Retirement seems a long way off but time has a way of passing without you realising. Days can drag as weeks, months and years flash past. I often think about some of the financial mistakes I’ve made in the past and how much further along in my plans I could be now had I learned certain lessons earlier in life. There’s little value in dwelling on the past though. My plan is to be able to give up paid work at the age of fifty which is just over fifteen years away. I may decide to continue working at that point, but the plan calls for me to be able to make that choice on my own terms without being trapped in the “rat race” and having to work for someone else to make ends meet. So far, I’m on track but I’m impatient. I want to have more and I want it now.
I’m signed up to a pretty good pension through my employer but a private pension, and state pension, will not be enough to give me the quality of life I desire in my later life. I want to be comfortable in later life, not having to worry about paying for either food or electricity because I can’t afford both. It seems tragic to me that most people work hard for their best years and then have little left over in retirement. As our society changes and we generally live longer, the strain on the economy is starting to tell. One only has to look at the NHS for proof of this. I’m not convinced that the same level of welfare will be available to people in my generation when they get to their retirement, as is available to those currently in their retirement. Something will have to give at some point.
In my experience, most people do not really understand how pensions work. I’m not an expert either, but I think I have a better understanding than the average person. The same people who think that pensions are “safe” tend to think that the stock market is “risky”. These people will be surprised to learn that many pension schemes are actually linked in large part to the performance of the stock market, with pension contributions used to purchase units in trusts or funds that are invested in various stocks. The two, pensions and the stock market, are so closely linked that to say one is “safe” and the other is “risky” is just a completely absurd statement to make. The only risk here is not having a full understanding of what your retirement plan is or how it will be achieved.
Will you want time in the sun after retiring? You'll need more than just a basic pension.
In FU Money, Dan Lok talks about your “number” which is the amount of money at which you will have the life you want. I can’t remember the specific items on Dan Lok’s list, but he details all the different things he spends his money on and arrives at an annual figure. I think Dan’s figure was in the region of $600,000 per year, but I’m ready to be corrected on that. Not everyone will have the same figure. Some people will have more modest desires and they could be happy with £12,000 per year, assuming they have no costs for housing. The point is to have a figure and an idea of what life you want. Make a list of all your different financial commitments and what they cost. Use that as the basis for your figure for retirement. The earlier in life you think about this, the better your chances are of achieving it. I have a figure in mind that will see me live a comfortable life when I hit fifty. I’m not going to talk about my figure specifically as it is private to me, but I will talk about my strategy for reaching that figure.
I made a decision when planning my retirement to ignore inflation in an active sense. If I was to factor inflation into my planning I would drive myself insane looking at spreadsheets and calculations. My somewhat simplistic approach is to assume that my cost of living in fifteen years will increase in line with inflation, but the value of my investments will also increase roughly in line with inflation and perhaps even outpace inflation. If we are looking at annual inflation of roughly 2%-3%, then so long as the value of my investments increase by more than this, I am doing well. Generally, the stock market will have peaks and troughs but over an extended period it will return anything from 3%-8% and sometimes more. Most cash savings accounts offer a derisory return of under 1%.
I have three main areas that I invest in; property, stocks and bonds. The primary goal is to generate passive income; income that is generated for me without any work needed from me.
I’ve spoken before about how I don’t think Buy-To-Let is a good idea for most people. I invest in property through crowd funding, which are generally large apartment blocks or student accommodation. I buy shares in these properties and earn rental income as dividends. Each month I roll up my dividend and reinvest that money into more shares in those properties, as well as using some of my earned income to buy additional shares. At present, I’m getting a 5% return on this investment. Rather than my return depending on just one or two dwellings, my investment is spread across dozens of different dwellings which reduces the risk to my investment.
I also invest in the stock market. I have shares in five different UK companies. I chose each stock after careful consideration and research. A good starting point for anyone looking to understand the stock market is the book Shares Made Simple, which I have linked below:
One requirement I had was for the stocks to have a stable dividend record. I now receive a dividend ten months of the year from my portfolio of stocks. Again, each dividend is rolled back up into the overall investment. There are lots of different platforms for buying and selling shares. For those investing modest amounts, there are platforms that offer a certain number of commission free trades per month, such as Trading212. I don’t personally like Trading212. I find the interface complicated and difficult to navigate. Some people swear by it though. There are other platforms that offer various levels of commission to buy and sell shares on an ad hoc basis, with smaller fees charged for regular investments where you invest a certain amount each month.
I use a service from a high street bank that is simple to use and charges a very low commission for regular investments. If I want to sell my shares, the commission is higher but I have no intention of selling these shares. My dividends are paid directly into my bank account and then I either use them to purchase more shares, or I direct that dividend to a different investment.
With interest rates being so low for regular savings, I choose to keep my cash in Premium Bonds. I know this will not make sense to some people as Premium Bonds do not generate a return as such, but rather pay out monthly prizes. My reasoning is that a typical cash savings account will generate just a few pounds for each thousand deposited. This is not really of any value. It’s a good idea to have some money that is fairly liquid and Premium Bonds offer that. I can sell the bonds and have the money in my account within a couple of weeks. For any major emergency I have a decent credit limit that I can use whilst those bonds are being sold. It’s difficult to envisage a situation where I need to pay for something that cannot be paid for by credit card until those funds are free. There is also the possibility that the bonds will win a big prize. To me, there is more value in a potential big prize than a definite insignificant return.
Education is the key to understanding the stock market.
I’m approaching a point at which I need to spread my wings and look at foreign investments. I don’t feel comfortable keeping all my eggs in the UK basket, especially with Brexit looming on the horizon (something I’m still not convinced will actually happen, but that’s a different subject). I think the next part of my financial education will be looking at how to invest in foreign markets without paying lots of commission. Whether or not Brexit actually happens, I don’t think we will see major capital gains in the UK stock market for a few years. I’m also concerned about investing in the US as I see their political situation as a powder keg ready to explode at any moment. Perhaps something in Europe or the Far East could be an idea, but I definitely need to do my research.
The only risk with investing is not doing the research. Investing without research is gambling. You might win, but you’ll probably lose. One of the best bits of advice I have discovered is that in any investment opportunity there is a winner and a loser. If you don’t understand the investment, then you are probably the loser and someone else is making money at your expense. There are two areas of a person’s financial life that should receive a lot of personal attention; your mortgage and your retirement. In my experience, these are the two things that people ignore or only give a small amount of attention to every so often. As some of you will know, I’m a mortgage advisor and I speak to people about mortgages for over thirty hours a week. It never ceases to amaze me how many people will base their decision, not on qualified advice, but rather the opinion of a friend or family member with no qualification or experience in the field.
Take control of your financial future. It does not cost much to learn, especially in the internet age where there is a vast library of information available for free. There really is no excuse for ignorance in 2018. I’ve included some links to some books that I have found useful in improving my financial education. I hope you will find them just as useful.
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A friend of mine has been messaging me over the last few days asking for advice and information about buying a property to rent out. I’ve done my best to answer his questions, but ended my reply by saying that I don’t think he should go with a buy-to-let (BTL) if he wants to make money. There are other ways for people to make money with less risk and greater return.
Before going any further however, a few points.
First, I am not a qualified financial advisor. What follows is my opinion, rather than advice.
Second, I am a qualified mortgage advisor so I think I have a decent understanding of what it takes to obtain a mortgage.
Third, the following article is aimed at a particular audience. It is not aimed at those who are experienced in property and investing. It is not aimed at those who are wealthy with lots of disposable income and can afford to take risks. It is not aimed at those buying property under the umbrella of a Limited Company.
This article is aimed at those who may not be financially confident or experienced, and who believe that buying a BTL is a safe, guaranteed way to make money.
Money pit or gold mine?
For the sake of clarity, I will use an example property based on research and experience. This property will be a two-bedroom apartment in Sheffield city centre. The property is on the market for £120,000.
How does BTL work?
With a BTL mortgage the deposit requirements are normally higher than for a property you are going to live in yourself. For a residential mortgage you can normally put down as little as 10% subject to lending criteria and credit scoring. For a BTL it is normally expected that you will put down a minimum of 25% and often you need to put down at least 40% of the purchase price to obtain good interest rates. In our example, assuming my friend goes ahead he will have to put down £30,000 as a deposit as a minimum.
Running Upfront Expense Total: £30,000.
The deposit is not the only one-off cost to be paid however. For a BTL, Stamp Duty will also be payable at a rate of 3% of the purchase price up to £125,000. Beyond this Stamp Duty rises to 5% and then 8%. So, in addition to the £30,000 deposit, my friend will have to pay £3,600 in Stamp Duty.
Running Upfront Expense Total: £33,600.
There will also be valuation fees and legal fees to consider. Some lenders will offer a basic valuation service which checks that the property is basically in liveable condition. It will not be a full and thorough survey. The costs for these can easily range up to £1,000, although the less detailed surveys can cost just a few hundred. The question is how much of a risk are you willing to take? You could spend tens of thousands in deposit and fees and then scrimp on your survey and find the property needs thousands of pounds worth of repairs. None of this accounts for the legal fees which can easily account for £500-£1,000 as well. Assuming that my friend went for a comprehensive survey and found a reasonably priced solicitor the total fees here could come in at around £1,500.
Running Upfront Expense Total: £35,100.
Is the property going to be furnished or unfurnished? If furnished, then this can easily add on a few hundred to a few thousand more depending on how far you want to go. I’m not going to get side tracked too much here except to point out that this is just another expense to consider. Let us assume my friend goes the unfurnished route.
So far I have described some of the upfront costs that will need to be considered. This list is by no means exhaustive and there are always going to be unexpected expenses when buying a property. If you are going to rent out the property there are also health and safety checks to be carried out for the gas, electric and so on. I don’t have experience in arranging these, as anytime I look at investing in BTL I add up the costs to this point (as well as the ongoing costs) and usually decide to invest elsewhere.
Another consideration is whether my friend will manage the property himself. Will he draw up the contract or use an off-the-shelf contract? Will he collect rent himself? Will he organise any repairs and maintenance that will come up from time to time? Will he deal with the inventory at the start and end of the tenancy? Will he advertise and market the property himself? Complete referencing and vetting of prospective tenants?
Renting a property out and managing it yourself can become a full-time job. I know a lot of people who have dabbled in BTL, managing the property on their own, and not a single one of them has found it rewarding either personally or financially. So the other option is engaging a management company or letting agent.
I’ve googled a reputable letting agent and calculated their fees based on this information. The property my friend is looking at should rent for £600-£650 per month. I’ll go with £650.
Arranging Viewings and General Marketing: One month rent + VAT.
Tenancy Set Up: £300.
Rent Collection Only: 10% of rent payable.
Full Management (Rent Collection in addition to maintenance and other related services): 13%.
Extend Tenancy: £150.
This does include fees for statements, billing, key-cutting, extra property visits and so on.
So, my friend would have to sacrifice his first month’s rent and pay VAT (20% of £650 = £130) on top to just arrange viewings and market the property. Then an extra £300 to set up a tenancy.
Running Upfront Expense Total: £35,530.
Net rent received after letting agent cut (full management): £520
The main ongoing cost is going to be the mortgage. Assuming a 25% deposit, you can probably expect a rate of between 1.5%-2.5% depending on lender and whether you will opt to pay a fee. Many BTL deals will come with a fee. Assuming a modest fee of £500 for the interest rate, which comes in at 2.0 % and assuming the mortgage will be interest only the monthly payment would be around £150.
Running Upfront Expense Total: £36,030.
Net Rent after mortgage: £370.
It can be time intensive to have to calculate all these costs as a landlord.
It’s important to remember that on an interest only mortgage none of the debt is being repaid. At the end of the mortgage term, the debt will need to be paid back in full. It’s also important to remember that once the initial interest rate ends, the rate will likely jump up and it can easily revert to a rate double that of the initial rate. The alternative is to switch to a new deal (likely coming with product fees again) or even switch lender (product, legal and valuation fees to be paid).
For this property there are other costs to consider. A city centre apartment will come with service charges and ground rent. I see these costs regularly through my job and this sort of property will easily have a minimum ground rent of £100 per year and almost certainly service charges that amount to over £75 per month.
Net Rent after service charge: £295.
Tax is another expense. I’m not a tax expert, but when I’ve looked into this for myself the information seems to suggest that you are allowed some reasonable expenses to be removed from the tax calculation but this does not amount to much. My friend is a basic rate tax-payer and will pay 20% tax in this band on income received.
I’m not sure if my friend would be taxed on the rent before agents’ fees are deducted or after. To load the case in my friend’s favour I will assume it is taxed on the amount received after the agent takes their cut; so 20% of £520 which comes to £104
Net Rent after all previous charges and rent: £191.
As I’ve mentioned, I’m not a tax expert or a financial advisor and some of this information may not be entirely accurate. Please do the research and feel free to comment with any corrections.
In addition to what has already been covered, there are other costs to take into account. The first to mention is “void periods”, which are the periods of time in which the property may be vacant. Although your property may be between tenants the utility companies will still expect to be paid, and so will the mortgage lender. A good rule of thumb is to account for one month “void” per year.
Net Rent (accounting for a 1/12 reduction of gross rent annually): £136.
Landlord’s insurance is another cost that is often overlooked. Some google-fu suggests policies can range from £15-£25 per month depending on how much cover you want.
Net Rent assuming basic cover: £121.
In summary, my friend will have “paid” upfront £36,030 to achieve a potential return of £1,452 per annum. This assumes only one month “void” per year, and that the tenant does not keep changing (as would cost more with agent to draw up additional tenancy agreements). It also assumes the tenant will actually pay their rent. I know two people who have had BTL with tenants that refused to pay rent. It is remarkably difficult to legally evict a tenant that is not paying rent.
£1,452 / £36,030 = 4.03%.
For all the above stress, effort and uncertainty the best my friend can hope for is a return of 4.03%.
Becoming a landlord is hard work. It’s stressful. There are no guarantees that money will be made. Many properties can become a black hole into which money disappears. It is difficult to get your money back. In my opinion, BTL should not be considered by those who are not financially literate or experienced. Don’t misunderstand me, I am not anti-property. I invest in several properties through other channels and receive my own rental income but this is all passive income with no day-to-day involvement from me. My return ranges from 4%-7% across the six properties I receive income from. I also invest in the stock market with companies that have a track record of paying dividends. I’m earning between 5% and 7% on these investments with no day-to-day involvement from myself. It’s completely passive income.
If my friend has £36,030 to invest there are plenty of other options other than BTL, and many other options for someone that is starting their financial journey. My opinion is that a BTL should not be a person’s first investment. The first investment should be improving one’s own financial education. From that point on, the mysteries of the stock market and beyond will become clear.
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Anyone with a passing interest in psychology will have probably heard of Maslow’s Hierarchy of Needs (HoN). Here is a visual representation of the Hierarchy of Needs.
By FireflySixtySeven - Own work using Inkscape, based on Maslow's paper, A Theory of Human Motivation., CC BY-SA 4.0, Link
The HoN is supposed to demonstrate the personal development of people as they move from the lower base of the pyramid to the upper levels. The idea is that you can’t sufficiently achieve the higher levels without building on the foundation of the levels below. I’m not going to focus too much on the different levels in Maslow’s theory as that is not the focus of this blog, but rather I wanted you to have an idea of the structure of the pyramid as I discuss my ideas around the Hierarchy of Financial Needs. If you want to read more about Maslow’s HoN there is a link to the Wikipedia entry at the bottom of this blog.
This is my proposed Hierarchy of Financial Needs (HoFN).
The base of the pyramid is Shelter, Warmth and Food (and water). These are the basic physiological necessities of survival. We need to be protected from the elements. We need our bodies to remain at a comfortable temperature and we need food and water to sustain us. These are the absolute fundamental parts of human survival and it makes sense that most people pay their mortgage/rent first and food shopping is a priority for spending.
The second level up refers to things that are not essential but are almost essential. Things that we generally need but if it came to a choice between spending your last tenner on food shopping or a haircut, most people would choose food.
The third level up is, in my experience, where people generally fall down. It comes down to how you prioritise your spending. There was once a time, not that long ago, when the internet was a luxury. I would now argue that it is a basic utility like electricity or water. However, there are huge differences in how you can purchase internet access. It is possible to buy mobile home broadband via a dongle or pay-as-you-go router for as little as a tenner a month. This will let people complete everyday stuff online but will probably struggle with streaming video or gaming. A quick bit of google-fu shows that you can get superfast fibre broadband with BT for anything up to and possibly over £55 per month. I’m not even sure if this includes line rental or not. But that is an eye-watering figure for internet access in my opinion. I have fibre broadband with unlimited data for £22 per month with no line rental.
I used to sell phone lines and broadband for one of the major providers. The number of people that had no clue what they were paying for was staggering. There were people who wanted to pay top dollar for superfast broadband and when I asked them what they used the internet for, it was things like general browsing and the occasional email. That person does not need 20mb speed. They could probably get by on a quarter of that with no real issue. However, they did not bother to spend a bit of time researching what they needed and it could end up costing them three or four times as much for internet access.
There is a similar issue with TV packages. I pay for my TV licence (£12 per month) and I also have Netflix (£8 per month) and Amazon Instant Video (roughly £80 per year for Prime membership which also provides cloud storage, free delivery and other benefits). I occasionally pay for the WWE Network (£10 per month). All in, we’re talking £37 per month with some of that figure paying for other Amazon Prime benefits. A little more google-fu shows that if you pay for Sky TV with all the bells and whistles you could easily pay over £70 per month. How many of these “bells and whistles” are needed? Some of them include HD channels, the ability to record multiple shows, TV show boxsets on demand and so on. If you can afford it and you think you are getting value for money, then great. However, take a moment to think about how many channels you actually watch. Do you have all these “bells and whistles” and if so, do you use them?
My opinion is that in our society, basic TV is pretty much a utility but all the other add-ons are luxuries. The problem is that many people view the top packages as necessities and I’m betting that many of those people paying for it will either hardly use any of the facilities they are paying for or use them as background noise whilst scanning Facebook on their mobile.
I have the fourth level called Entertainment. I’m referring to things like cinema, theatre, socialising and so on. These are things that can be good for the mood but are not essential to basic survival. The fifth level is all about luxuries in life; holidays, fine dining and so on.
In an ideal world, people would budget from the bottom up spending money on the basics of survival with surplus money moving up the pyramid. In my experience many people just throw their money at all levels without thought. Then, they run out of money before the next payday. As such, the basics of survival are paid for on credit. This debt is not paid off which then adds another layer to the pyramid as the person needs to pay that debt back somehow. However, the person already has more money going out than coming in so this debt will never really get paid. Instead, the person simply runs out of money earlier in their pay cycle and resorts to credit a day or two earlier. Over the course of weeks and months this debt spirals out of control.
Effective money management is a skill that can be learned. It just takes practice. The first step is to get an accurate idea of what you are spending. This is easier if you pay for most things on card. Just go through your statements and your list of direct debits. Use the HoFN and see where the different proportions of your money are going.
In this blog I compared the cost of two things; internet and TV and just between those two things a saving of £80 per month can be made with some thought and research. How much money could you save on your phone bill, food shopping, insurance and other bills?
As I’ve mentioned in previous blogs, I am not a financial advisor. I’m just someone who thinks a lot about money and hate to see people struggle financially when they could be doing so much better. Money management is an essential life skill. It’s at the very core of your life from the day you start taking control of your own finances. There are people who are in severe financial hardship. This blog is probably not going to help them very much. There is only so much you can do to tweak your finances and if you still have too much month left at the end of your money, then I can’t change that. There are more qualified people than me out there that can help. Please see links below for Stepchange, a government backed debt advice charity.
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