mortgages-and-property/mortgages/getting-a-mortgage/bank-of-england-base-rate-and-your-mortgage-albl35s6phq0
  30. https://www.uswitch.com/mortgages/interest-rate-rise/
  31. http://www.thisismoney.co.uk/money/news/article-1607881/When-UK-rates-rise.html
  32. https://simplelivingsomerset.wordpress.com/2014/04/06/when-not-to-buy-a-house-a-cautonary-tale-from-a-quarter-of-a-century-ago/
  33. https://www.financialsamurai.com/what-if-you-buy-a-home-at-the-top-of-the-market-and-a-recession-hits/
  34. https://www.theguardian.com/business/economics-blog/2014/mar/03/uk-interest-rates-a-brief-history
  35. https://www.theguardian.com/commentisfree/2018/may/10/celebrate-house-prices-falling-britain-property-values