That feeling of existential dread.
Emerging a little as the weekend draws to a close, Sundayitis.
Experienced towards the end of a holiday, particularly the Christmas break with all its talk of new beginnings.
We get it while sitting in the waiting room at the dentist. When organising life insurance or a legal will.
Or in this case, while reviewing my finances.
Not the mindless updating of tracker spreadsheets. Nor the unthinking production of pretty charts.
No, the part I dread is the analysis. Critical assessment. Having issues brought to my attention.
Once seen, they cannot be unseen. Ignorance shattered, blissful no longer.
Something needs to be done. Action required. Changes made. Difficult conversations had.
Rationally, we know it won’t be as bad as it feels. Dishearteningly, it will be pretty much as we expect.
Dragging my inner saboteur kicking and screaming to sit down and do the work. Forcing myself to grind through it, wise to the endless tricks, excuses, and procrastination. Rabbit holes to go down. Distractions found. Desperate to be anywhere but here, in the moment, discovering inconvenient truths and thinking through their implications.
The irony of this is not lost on me, given that every now and then I write about personal finances.
In part, the dread comes from already knowing, roughly, what the numbers will say.
From suspecting that I won’t like the tale they tell.
After all, it was me who was doing the investing, saving, or spending. But that was down at the micro-level. Individual transactions. Hiding amongst all that noisy detail.
The menu of headline figures are many and varied. Allowing the humble blogger to cherry-pick those that support their narrative or inflate their ego.
Net worth up. I’m an investing genius! All alpha, baby! Maybe I should write a book…
Income up. Smarter, better looking, and more valued than ever before!
Others are less flattering. Excuses found. Explained away. Or not mentioned at all.
Expenditure up. Blame the government. Curse the Fed. Inflation, inflation, inflation.
Savings down. One-off this, COVID that. Treat myself, I deserved it after a tough year.
The reactions proving more instructive than the numbers. Irrational human behaviours are fascinating.
I caught myself exhibiting several of these behaviours. Grimacing at the expenditure figures, then making excuses.
“Capital gains tax on the disposal of a property, but I won’t be doing that again any time soon…”
“Nanny wages, but the younger child will age out of needing school pickups in a year or so…”
“Gift budget blowout, but I didn’t take any international holidays this year, so it cancels out…”
After spending a few minutes massaging my numbers into a more palatable reflection of normal I stopped and laughed at myself. What was I doing? When is any year ever “normal”? The specifics and timing may be unpredictable, but some random “life happens” events are bound to occur.
So I stepped back. Zoomed out. Adopted a broader perspective.
First, aggregating each category of numbers by year.
Second, adjusting each annual aggregate for inflation. By bringing each number to a common current purchasing power basis, it allowed me to distinguish between my own lifestyle inflation and externally imposed economic inflation. The former is within my control, the latter not so much.
The result allowed for a meaningful analysis of trends and time-series comparisons, as opposed to the nominal nonsense often served up in year-end summaries. The interesting part isn’t the numbers, but how they feel, which only inflation-adjusted numbers can provide.
Third, I calculated some averages to provide a basis for projecting into the future. The averages were calculated over the last decade, to smooth out genuine one-off peaks or troughs, and to ensure a more representative sample than that provided by these recent COVID years alone.
What did I learn?
My inflation-adjusted needs and housing costs, which combined might represent a “Lean FI” baseline, have been largely consistent since my younger son graduated out of nappies. This surprised me.
Meanwhile, my inflation-adjusted wants had bounced around like a sugared-up toddler at bedtime. This didn’t surprise me. The main variable being vacation spending, particularly trips home during peak school holiday periods. Adding wants to that “Lean FI” figure would get me to a rough “Fat FI” baseline, though one that optimistically but shortsightedly ignores taxes.
Out of curiosity, I decided to model how one of the retirement funding approaches commonly espoused by segments of the FIRE community might play out.
Coast-FI. Unfortunately, this one doesn’t result in beachside living, but rather is where a person decides they have already invested enough to fund a comfortable retirement in the future. From that point onwards, they save no more, preferring to coast their way towards retirement as time and compounding returns do the heavy lifting for them.
A key assumption built into this approach is the level of anticipated returns that will be achieved. Bloggers commonly cite a proxy, such as the S&P500 Total Return. Since its inception nearly a century ago, the headline S&P index produced an average annual total return of roughly 12%.
Except for most of us, this number will be optimistic. The index doesn’t suffer the drag of a multitude of anchors that investors may. Management fees. Platform fees. Brokerage fees. Foreign exchange fees. Withholding taxes. Dividend taxes. Capital gains taxes.
Few will have their entire net worth concentrated in US Equities, perhaps diversifying into bonds and/or global equities. Many diversify further, across asset classes ranging from property to crypto.
So if a 12% projected return before accounting for fees, taxes, and inflation is high, what would represent a reasonable proxy after all those fees, taxes, and inflation have been taken into account? This will be a subjective judgement call, with every person arriving at a different answer.
In my case, I looked back over the records documenting my 30+ year history of investing. An evidence-based figure is going to be a better guide than any number I made up based on solely upon selective memory and wishful thinking.
It turns out my average annual nominal gross return was just over 12%, comparable to that S&P500 total return figure, though I remember it requiring more work than riding a passive index tracker.
Crunching the numbers, I calculated how much I had paid in taxes on investments over the years: more than £500,000, ouch! Mostly stamp duty and capital gains tax on property investments, wealth taxes both, and diabolically difficult to avoid back when I still thought residential landlording in London was a good idea.
Sometimes I wonder whether those landlords swimming in the shallow end of the market in Northern England, where properties are priced below the stamp duty threshold, may not have been the smart ones? Then I remember how many properties would be required to make any real money, and the resulting quantity of tenancy hassles involved, before concluding the high-value low-volume approach was probably the right one for maintaining my sanity!
Next, I worked out a rough number for unrealised capital gains on investments I still held and which had appreciated in value. From that figure I calculated a provisional capital gains tax liability that would be due were I to liquidate my portfolio. It was an eye-watering sum, one that made me want to escape to my happy place.
Finally, I totalled up all the various fees and charges incurred in acquiring, holding, and occasionally disposing of investments I’d held over the years. It was heartening to observe how much fees have reduced over time, as competition and technology have changed the financial services landscape, mostly for the better.
It turns out I have averaged an annual return of between 4% and 5% after fees, inflation, taxes paid, and taxes notionally payable. Regardless of whether that outcome is good or bad, it is a world away from a naïve expectation of coasting into retirement based on earning a 12% compounding annual return.
Some of that damage could potentially be mitigated using tax-advantaged or tax-exempt investment accounts, keeping an eye on fees, and liquidating assets gradually rather than en masse. That said, it would be difficult to sell off annual slices of investment property, and (unlike Australia) it isn’t currently possible to hold an English property within a tax-advantaged pension wrapper.
The bottom end of that return range was 4%, coincidentally the same figure many within the FIRE community base their retirement numbers upon.
Which raises another key assumption, this time of withdrawal rates.
In this fantasy land of projections, where trends are linear and returns predictable, running a 4% withdrawal rate over a portfolio generating a 4% annual real net return would consume all future growth, leaving the original capital amount intact but capping future income streams.
Unsurprisingly, a lower withdrawal rate starts out with a lower income initially, but as the compounding growth of the residual invested amounts steadily increases, so too does the annual amount paid out for the FIRE-seeker to live on. In time, the income paid out by a 2% withdrawal rate would exceed that of 3% and 4% withdrawal rate strategies, assuming we live long enough to see it. The difference between enjoying cake today versus having cake tomorrow.
How accurate are those numbers? Not very. The only certainty is that the future will look nothing like them.
Over my 30+ year investment career, I’ve had three down years where I finished the game with less than I started with. Which was bruising to my ego, but fortunately not the end of the world. It did teach me that market returns are both variable and outside of my control, no matter how much I may have once believed it were otherwise.
On average, these numbers paint an attractive picture, but nobody lives the average.
Some years, a withdrawal rate will look ridiculously conservative.
Other years, that same rate may appear insanely generous.
It all averages out in the end, reverting to the mean, but with no guarantees that will occur within our preferred timescales or indeed within our lifetime.
Based on these projections, I might be financially independent already.
Assuming the assumptions hold up.
Assuming the future is as simple and predictable as my spreadsheet would have me believe.
Assuming my net worth remains allocated to productive investment assets, rather than spent on dream houses, Tesla cars, and rides in Jeff Bezos’ rocket ship.
And assuming it remains largely intact. Not decimated by divorce. Nor depleted as the Bank of Mum and Dad.
That feels like an awful lot of assumptions, several of which I wouldn’t bet my financial future on.
Not yet anyway.
- Slickcharts (2022), ‘S&P500 Total Returns by Year‘