Declaration of financial independence?

Over the new year break I found myself really enjoying the blog post 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 image below:


His core point is that his level of financial independence depends on

  1. the amount of his expenses – some of which are ‘wants’ rather than ‘needs’,
  2. the level of investment income he can expect and
  3. how much ‘time he wants to sell’ (i.e. paid work he wants to do). He isn’t fully independent, but only ‘sells’ about half his time.

One thing that shows up clearly in {indeedably}’s graph is that investing can be expensive. In his case, a significant portion of his assets are property, and as a result his investing expenses appear to include a) mortgage costs b) property management and c) property maintenance – among other things.  I think they will also include his investment fund expenses/fees too.

Putting on {indeedably}’s glasses

I spent a few hours bashing my expense tracking data into a similar format to {indeedably} and now can view my cashflows on a broadly comparable basis.

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Avoiding tax in the UK

I was asked to help a friend of mine, a (~50 year old) widow, complete her UK tax return recently. In the UK the final deadline for filling in your own tax return is 31 January, and the process these days can all be done online via the taxman’s excellent website. Her finances were illuminating.

What is a rich widow?

This widow’s income is roughly as follows:

  • £45k of earnings. She is a freelance creative.
  • £25k of investment income, about half of which was taxable (‘unsheltered’). She has about £700k of investments, roughly half in tax-free accounts (ISAs/SIPPs), and half unsheltered. She has no other income-generating assets.
  • £10k of contribution to her pension. She is a (non-executive) company director of her ex-husband’s company which doesn’t pay her but does make £10k per year payment into her SIPP.
  • £12k of (realised) capital gains last year, all in unsheltered accounts .

This lady’s total income/gains last tax year amounted to over £90k. This puts her in the top 10% of the UK by income, but not the top 5%.

But how much does an ‘average striver’ pay in tax?

Now, before we continue with my widow friend, let’s have a think about ‘average Joanna’, a typical striver in the UK.

Consider Joanna, a (hypothetical) 50 year old who works full-time for the NHS, earning £45k (roughly the London average wage). For a like-for-like comparison, her pension (contribution, from her employer) and (NHS pension investment equivalent) income on top of this would add about £25k to her taxable income, all tax-free.

Joanna pays £6.6k of tax, and £4.4k of national insurance, totalling £11k of tax/NI. This works out as 24% of total gross pay.

How much tax does this ‘rich widow’ making £90k pay?

“the art of taxation consists in so plucking the bird as to obtain the largest possible amount of feathers with the smallest possible amount of hissing.” – Colbert, paraphrased

What total tax/social charges (National Insurance, in the UK) do you think she owes on her annual income/gains?

Before continuing reading, think of a number.

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Leverage reaches its limits

Longstanding readers will know that I have been an avid user of leverage, ever since I used it to buy my Dream Home in January 2016. At that point I was able to borrow funds, very flexibly, secured on my portfolio. And rates were well under 2% in all major currencies.

When I started my leverage journey, I was borrowing over GBP1m, in a ratio of 3:2 GBP:USD.  The rates on both were, from memory, between 1% and 1.5%. At this point the interest is more than covered by the after-tax dividend income on the securities, leaving any capital gains or untaxed income as leveraged upside. My main concern from having debt was not the financing cost, but the leveraged exposure it left me with – a 10% drop in markets would have hit my portfolio’s value by around 15%, and potentially left me vulnerable to the bank calling in some of the debt (via ‘margin calls’).

Since January 2016, base rates have started to climb – for the first time since the Global Financial Crisis in 2008. This change was long heralded and a long time coming.

I’ve been aware of the change in rates posture, but not been paying too much attention.  After all UK base rates have risen to only 0.75%.  Euro rates haven’t changed.  But I must admit I had somewhat missed the fact that US base rates have risen above 2%.  Two per cent!  That’s becoming a proper base rate.

In the meantime, I’ve succeeded in reducing my leverage very significantly.  In debt terms, by around half.  In loan-to-value terms, by more than that – because my portfolio has grown as my debt has shrunk.

I recently reviewed the rates I’m paying for my margin loan and finally clocked that now my USD debt is costing me over 3.25%.  IB’s rates start at 3.7% and then drop to 3.2% up to $1m of loan.  This much higher interest rate has made me reconsider my target leverage.

2018 11 20 USD IB rates

With USD rates over 3%, but my loan to value being around 15%, my main concern now is the financing cost / spread, not the level of exposure/risk.  Paying interest of over 3.25% out of after-tax income now requires yields of 6% or more, which is getting into ‘high yield’ securities only – something that I know from experience tend to deliver pretty poor total returns. Of course capital gains may yet deliver an overall gain, even after tax and interest costs, but that is much more of a gamble than I faced two years ago, especially with October’s correction still a very recent memory.

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