Samuel Taylor Coleridge once wrote: “Water, water, every where, Nor any drop to drink”. He was describing the unfortunate lot of a becalmed mariner, who finds himself surrounded by an ocean full of salt water, but sorely lacking in drinkable fresh water.
The older I’ve gotten, the more I think money and water share a lot in common.
We take it for granted.
It is a basic need for survival.
It is easily lost via splashing out, leaks, or evaporation when you’re not paying attention.
The more you have, the healthier and happier you are… to a point.
Too much of a good thing can become a bad thing. Sometimes a very bad thing.
And much like Coleridge’s ancient mariner, while there may be plenty of it sloshing around our immediate environment, often times it feels like a commodity in scarce supply!
How I money
I maintain a dedicated, fee-free, current account at a bank backed by the FSCS guarantee. The funds it contains are instantly accessible via debit card or internet banking whenever I experience an unexpected need for cash.
When water is poured into a glass, it first fills to capacity, then overflows.
My contingency fund works in a similar way.
All my personal cash flows are channelled into this account. Any excess balance, over an arbitrary threshold, is then automatically swept into my bills account.
What I like about this approach is the contingency fund is self-healing. It automatically replenishes itself, without my needing to think about it.
Long ago, I used to just hold a four-figure balance in my everyday banking account. Simple answers are usually the best ones, right?
Having my account frozen while on an overseas holiday cured me of that habit.
To give credit where it is due, the bank’s fraud prevention systems did this by design, acting when they observed someone attempting to withdraw money in a country I hadn’t previously visited.
The only problem: that person was me!
I subsequently established a stand-alone account with separate debit card access.
During the Global Financial Crisis, I witnessed some banks forced into shotgun weddings and others going broke.
I concluded it would be prudent to hold this account at a separately licensed bank to the one I use for my everyday banking.
Contingency funds should be held at a separately licensed bank to your everyday banking account.
Reward credit card
I apply a general principle of using a reward credit card for all my personal spending. The only exception to this principle is when a vendor charges a penalty or surcharge that would exceed the reward value.
Spending on the reward card is much like a water faucet. The more use it gets, the faster my money flows away.
The card I use is affiliated with a large chain of grocery stores. A typical year’s worth of household spending yields sufficient rewards to cover the family grocery bill for a month.
In the dim distant past, I faithfully used a card that accrued frequent flyer miles. At one point I even scored some “free” tickets to the Caribbean!
However once the school holiday travel constraints were applied, the notion of a family’s worth of reward seats on the same flight became a pipe dream.
A direct debit from my bills account automatically pays off the full balance of the reward credit card every month.
Reward cards fund a month of free groceries each year, providing the balance is paid off in full each month.
I maintain a second fee-free current account, held at a different bank, which is separately covered by the FSCS guarantee. Money held here is instantly accessible via debit card and internet banking.
Anyone who has attempted to put a toddler through the bath will know that bath time is one of the highlights of their day. Much fun is had as water enthusiastically gets squirted, splashed, and spilt around the bathroom!
After much study, I have concluded there is little correlation between the amount of water splashed around the bathroom and the volume of water originally contained in the bath.
Therefore more is generally preferable to less, to achieve a successful outcome managing finances or bathing toddlers.
My bills account provides the funding for all my expenditure that shouldn’t be made via the reward card. Here reside the direct debits and standing orders for things like utility bills, tax payments, and paying off the reward card balance.
This account also provides the funds for any non-leveraged investment purchases I may make.
Many banks over incentives for opening a current account with them. Shopping around can earn you up to £200.
Tax-advantaged investment account
From a financial well-being perspective, after the NHS, in my opinion tax-advantaged Stocks & Shares ISA accounts are one of the best things about being a resident of the United Kingdom.
At the time of writing, these magical accounts allow after-tax funds (up to a generous annual limit) to be invested in any listed company, under a promise that any income or capital gain earned from that point onwards will be entirely tax-free.
That is a very generous tax arrangement that very few jurisdictions are willing to match.
An ISA is like a sealed terrarium, where a finite amount of water is added to some soil and seeds, then it is left alone in the sun. Over time the garden flourishes without need of further intervention, creating a self sustaining eco-system.
Of course there is an ever present regulatory risk, that at some point the government won’t honour its promise. Until then annual ISA limits are an investing superpower that should be fully utilised.
I hold a Stocks & Shares ISA with a low cost brokerage firm.
Beware brokers who charge hefty platform fees, particular those based upon the value of your holdings.
Taxable Investment account
I maintain a second brokerage account for share investments made in excess of the annual ISA contribution limits.
If the tax-advantaged investment account above resembled a bucket, then a taxable equivalent resembles a watering can. Both happily hold water, but the watering can’s spout provides an easy means for water to escape. Taxes similarly drain on investment returns.
This account is held at a separate stockbroking firm to where I keep my ISA. As with the bank accounts, this mitigates some of the risk and inconvenience involved should a broker go broke or my account gets frozen for some reason.
Taxes take their toll on investment returns, but the tax tail should never wag the investment dog.
Line(s) of credit
Directly owned real estate investments have contributed materially to the growth of my net worth.
The ability to buy income generating assets using other people’s money, while retaining all the benefits of ownership, is a powerful thing indeed. Like any great power, it must be used carefully or it will end in tears.
Property investments remind me of ice cubes, as the investor’s equity is difficult to access while held in that form, just like water when it is frozen solid.
Many people use fixed-term or variable rate mortgages to finance real estate investments. These arrangements require the borrower to make regular repayments over an extended period of time. Each payment covers the interest charges for having borrowed the money, and sometimes a portion of the principal borrowed also.
A less common approach is the use of a Line of Credit facility.
These are secured loans like a mortgage, but operate more like a bank overdraft. The arrangement has an overall lending limit that cannot be breached. Within which the borrower is free to determine for themselves what (if any) repayments will be made during the life of the loan, and when.
Interest is only charged to the actual monies borrowed. There are no penalties for overpaying or redrawing capital. The price of this flexibility is higher interest rate charges.
When I am considering the purchase of directly held property investments I prefer to use flexible line of credit facilities where possible.
I never cross-securitise property loans, as this potentially creates a mess when the time comes to sell one of the properties securing the loan.
Home equity lines of credit provide great flexibility, but that flexibility comes at a price of higher interest rates.
Free cash flows and rebalancing
Closing the loop on my circular flow of money, the free cash flows generated by my investments are channelled back into my Contingency Fund.
The exception to this is tax-advantaged dividend income within my Stocks & Shares ISA. This income remains within the ISA wrapper, where it can be put work its compounding magic safely shielded from the eroding impact of tax.
During my accumulation phase, I rebalanced primarily via the investment of additional funds into asset classes where my current holdings were under-weight.
Now I periodically validate whether my actual asset allocations differed markedly from my target allocation. If this proved to be the case then I would likely take corrective action, but fortunately this has not (yet) proven necessary.
Funding my semi-retired lifestyle
One of the hardest mental adjustments to make when I shifted to a semi-retired working pattern was the notion that I would be consuming, rather than reinvesting, the free cash flow generated by my investments.
After 30+ years of accumulating, that represented a huge shift in mindset.
Even today, three years into my new working pattern, I still feel slightly guilty each time I withdraw the quarterly dividend payments from my brokerage account rather than reinvesting them.
I can only imagine how much stronger those feelings would be, were I to follow a “safe” withdrawal rate approach of selling down capital to fund lifestyle costs!
Eagle-eyed reader will have spotted the absence of pension accounts from this “How I Money” overview.
There are a few reasons for this, which would probably require a post of their own to discuss properly.
For now I’ll just observe that pensions can be a powerful tool in the personal finance toolbox.
For the right person.
In the right circumstances.
Indeed, they remain one of the most tax-advantaged ways to invest in the United Kingdom.
Like any tool, pensions work best when used for their intended purpose.
Time horizons, geographic arbitrage choices, and lifestyle preferences are all factors that determine whether pensions are the right investment vehicle for you.
Ask the audience
I’ve shown you mine, now it is your turn!
How do you money?