Saturday, 25 April 2015

Fire Fighting after FiRe - How to Manage an Emergency Fund when the Salary Stops.

The standard advice about a emergency fund is that it should contain 3 to 6 months' worth of expenses (or even more - for a heated debate on this take a look at this recent MSE thread). The reason given for needing to keep this amount of cash is "what if you lose your job?" However, by definition, this can't happen in retirement (although there are many flavours to FI, some of which will involve earning an income of some kind). At this point we need to rethink our calculation and reassess our actual requirements. Will we need an "emergency fund" at all when we are drawing a pension or living on savings/investments? If we do need one how should we assess how much we need to keep in it, and, crucially, how do we top it up when it gets depleted.

There is an interesting discussion about this on "Get Rich Slowly" - Is it Possible you don't need an Emergency Fund which started me thinking about our own situation. What kind of emergencies could we encounter?  - fire, flood, pestilence (a plague of pigeons :-))?  but anything catastrophic of this nature would be more than likely be covered by insurance. Medical emergencies figure heavily for Americans - according to Lisa's figures they represent the most common financial emergency, but they shouldn't cause so much concern to UK citizens. (However who knows what the future might bring regarding the NHS. As an aside one of the main reasons we would like to have a fair amount left to pass onto our sons is that they both have an inherited medical condition that could mean they have periods when they can't work in the future, or need drugs that the NHS will no longer supply. This worry and the threat of the possibility of one or both of us needing care home support is why we would like to leave our ISA funds in tact for as long as possible - so maybe this is a form of long-term medical emergency fund in itself.)

Our emergencies are most likely car, white good or kid related. I do not count holidays as an emergency (although taking one sometimes is :-) - probably not so much the case when you retire). Holidays, despite being paid for in chunks of cash, will continue be paid for by credit card when we retire and have been accounted for as part of our day to day expenses. Thinking about what has happened in the past and when we have unexpectedly needed cash it has generally been to make loans to the kids (some paid back, some not) for things like clearing student overdrafts, help with rent deposits and prop-ups so that they could complete their education. We have not (as yet) joined the growing number of parents who have helped their kids with buying a house but several of my friends have. If we do go down this route though it won't be an emergency. So, in the past the kind of figure we would be looking at that we might need at short notice could be up to around £3,000. In certain situations this could happen maybe 3 times a year - major car repair, fridge and telly both pack-up and the dog needs an operation.  This semi-educated guesswork gives me a figure for our own particular emergency fund of £12,000 going forward. I'm happy with that, it can continue to sit in our "high" interest Santander 123 account and hopefully seldom get touched.

But that's not the whole picture. In addition to this I do have to look at the bits of our income post retirement that aren't guaranteed. From when I retire at 58 and until I'm 66 and my state pension kicks in not all our required income will be coming from guaranteed sources. We will be relying on our rental income and dividends from our ISAs to make up between 30% (58 to 60) and 15% (60 to 66) of our £30,000 income. Neither of these sources are sure-fire or inflation linked. They are liable to fluctuate and may not always be available, or we may not always want to take them. In the case of the rental income we may have an extended void period or large repairs that eat into the rent. (I do only ever assess the annual income from the flat on 10 months' worth of rent but I want to be super careful here). In the case of the ISA dividends we might want to take advantage of a market drop to plough them back in and buy when things are cheap, rather than depleting the funds when they are low. In these situations extra cash in the emergency fund might come in handy.

Given that between £4,500 and £9,000 of our income over those 8 years is not entirely secure, it probably makes sense to have at least a years' worth of the average required (£6,750) available in the emergency fund. This should be added to my original £12,000 and can all be fitted into the Santander 123 giving a total emergency fund of £19,000.

So, I have my figure, we need a £19,000 cash emergency fund until I am 66 when it can probably be run down slightly. Getting the cash into the fund is doable - we currently have just under £14,000 as we've just used some cash to change the car. Making up the extra £5,000 won't be a problem over the next few months before my husband retires. The question that bothers me is how to keep it topped up once we have both retired and are maxing out our income. The whole point of the fund is that it will get used - although it would be nice if it didn't - so how do we fill it back up to comfort level when it does?

The only solution I can think of is to make a point of moving any capital gain from the ISA into cash as and when it becomes available? I have been doing a bit of rebalancing recently using a couple of funds that have made over 25% gain, sold some stock and bought more of assets I'm still a little low on. Should the same strategy be used to keep an emergency fund at the required level? It certainly makes sense from a "sell high" point of view and the whole point of the emergency fund is to avoid a situation whereby you are forced to sell when stocks are low. Of course the potential for more growth is lost by moving down into low interest cash but you are at the same time dodging the bullet of real loss if you need to sell at wrong time. I'm proposing the following sequence of events:
  • Son needs help with the airfare and living expenses for interview and then relocation in Toronto (this might actually be happening which is very exciting :-) He's just finished his PhD and is applying for a research position there.)
  • Remove £5,000 from the emergency fund 
  • Check ISA for any funds that are showing signs of good growth (this is independent of any ongoing asset rebalancing that is going on).
  • Sell an appropriate amount of any funds that are showing more than a pre-defined amount of growth (15%, 25%?)
  • Top up the emergency fund
  • If everything in the ISA is showing red do nothing, wait but rebalance ISA annually as usual if necessary. Wait. Wait. Hope emergency fund holds out despite deciding to use cash from it instead of taking dividends out of the ISA during the bad patch. Wait.
  • Breathe sigh of relief as markets start to rise again. Wait for strong growth and eventually take some profit and rebuild the emergency fund.

Any other ideas anyone?

Thursday, 16 April 2015

Wealth and Glamour - the "Chelsea" Effect

I had a rare (and brief) "reality shift" into the high life last weekend whilst visiting my son in London. We went out for a fantastic Sunday lunch at a semi-exclusive establishment which cost much more than I've spent on eating out for a very, very, long time. We had champagne cocktails to start with, a bottle of good wine and all the extras. I really enjoyed myself. Strangely, and a little uncomfortably, the large bill almost added to the enjoyment. After the "high" of the experience died down I began to wonder what it was that I had actually paid for?

Like anyone who makes a habit of being aware of how they are spending their money I automatically question the value of what I buy and weigh up if it's "worth" what I'm paying. I admit that this calculation, for me, is not always as simple or as "pure" as it is for some FI'ers. I'm quite happy to add factors into the equation that could be regarded as self indulgent or self-defeating from a FI point of view - time being a frequent consideration. For example, I might buy something at one supermarket that I know I could get cheaper elsewhere, just because I am already in the shop and it would take a chunk out of my free time to save the difference. Not worth it, in my view. Similar calculations about value might include stress-reduction, health, quality and social responsibility. It's not as simple as pennies and pounds.

But when I think back about the meal at the weekend I realise that one of the things that I must have been including in my calculation of the "value" of the meal was the glamour of the whole experience. "Glamour" is an interesting word. The archaic meaning is "a magic spell, enchantment or charm" but modern definitions refer simply to "exciting" or "attractive" and current usage of the word definitely tends to overlay associations of the excitement and allure of wealth. Was I happy to pay more purely because I was seduced by being part of all that affluence, was I paying to be "glamoured" (anyone a "True Blood" fan?) - I suspect so. That's not a comfortable realisation.

Co-incidentally "Made in Chelsea" is back on Channel 4 this week. It is a (very) guilty pleasure of mine, watched alone and in secret, seldom talked about or admitted to :-).  For those who haven't come across the series it is a structured-reality show featuring a group of very attractive twenty-something year olds living in London with more money than they can handle, no responsibilities and no grip whatsoever on what life is like for the majority of their contemporaries. Strangely enough, despite all the champagne-swilling, holidaying in Barbados and shopping in exclusive boutiques they seem no happier than "ordinary" people and they spend as much time obsessively discussing and dissecting relationships, crying, falling out and making up again, as young adults in all walks of life.

However the overiding theme of the show is "glamour" and the cult of the mystique of wealth; not what money can do, or buy, but what having money makes us into. Somewhere along the line we seem to have bought into the delusion that this equates to attractive, charming and happy. And that, apparently, includes me .... (or at least a small part of me :-))

Made in Chelsea cast (Facebook).
Mark-Francis (second from the right) expresses his disdain for the sort of people who would order beer-battered fish and chips: "You'd leave before they'd even finished the sentence!" he gasped, his face contorted into utter disgust.(

Thursday, 9 April 2015

Defining the Benefit. When to take a Defined Benefit pension.

Timing risk and when to draw a Defined Contribution pension are well documented. I was fascinated to read RIT's recent post on this in which talks about SWR and links to a video which uses historical data to illustrate that when a pension "pot" is put into drawdown is a major factor in determining whether or not it will last and that no withdrawal rate (whether 4%, or even less) can be regarded as "absolutely" safe but must be assessed in the context of the "value" of the markets at the time the pension is taken.

I was fascinated, but in a detached kind of way, because this kind of deliberation about "when" has never been considered necessary for those of us lucky enough to have index-linked DB pensions. Received wisdom is simple - never take a DB pension before scheme payment age if at all possible, actuarial reduction is to be avoided at all costs. But I've been thinking about this recently and have come to the conclusion that deciding when to take a DB pension is not that simple after all. We may think that it is but that is only because, unlike with a DC pension, it is easy to count the cost of taking the pension early, when what we should actually be doing is making some effort to measure this cost against the benefit.

As an example my own figures come out like this: (I currently have £35,000 in my SIPP and was intending to boost this up to around £50,000, retire at 58 and defer my LGPS till 65).
  • Pension if I take it at 65 - £9,300. Tax free lump sum -  £13,000. (When taken this this would be partly subject to 20% tax as I have a small amount of rental income, plus state pension would become payable at 66).
  • Pension if I take it at 60 - £7020. Tax free lump sum - £11,500). (This would be taken tax free until 66 as I intend to pay myself just enough out of my SIPP to take me up to the PA).
As I would get the pension for 5 years longer if I take it at 60, I will start to go into a "loss" at age 75 when I will be £2,300 pa worse off. I would therefore be down by around £35,000 if I live to 90 and this loss would increase year on year. Sounds like a bad deal and I should not even be considering it as an option if I can avoid it?

But what this calculation doesn't take into account are the benefits attached to:
  • Not having to stretch our finances to allow me to retire at 58 (in other words, the pressure is off as I already have enough in my SIPP. In fact I shouldn't put any more in there as I am already at the limit of what I can use tax efficiently should I decide to access my LGPS at 60)
  • Being able to take advantage of a tax free lump sum of £8,500 from my SIPP at 58 which could be re-invested in my ISA, in whole or in part. The rest of my SIPP would adequately fund the two years before I taking my LGPS.
  • Being able to access my LGPS tax free lump sum and AVCs at 60 instead of 65 (when my husband would be 71 and we may not be able to put it to such good use). My TFLS/AVC fund currently stands at around £16,000 but could be bumped up to £25,000 by paying what I was going to put into my SIPP for the next two years into my AVC instead. (It is a perk of the LGPS pre-2014 that the whole of the AVC fund can be used to boost the tax free lump sum - subject to certain upper limits that don't apply to me).
  • A big part of my income between 60 and 65 would be index-linked and risk free (via the LGPS) rather than managed myself via my SIPP (and therefore subject to market risk or inflation risk if I move it down into cash).

All the above add up to a clear win, for me, to taking my pension early despite the 24% reduction. This win is personal and depends on my lifestyle and situation, what it actually costs in monetary terms is just one of the considerations. After thinking it all through I'm pretty sure which way to go and have revised my targets accordingly. In fact the only one that I haven't yet hit is the one that means I need to add another £1,000 pa to my LGPS pension and that is simple to satisfy  - I just need to keep working for another 2 years.  

On a more general note, if things stay as they are with DB pensions and public sector ones in particular - which is unlikely but does provide food for thought - then it seems probable that some sort of "retirement age" gap could grow up between those with DC pensions, who let the decision on when they want to retire drive their saving and investing plans because no-one can actually tell them in advance what will be the best time to go, and those on DB pensions who just "expect" to have to stay in work until they reach scheme retirement age (which is increasingly being brought in line with State Retirement Age). Of course, there is nothing to stop DB pensioners funding (slightly) early retirement but it does need the foresight to set up an additional personal pension, a fair excess of salary over needs and a willingness to confront the horned beast of actuarial reduction, and assess the benefits of taking a hit on total pension received, in the context of the whole retirement plan, rather than with "just don't do it" blinkers on.

Knowing the financial cost of something is an advantage, but it can be a brake in just the same way as not knowing can (and maybe even more so). When deciding when to take a pension we should all make sure we take due diligence with our cost/benefit analysis and never forget that the only thing we can really be sure of is the value of time.

Wednesday, 1 April 2015

March 2015 Update

Portfolio Update Here.

Overall it's been another good month. At one point I actually hit my current ISA target of £70,000. This has slipped slightly again now but hopefully it will soon be consistently hovering around the mark (until we have a significant market fall that is - when and if that will happen seems to be anyone's guess so it's not worth worrying about.) For the time being I am calculating my investments with Abundance along with my ISA for the sake of simplicity. Although the interest on Abundance is taxable the recent budget changes regarding the £1000 tax free allowance on the interest on savings mean I am very unlikely to ever actually pay any tax.

I paid a fair whack into my SIPP in March (£3,000) but I have been thinking about my strategy for my pensions recently and may well be revising it (yet again). More details to follow.

On my current calculations (and current market positions) I have less than £16,000 to go to be on track for retirement in exactly 2 years time. My SIPP is key to this and I do still feel a little vulnerable to a large market drop with this. However I am protected to some extent by the CIS FSAVC which shouldn't lose much value whatever happens (famous last words). I intend to drop down to a less volatile position with the rest once I have transferred in the FSAVC around Sept time.

Since I started taking an active interest in our savings and investments one year ago I calculate that their value has increased by around £28,000 due to concentrating on budgeting and investing as much of our income as possible (around £8,000 has been in investment profit). Not bad for a year's work :-)

My Portfolio

Going forward we won't be making anything like the same kind of gains as my husband will be retiring fully in June. Still it does feel as if the bulk of the work has been done.