The run up to Financial Independence (part 4)

By Slow Dad - June 10, 2017

What did I change to achieve Financial Independence? What has changed in the 12 months since then? I say no a lot more, and am much happier for it.
Last time around I ended my post poised on the edge of a metaphorical precipice. A glimpse of mortality had led to my questioning who I was, who I wanted to be, and what I was doing with my life. It ultimately boiled down to the question: “if not now, then when?”.

I took stock of my lifestyle, many aspects of which hadn’t been making me happy for quite some time.

I reflected on what I enjoyed, what made me happy, and what I derived satisfaction from.

Then I looked at everything else I was doing with my (now precious and scarce) time, critically assessing whether each action was in some tangible way contributing to achieving a warm fuzzy feeling of contentment.

If something isn't making you happy then why do it?

Would somebody die if I didn’t do it?

Would the sky fall?

Would the world end?

Almost invariably the answer was no.

If something isn't making you happy then why do it?

Of course there were some exceptions, like emptying the cat litter tray or helping my kids with their homework. In both cases, while unpleasant, these were necessary evils as the long term consequences of not doing them far outweighed the short term benefits of avoiding them.

Saying no to a bunch of stuff is the easy part

Still being able to make ends meet afterwards is a bit more challenging!

I took a deep breath and delved into my personal finances. Believe it or not I don’t much enjoy doing this, in fact it is one of the few things that will have me get me out mowing the lawn or vacuuming the floors just to procrastinate a little bit longer in the forlorn hope it magically goes away.

I do keep tabs on where my money goes once a month, but I’ve never been one for budgeting.

Indeed once I’d reached a sufficient level of financial comfort where I didn’t have to puzzle out how I would pay for something (which is worlds away from being rich!), the whole thinking about money thing seldom enters my head.

In fact one of the main motivators for my starting this blog was to force myself to think through various financial scenarios as they arose. The discipline of writing them up meant I couldn’t just pretend to be an ostrich and stick my head in the sand hoping they would go away.

To my simple mind the key to Financial Independence is cash flow. Have a big pile of (hopefully) appreciating assets is nice, but without selling some of them you can’t pay for the groceries.

On the other hand one of the reasons most of us are employed is to get that warm fuzzy feeling when our bank account gets topped up with our pay cheque. People feel richer at bonus time because more money is flowing in, while they often feel poorer after Christmas or after their summer vacations because money is flowing out to cover credit card bills.

I looked at the money I had coming in

Income from my business accounted for a large portion of it. However if I was going to pull the pin on working then this would reduce or be eliminated altogether.

Next came rental income from my investment properties. These generated quite a bit, indeed a couple of the central London properties each earned more in annual rent than the average UK worker earns per year.

Then there was a mixture of dividends and interest. Collectively these generated a few thousand per year, but weren’t life changing.

So the income side things were looking ok.

Then I looked at the money going out

This is the point in the story where dark clouds gather overhead, sinister music plays, and the hero gets a feeling on impending doom.

In aggregate my investment expenses were more than covered by the investment income... but not much more!

Property mogul

I tend to purchase property based upon extensive research and analysis, identifying locations that are set to experience above average capital growth over my investment time horizon. This approach focuses on the potential of the property, and surrounding area. Getting this right has achieved some pretty impressive returns, but it can mean the rental yield has been more about minimising holding costs than generating a sustainably comfortable income stream.

Over time the value of the properties tended to rise, building up the amounts of accumulated equity I possessed in each property. Each time this accumulated equity crossed the threshold of another property deposit I would extract the equity to finance the next property purchase. This is where flexible lines of credit financing really comes into its own.

It is worth pointing out that I never draw down further than the rental income of the individual properties could comfortably cover, meaning additions to my property empire were entirely funded by the property portfolio itself.

Image credit: William Warby

Cash flow neutral for tax minimisation?

Historically I had tended to run my portfolio at a cash flow neutral gearing level. This was fine while I was in the acquisition phase, but if I wanted to start living on this rental income then I was going to need to change strategies a bit.

My rationale for operating cash flow neutral is a bit dubious. I long ago figured that if I made a profit then I'd have to pay tax on that profit, and I already paid far too much in taxes.

However with a bit of age and wisdom behind me I suspect that line of reasoning to be mostly bollocks, as even if I paid 50% of any profits in tax I would still have been left with the residual 50%.

From an academic perspective it would be interesting to run the numbers and see how differently things would have worked out had I operated with lower gearing / higher income equation. I suspect I would have ended up fewer properties, but am not sure whether or not I would have been financially better off.

Time to reassess

For the first time in a long time I critically assessed each property in my portfolio, reassessing the capital growth prospects and rental yields that were now achievable using a variety of gearing levels including paying each one off entirely.

One property I had owned for nearly 20 years. Much of the above average capital growth I had anticipated when buying the property was now behind me, the areas having experienced growth due to infrastructure improvements or the establishment of a shopping centre nearby, or whatever.

Things don’t always go as plan however. I bought one property on the promise of a neighbouring golf course expansion, and the creation of an exclusive neighbourhood wrapping around the extended course. Unfortunately that didn’t eventuate, due to the local government rescinding planning consent because of the discovery of some rare endangered creepy crawly that happened to inhabit the site.

Too much of a good thing?

Having reassessed the future prospects of each property, I made some strategic sales.

I sold a well located flat in a posh part of London, as the property market in that neighbourhood was driven by foreign investors.

Under the prevalent nationalistic “foreigners go home” government migration policies, combined with the increasingly anti-landlord orientated tax regime, the overseas investors were starting to look elsewhere (like Vancouver, Toronto, and Sydney).

New developments were being mothballed, partially completed ones were not selling, and there remained a lot of uncertainty as to whether this was just part of the normal property cycle or a more structural change in a post-Brexit Britain.

An uncertain post-Brexit property market

The money raised was used to rebalance my asset class allocations, choosing to invest in low cost index tracker funds and low cost bond funds.

In other cases the money realised from property sales was used to pay down the lines of credit over some of the properties I retained.

The end result? A property portfolio that still possessed the promise of capital gains (thought I’m less confident of the long term prospects of the UK based properties post-Brexit), but now after expenses throws off a significant stream of passive income.

Stocks and bonds

I looked at my stock portfolio. Historically I’d been an avid (though sporadic) stock picker. Sometimes I’d even done well in my selections. However I’d done a lot of reading and researching into the argument that low cost index trackers were more likely to outperform stock pickers over the long run.

I sold out of most of my direct share holding positions, retaining only those companies that had significant strategic advantages in their markets, what Warren Buffett describes as a moat. I invested the proceeds in low cost index trackers and low cost bond funds.

The combined stock and bond portfolio now has a dividend yield of around 2.5%, which is pretty low but also fairly reliable.

Where did that leave things?

I listed out my lifestyle expenses, starting with my needs.

The dividend income covered these comfortably. I should never need worry about paying a gas bill or buying groceries again. Result!

Next I added my investment expenses.

These were also covered by the dividend income stream.

Finally I added my wants, the remainder of what it costs to be me (excluding housing). The dividends covered these too. That takes care of things like my broadband bill and Sky Sports subscription. Winning!

So close, and yet so far

It wasn’t all good news however. The eagle eyed among you will have spotted that there is an elephant in the room, my housing costs.

Those exceeded the remaining dividend income. And the rental income. So there remains some work to do.

However the great thing is I had gotten to a point where I could comfortable live without having to work full time, or work for clients whose only redeeming feature is they pay well. Instead I now had the luxury of picking and choosing projects based more on interest than remuneration.

Providing I worked roughly 3 months a year I could sustainably support my living costs without needing to resort to selling down assets. That really appeals to me, as I’m not a big fan of the safe” withdrawal rate concept… I’d prefer die with a big pile of assets to leave to my kids rather than play chicken with mortality, hoping my life runs out before my assets do.

What has changed?

12 months after I realised I was Financially Independent a few things have changed.

I took 7 months off, and didn’t miss working even a little bit.

I looked at working part time, maybe 10-15 hours a week. Unfortunately in my game those kind of roles just don’t exist.

The next best option was to adopt a seasonal working pattern, enjoying the sunshine and warmer weather through the spring/summer/autumn... then hiding out in a nice warm office somewhere over the winter while working on an interesting project. I’m just coming to the end of my first seasonal working stint and I have to say that I’m very much looking forward to resuming my retirement. The re-entry to the work force was brutal, and I’ve found putting up with the office politics and institutional silliness to be more frustrating than it ever used to be.

So what?

Long term I’d like to find a few recurring clients who wish to engage my services remotely for sporadic interesting projects. Whether that transpires or not will be interesting to see.

Relax, work remotely, enjoy life.

I’m playing the long game when it comes to addressing my ridiculously high cost of housing. My kids are happily settled in schools, my wife loves where we currently live, and the prospects of moving somewhere cheaper are somewhat remote. Having moved 13 times in 19 years I must admit the idea of packing things up yet again isn’t one I’m in a particular hurry to repeat.

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  1. Addressing the cost of housing so as to be FI in London seems like a very difficult challenge, even for solid earners. And as I think you alluded to somewhere, it's also not really practical to live in a ritzy borough with a family and lead the "baked beans on toast/tuna and two-minute noodles" lifestyle. A living standard that is too far away from "normal" has it's consequences :)

  2. Thank Cameron.

    For mine the key is where you draw that baseline of "normal", more so than the location or house price.

    I lived in Kensington quite happily in a flat I owned outright for 6 years. My non-housing related outgoings were consistent with what they would have been just about anywhere in London, in fact this is one of the main reasons I account for housing costs separately to other "needs".

    However we were definitely viewed as one of the "poor" families at my son's school because we didn't summer on Lake Como or drop the kids off in a shiny new Porsche Cayenne. I watched in equal part horror and fascination as some of these families would drop thousands on a 5 year old's birthday party.

    Eventually my family expanded beyond the capacity of the flat, so we moved on while retaining and renting the property out. My son moved to an amazing state school, and with pretty much the same level of non-housing outgoings we're probably now viewed as one of the "rich" families! Perspective is a wonderful thing.

    I really miss the neighbourhood, having Holland Park as a backyard, High Street Kensington and Westfield as the local shops, and the amazing Hare & Tortoise as the take away on the way home. However (perhaps unsurprisingly) I don't miss the often chichi pretentious people even a little bit!

  3. Thanks for sharing your journey to FI, Slow Dad - it's been an interesting read. Sounds like getting into property has been key for you.

  4. Thanks weenie. Property has been (mostly) good to me, but I think it has been the ability to use other people's money without the risk of margin calls that was the true enabler. I

    I've been fortunate that the bottom hasn't fallen out of the market where I've invested, though one locale where I owned four properties experienced no capital growth for 7 years due to an arbitrary government decision (much like austerity really). Eventually common sense prevailed, the silly policy directive was reversed, and growth returned... but it made for a bumpy ride and served as a reminder that regulatory risks are one of the elephants in the room when it comes to early retirement.

    In a similar vein SIPPs and ISAs are great vehicles today largely due to their tax advantaged status, but were that to be watered down or removed entirely it would ruin many an investor's day. It sounds far fetched, and hopefully is, but then so did private landlords losing the ability to offset financing costs against the investment income generated from that same financing!

    I guess the moral of that story is make hay while the sun shines, but also to plan on the basis that nothing is certain or forever (e.g. pension age, state pension eligibility, etc).