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ISAs and SIPPs are the building blocks of FI wealth.

This is part six of a series on how to maximise your ISAs and SIPPs to achieve financial independence (FI).

I put this series on hold when coronavirus gripped the world but it doesn’t look like the pandemic is disappearing any time soon.

Life marches on so let’s pick up where we left off.

Where was that exactly?

Right here:

  • Part one laid out why you need to juggle your ISAs and SIPPs if you’re to retire early.
  • Part two investigated why the tax breaks favour personal pensions over ISAs.
  • Part three showed the simplest way to divide your stash between your ISA and SIPP.
  • Part four dealt with choosing a separate sustainable withdrawal rate (SWR) for your ISA and your SIPP.
  • Part five walked through the entire FI calculation incorporating age, income, outgoings, tax, time horizon, SWR, expected returns, investment fees, and access to the State Pension and defined benefit pensions. (This one nearly killed me!)

The final part of this series deals with a very specific part of the puzzle.

How do you bridge the gap between living off your ISA and finally cracking open your SIPP at age 55 or later?

Minimum pension age blow – Since we started this series, the government has confirmed that the earliest age from which we can access our personal pensions will rise from 55 to 57 in 2028. Thereafter, your minimum pension age will be set 10 years before your State Pension age. If you’re born after 31 Dec 1972 then you’re liable to fall into the 57-year old camp, depending on the date in 2028 when the new rules take effect. If you’re born after 6 April 1978 then your minimum pension age will be 58. It’s possible that others born before those dates could still be caught up in government fiddling if the new thresholds are tapered in, or your State Pension age changes, but they’ve yet to publish the details.

Part 4 in our series showed that you can choose a sustainable withdrawal rate (SWR) of 8% to bridge a ten year gap between living from your ISA and the arrival of your pension reinforcements. If the gap is wider then the SWR goes downhill pretty quickly.

But what if your gap is shorter than ten years? Then it gets much riskier to fund your living expenses from a portfolio of volatile equities because you’re more exposed to the chance that asset values could slump. You’re a forced seller because you have to pay the bills regardless. This can end up driving your ISA portfolio off a cliff before your pension comes on-stream.

This graph from the Barclays Equity Gilt 2020 study illustrates the volatility problem:

A graph of max and min returns for UK equities, gilts and cash

The range of annual returns for UK assets is wide over any period of less than a decade. We can see that equities are the asset most likely to deliver a positive average return over 20 years or more. But they can smash you with a -60% loss (or worse) in any given year.

Even over ten years, average real returns can be negative. This means we can’t risk funding our lifestyle from a portfolio of 100% equities – they’re just too volatile. It’s this volatility that conjures up the dreaded sequence of returns risk.

See part 4 for asset allocations that are better suited to shorter time horizons.

Note that while the range of outcomes increases for periods under ten years, cash is much less risky, as you might expect.

Liability matching

The alternative to paying your bills using a portfolio of volatile assets – including a hefty slug of equities – is to pay them using a portfolio of low volatility assets that don’t include equities.

In a nutshell, you predict what your annual expenses (or liabilities) will be for the ISA bridge period. Then you save enough low volatility assets (cash and bonds) to pay off those liabilities…

Year Liabilities Savings match
1 £25,000 £25,000
2 £25,000+inflation £25,000+inflation

… and so on, matching low risk assets to liabilities for every year you need to fund.

The FI capital you need to save is the sum of your future expenses, adjusted for growth and inflation.

Now, you may be thinking that predicting your future expenses and inflation is a tall order. However we take the same punt when creating any financial independence plan.

The reality is we need to build in plenty of margin for error – and to hold off pulling the trigger if life deals us a bad hand along the way.

The ideal liability-matching solution is to build a ladder of individual index-linked1 bonds (also affectionately known as linkers).

If your expenses were £25,000 (in today’s money) and year one of your retirement was scheduled for 2030, then you’d buy a linker that matures in 2030 and pays you back an inflation adjusted £25,000.

Holding the individual linker to maturity means you wouldn’t be exposed to a capital loss, while its RPI-linked payout staves off alarming reductions in purchasing power.2

The next linker in your ladder would pay out in 2031, the next in 2032, and so on. Your last maturing bond finances your final year before pension day.

This is the safest way to match future liabilities because index-linked bonds (or gilts) are backed by the government.

The problem is a linker ladder is extremely expensive.

Index-linked gilts are currently paying negative yields. You lose money on them every year if you hold them to maturity. Their yields have only worsened for years. There may even be a structural problem with the UK linker market.

The upshot is that few of us can afford to pay for our future using an asset yielding -3% or more per year.

The next best alternative for ordinary investors is cash.3

Bridging the pension gap with cash

Cash isn’t typically prey to huge swings in value. It often does okay inflation as you can switch to higher yielding accounts pretty quickly.

You can stuff plenty of it in your ISAs and use your personal savings allowance to ward off tax, too.

Go cash!

A liability matching strategy means that our SWR-based FI calculation doesn’t apply, and you could save the required cash more rapidly than you can build an investment portfolio.

The following example shows how you can calculate whether cash is the better option for your ISA bridge.

If we need £25,000 per year for ten years using an 8% SWR, then our FI capital requirement equals:

£25,000 / 0.08 (8% SWR) = £312,500 stash needed.

But this isn’t the case if we meet our £25,000 per year liability out of cash.

Our cash ladder (in today’s money) is the sum of our liabilities adjusted for expected inflation:

Year Liabilities (£)
1 25,000
2 25,750
3 26,522
4 27,318
5 28,137
6 28,981
7 29,851
8 30,746
9 31,669
10 32,619
Total FI capital 286,597

Assuming expected inflation of 3% p.a.

Ten years of retirement starting tomorrow would cost us £286,597 in cash money. That bakes in an annual inflation rate of 3%,4 so that the equivalent of our £25,000 liability in year ten is £32,619.

I should factor in an estimate for the interest we’ll earn, too, but I won’t. Let any interest be our wiggle room in case expenses are more than anticipated.

The USP of £286,597 is clearly that it’s much less than the £312,500 involved in the SWR strategy.

  • So how quickly can we save our grand total?
  • How do we account for the fact that we’ll need more than £25,000 per annum in X years to deal with the money-withering inflation we’ll experience as we save?
  • Where did that 3% inflation assumption come from?

We walked through the calculation for accumulating your FI capital in part five.

Here’s how to adjust for cash:

In this example, the part five calculation reveals we should sock away £1,446 per month into our ISA.

To estimate how long it will take us to transform £1,446 per month into our FI stash of £286,547, we turn to the How Long Investment Calculator from Candid Money. (Other investment calculators are available.)

How long it takes to save FI capital of £286547

Target sum = FI capital figure: £286,547 in this case.

Monthly saving = £1,446 derived from the part 5 income layer cake calculation.

Annual investment return = A downbeat assessment of how much interest we’ll earn from cash over our saving period.

Annual charge = 0%. I trust you use fee-free cash accounts?

Are you a taxpayer? = Non-taxpayer, as savings will be sheltered in ISA or by the Personal Savings Allowance.

Annual inflation rate = 3% based on Bank of England implied inflation forward curve. See the expected inflation section below.

The result = 20 years to reach the target after inflation (in reality we’d need to adjust our contributions and the target sum in line with inflation every year).

Notably, it only takes 14 years to accumulate the £312,500 required by the SWR strategy, with £1,446 per month stocks and shares ISA contributions and the following assumptions:

  • Expected real return of 4%
  • Investment fees of 0.5%

So I’d stick to the SWR strategy in this case.

The situation swings in favour of cash when the ISA bridge period is seven years or less.

You’d only need £191,561 in today’s money to bridge a seven year gap using the cash ladder figures above.

How long it takes to save FI capital of £191,561

Now it will (hopefully!) take just 12.5 years to reach the target sum.

We don’t have any data to show that a higher SWR is viable for volatile investment portfolios that only need to last seven years instead of ten.

If investing instead of saving cash, I’d still accumulate the full £312,500 given the wild range of possible outcomes over short periods. The ISA portfolio should outlive the seven year time-frame and I can use what’s left to spend more on fun things once I’m living it up on my pension.

Personally I’d likely go for the liability matching option, though, because it’s quicker and safer.

The trade-offs we need to think about are:

  • It’s quicker to save the cash needed for the liability matching portfolio.
  • You’re much less vulnerable to sequence of returns risk – both as you accumulate the money and also when you spend it.
  • You’re somewhat vulnerable to inflation risk.
  • The capital is likely to be entirely spent at the end of the bridging period.
  • Without equities there’s little chance of upside, but there’s also much less chance of a catastrophic downside, too.

At the eight year mark, with these assumptions, it’s a total toss up, especially given the uncertainties inherent in this planning process.

On assumptions – I’ve used reasonably conservative ones throughout the series. You can always be more cautious. And you can never be absolutely safe. The more money you save, and the less you spend, and the safer you will be. But the longer it will take you to get there, the less time you will have left.

To shoot for the £312,500 target in 14 years with an expected return of 4% means taking on a lot of equity risk. You don’t face that risk with a cash liability-matching strategy.

Before we’d access our £312,500 ten-year ISA portfolio, we would lower our equity allocation to reduce our exposure to major market crashes that we do not have time to recover from. The potential upside from a large dose of equities is just not worth the risk of running out of money.

Part four of the series shows that the highest historical success rates for time periods of less than 20 years were achieved with global equity asset allocations of around 30%.

That’s in complete contrast to the 80% equity portfolios – they proved most successful over time horizons of 30 years or more.

Expected inflation assumption

My inflation assumption uses the UK instantaneous implied inflation forward curve published by the Bank of England:

An expected inflation curve from the Bank of England

The curve shows inflation hovering around 3% in 15 years, which is approximately the time our example liability-matching cash goes into action. Inflation then dips under 2.5%, ten years further down the curve.

My crude eyeballing plus a dose of pessimism therefore conjures up an annual inflation rate of 3% for the purposes of planning.

The BoE derives the curve (to massively simplify) from the difference between conventional gilt yields and index-linked gilt yields. This theoretically gives us the bond market’s inflation expectations over time, because conventional gilt yields factor in a premium over real yields to compensate for inflation risk.

Nobody is saying that this measure is a dead ringer for future inflation!

It’s just the market’s best guess right now.

The end of the road

I think we’ve covered every important aspect of combining your ISAs and SIPPs to reach financial independence somewhere in this series.

Although there’s much more to say about achieving and managing FI, I’ll now draw this six-parter to a close unless anybody needs anything else covered. Let me know in the comments.

Take it steady,

The Accumulator

Bonus appendix: How much?

I’ve assumed all cash savings are protected by ISAs / the PSA so there’s no need to scale up the FI capital required to account for tax levied on any interest.

The £20,000 annual ISA limit allows for a max monthly contribution of £1,666.

The Personal Savings Allowance further allows basic-rate taxpayers to shelter:

£1,000 / 0.012 = £83,333 tax-free at 1.2% interest.

Higher-rate taxpayers can shelter:

£500 / 0.012 = £41,666 tax-free at 1.2% interest.

Remember to adjust your SWR for investment fees and taxes as shown in part 5.

If you want to adjust down a little more due to the prospect of prolonged negative yields on bonds and negative interest rates then I wouldn’t blame you.

Data can only get us so far. You’ll need to take a personal call on how bullet-proof you want your plan to be from the outset versus adapting it later.

  1. That is, a return that keeps the value of your investment unchanged in real terms after a particular measure of inflation. []
  2. Subject to your personal rate of inflation roughly approximating RPI. []
  3. The best case scenario would be the government releasing National Savings index-linked certificates back on to the market, but it won’t. It’s much cheaper for the government to fund debt in a market prepared to buy index-linked gilts at negative yields than to pay ordinary UK citizens even a CPI +0% rate of interest. []
  4. Multiply year one’s £25,000 by 1.03, multiply year two by 1.03 etc. []

Weekend reading: Smooth the ride, or just ignore the bumps?

Weekend reading logo

What caught my eye this week.

I read this week of a successful US hedge fund that’s closing down because it finds the work too onerous.

“Soul sapping” in its own words.

It wasn’t the challenge of hunting for good investment ideas that did for the Echo Street’s hedge fund, apparently.

That was “joyful”, it said. (Something I can personally well believe).

Rather it was a requirement to manage volatility – to “smooth the ride” – that has seemingly ruined the business of managing billions and making millions as a hedge fund.

Institutional Investor quotes from an Echo Street letter to clients:

“Why is the environment for hedge funds getting harder?” the September 9 letter said.

“Managers live inside the box defined by their risk constraint. They can do whatever they want, as long as they stay inside that box…

If that box includes a need to ‘smooth the ride,’ then that box gets tighter and smaller every year.

As the techniques we use to smooth the ride get discovered, they no longer smooth.”


Of course, I don’t expect abundant sympathy for Echo Street’s management. It’s hard to bust out the tiny violins for fund managers paid a fortune because they have a few too many bad days at the office.

Besides, the firm may be closing its hedge fund and returning money to clients, but the business itself isn’t shutting down – it will continue to offer long-only funds.

So in that respect a decision like this is just opting for an easier life. It’s pushing the difficulty of reducing volatility through diversification or other strategies back to the customer.

Which is what makes it relevant from a Monevator perspective.

We’re all bemoaning the difficulty of properly diversifying a portfolio in today’s low-yielding, more correlated world.

For example, to just mention the phrase ‘government bond’ in a post here is to set off a torrent of anguish in the comments below.

Perhaps it’s not reassuring to hear that a winning hedge fund with resources far greater than our own also sees the difficulty – albeit through a prism of regulation and box ticking.

Not reassuring, but it’s surely telling, no?

Maybe we just need to accept that the best way to ‘smooth the ride’ on today’s investment journey is to try to keep our eyes on the distant finishing line, and to try not to look out of the window – at our portfolios – any more often than we need to.

The view from the Channel Tunnel isn’t very enticing. But Paris is still glorious when you finally get there.

Have a great weekend!

[continue reading…]


I hit my FI number

A person completes their FI journey after a long slog.

I hit my number. I hit my number. Sweet Holy Jesus, I hit my number! [Falls to the floor and sobs with joy].

Okay, these aren’t quite the scenes at Accumulator HQ – because I’m an emotional pygmy.

But I have hit my number… and I don’t really know how to feel.

I actually hit my FI (Financial Independence) number during the stock market surge in January.


That looked like the end of that dream. I was minded of Alf Ramsey’s words to the England team before extra-time in the 1966 World Cup Final:

You’ve won it once. Now go and win it again.

But the Central Banks came out blazing – better than a Geoff Hurst hat-trick any day – and eight months later “I’m over the moon, Brian” about my Independence Day 2.

2020 has cast an air of unreality over everything so for sanity’s sake I’ve stopped obsessing over my target figure.

That’s meant prioritising cash savings since February. There should now be enough in my vault to see out the next half-decade or so.

If the stock market dives again, I’m not changing the plan.

It’s meant to survive crashes of historic magnitude.

(No, that doesn’t mean it’s safe.)

I did it my way

I’m no poster child for the FIRE1 movement – I’m 48. But maybe my story can offer hope to other late starters:

  • I didn’t set out for the FI Promised Land until age 41.
  • I’ve never earned a six-figure salary.
  • I’m not a tech bro or finance pro.
  • I’ve peaked at mid-five figures in a declining industry.
  • My personal finances were a mess that I didn’t begin to clear up until age 35.

Financial independence can be achieved surprisingly quickly – faster than the 10 years I reckoned on.

The middle years can be bleak but you gain momentum once you’re over the halfway hump.

What now?

Just chillax and enjoy life? You must be joking. That’s not me at all. I need negative energy to feed upon.

But there’s no need to grasp around for any old anxiety. I’ve had mine lined up for ages.

An earlier version of me crashed and burned when I got all the time and freedom I could mishandle. I was like a small child who loved Haribo and then, when given control of their meal plan, ate Haribo morning, noon, and night.

Inevitably there was a reckoning and it still affects me years later.

So this time… no sudden moves. I’ve watched too many others in the FIRE community quit their jobs, move to an exotic new location, and apply for gender reassignment all at once.

That much rapid change is a shock to the system. It’d be too shocking for my system.

I need to take things slowly and acclimatise. It’s not very devil-may-care, but I’m a cautious soul by nature.

Hard-charging for financial independence meant a massive lifestyle shift. But it also threw into relief the many things I’m damned if I know how to change.

I’m wired up a particular way. For better or worse I come with complementary baggage that I can’t just pop down and leave. Wherever I go, I’ll still be bringing ‘him’ along.

I may be FI but I’m still the same sack of problems. I haven’t reached the end of the rainbow.

So I’m carrying on as normal for now. Or at least as normal as it gets in the midst of a global pandemic – which has frankly made me reluctant to even talk about FI these past months.

Stress relief

One thing is for sure, a recession is much less scary for following the FI path.

All those stories back in March about FIRE being over? They were garbage at the time, anyway, but more importantly everybody who was on the FIRE journey was (and is) in a better place for it – whatever the future holds and no matter how far down the track you are.

I’ve seen the look of fear on colleagues’ faces as demand slumped. Then the relief when a client crackled back into life – like radio comms from a rescue team in a post-apocalyptic movie.

But I’ve been sleeping well. KPIs don’t disturb my dreams. I’m not weighed down by that fat-suit of dread that I wore during the Global Financial Crisis. My work stress has fallen away, now that I have the option to walk.

Something else changed, too

During our December FIRE debate, The Investor (and I hate admitting this to him) got to me more than I realised. His crudely repetitious argument for working beyond FI lodged itself in my brain, even though I clearly crushed him intellectually…

I’d always imagined that making FI would be swiftly followed by pulling the trigger.

I set the number so that could be the case.

But I haven’t gone for a super-resilient, sustainable withdrawal rate (SWR) of 3% or less. And I’m on the lean side of FIRE. A little more room for manoeuvre wouldn’t go amiss.

Carrying on working in some capacity seems a lot more sensible than fretting about bond yields. It suits my ‘no sudden moves’ self-management plan.

What I really wanted was an end to work as marred by the riptides of restructurings, obsolescence, misfortune, performance assessments, and all the BS of office politics (you remember offices?)

I’m not worried about any of that now I don’t have to fight for survival in the corporate jungle.

Being able to walk away makes walking away much less urgent.

FIRE-d up

So now I have enough to live on, how am I actually going to live?

That’s what I’ll focus on for the next few months. It’s a liberating feeling.

And I am happy. Did I mention I was happy?

Take it steady,

The Accumulator

  1. Financial Independence Retire Early []

Weekend reading: What gives?

Weekend reading logo

What caught my eye this week.

You know the big things you grapple with as a kid – where does space end, what happened to your hamster when he went to sleep and never woke up, and why would anyone ever kiss anyone ever EVER yuck?

Well I find the graph below from asset manager GMO similarly perplexing.

GMO has charted the valuation of energy and mining stocks compared to the S&P 500. The graphic shows that the relative valuation of such stocks is at an historic low:

Just look at that thing! It’s enough to make abandon passive investing, fire up Freetrade, and get to work being contrarian, right?1

Before you do: a moment.

GMO puts forward resource equities as a value opportunity and inflation hedge, but of course there are two ways for such extreme divergences to be corrected.

And watching your diehard gold/oil/mining bug mate getting rich when such shares soar is by far the least painful.

Because this is a comparative chart, and the other way for the ratio to return towards its average is for the wider S&P 500 to plunge in price.

Which today mostly means a tech crash.

Yet technology shares are expensive for a reason. We’re living in a 90% economy world where millions of our fellow citizens are afraid to even leave their homes. Each day tech wins more long-term mind-share and revenues at a rate not seen in the previous 100 years.

Or maybe not – not sustainably, anyway?

Ponder, ponder, ponder.

Have a great weekend!

[continue reading…]

  1. Note: That’s an affiliate link to Freetrade. Sign up and we both get a free share. []