Annual FI audit

It’s that time of the year when we take stock. Here at FIREvLondon, that means it’s time to do an ‘audit’ of our Finances, and our financial Independence.

Let’s take a look at some of the key questions an audit should consider.

Q1: What state is the balance sheet in?

I review the portfolio performance monthly, and it’s progress against ‘budget’ (i.e. target allocation). As this post highlights, December saw a very strong performance with net assets up almost 23%. An exceptionally strong performance, by historical or future standards, reflecting the 30% gain in the US stockmarket in 2019.

Liabilities remain very much under control too. The margin loan that provides my account with leverage amounts to just over 10% of the value of the assets.

Off balance sheet, the recent move to sell a key residential property and reinvest the money will provide further strengthening of the balance sheet.

Q2: How does the income statement look?

A year ago I borrowed a framework by {indeedably} in which he breaks down his assets and income. He has an unusual way of looking at his state of financial dependence, as shown by his (updated) image below:

Using this framework, 2019 saw me, like 2018, make a clear ‘profit’, or surplus, between total inflows and total outflows. However, from a Financial Independence perspective, i.e. stripping out earned income (and taxes on them), I saw a slight deficit – with outflows exceeding inflows. The chief reason for this was a very high level of expenditure on ‘wants’.

However, like any business, what really matters is the rate of change of these numbers, and some of the detail (‘notes to the accounts’, if you will).

My total inflows are up 10% on the year.

Inflows are up, despite my rent income being down about 30% (due to having had my Previous Dream Home vacant during the sale process). The last two years have seen my work change materially. I am now working full time – in fact rather hard – and all on PAYE. I’m not earning my ‘market rate’ but I’m not too far off it, and my income from ‘selling time’ is up 30% on 2018. My ‘taxes on time’ are, accordingly, up about 30% too.

But my outflows are up over 12%

Ouch. This deserves a deeper dive. What’s happening here?

• My ‘needs’ and ‘housing’ expenses are up 15-20%. In the scheme of things, these costs are fairly low numbers. Housing includes council taxes, cleaning, minor repairs, household consumables and gardening expenses. ‘Needs’ includes groceries (>£5k! not including wine!!), office lunch/food, utilities, public transport, and medical insurance/bills.
• My ‘wants’ are up almost 40%, to over £100k. The three big ‘wants’ are eating out, travel, and charitable/political donations; other, smaller, components are cars/taxis, entertainment/alchohol, gifts and other shopping. The increase in 2019 reflects a very expensive family holiday, some political donations in this year of elections, and some significant charitable donations.
• My ‘investment expenses’ are down by over £10k. Like {indeedably}, costs associated with rental real estate are ‘investment expenses’ – such as mortgage interest, service charges, estate agent fees, etc. Margin loans, bank charges (notably private banking fees) and fund charges all fall here. And, importantly, accountancy bills.

Looking at my total investing expense ratio, I have managed to slowly reduce my expense rates. My blended expense ratio has dropped to c.0.41%; excluding my private bank it has dropped to only 0.22% (from ~0.26% in mid 2018). This includes the platform fees, Ongoing Charges, Total Expense Ratios, and so forth (but not, in terms of this ratio, the interest charges on my margin loans).

A key question for normal audits is the cashflow statement. In my case nearly all of my reporting is on a cash basis, so there isn’t much to say here. However I did spend over £30k on ‘projects’ last year – ‘capex’, in business lingo – repairing a wall and such like that should, hopefully, see me good for 10+ years. These costs dwarfed the ‘opex’ of housing costs. I have a potential roof repair to factor into 2020 so these ‘project’ costs will continue.

Q3: What taxes are due?

My ‘blended tax rate’ (across all my/Mrs FvL’s accounts, including tax sheltered accounts, my Ltd company, etc) has risen to 30.8%. This is because my marginal tax rate is now 45%, the highest rate, not 40% as it was last time I did this analysis.

Bizarrely, my ‘taxes – other’ outflow is a surprisingly low number – possibly incorrectly so. My ‘taxes other’ expense amounted to less than 15% of my investment income, a much lower tax rate than my 31% blended tax rate. Partly this low tax rate is due to some ‘investment expenses’ being tax deductible. And partly it is due to angel investment tax breaks that I take advantage of. But probably some of this not sustainable.

Closely associated with taxes are accountants. My accountancy bills are significant. This plays into the next topic, complexity.

Q4: What are the key risks I face?

Most investors, when considering ‘risk’, would consider the likelihood of a market drop. For me that scenario planning is how I set my target allocation – which remains very long on equities for now, and I believe is robust to a severe market drop (admittedly my psychology may yet fail such a test).

Another key risk to consider is fraud/theft. As a high net worth individual I am worth targeting. Nonetheless, I think my defences are reasonably strong. Having multiple accounts gives me one layer of protection; paying close attention to my finances provides me with another. I abide by the basic rules of cyber protection – I use two factor authentication where possible, my passwords are secure, and so forth. This blog itself creates some additional risks but I try to remain alert to them and take steps to protect myself.

The issue that comes to my mind, under the heading ‘risk’, is in fact complexity. I remain overdiversified to a high degree. Increasingly, I am aware of the knock on impact this has on me – partly through the high accountancy bills I pay, partly on the stress I know my executors would face in handling my estate.

I do have a Will, but still need to create a Living Will (/Lasting Power of Attorney). But when my number’s up, the process of fulfilling my Will would be a complex one.

I get an inkling into how a third party would manage my affairs every year, when I file my annual taxes. I may yet post a separate blog post about this.

The good news is that I have managed to avoid the complexity growing, in the last 18 months, with the proviso that I am now using slightly more accounts (mostly for FSCS-related reasons). Here are how my ‘complexity metrics’ are faring as of 31 December, versus August 2018:

Metric	Aug 2018	Dec 2019
% of value in top 20 holdings	49%	55%
# of accounts – taxable (GIA/similar) accounts – pension/SIPP accounts – other tax sheltered accounts # of independent providers (e.g. my private bank)	16 – 7 – 4 – 5 8	19 – 9 – 4 – 6 9
# of unique holdings	168	167
# of holdings <£5k	3	0
# of Funds held	32	30
Minimum size of new position	£5,000	£5,000
Fees, % assets (excluding private bank account)	0.26%	0.22%

In conclusion, my affairs have had a good year, albeit in a good year. I have Financial Independence, without compromises, within sight. But I have work to do on the admin/complexity of my arrangements. Watch this space.