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Like Lennon and McCartney, sweet and sour pork, and Matt Hancock and his job, there are multiple tensions at the heart of Monevator.

The biggie probably isn’t active versus passive these days.

Following the lead of Macca in his prime, The Accumulator has produced hit after hit on why and how to use index funds.

Whereas I’ve – metaphorically – taken my naughty stock picking and left the band. At least for now.

Imagine!

No, I’d say our biggest on-site difference of opinion is the RE part of FIRE.

We’ve debated that in the past, too.

In short I nowadays believe that early retirement is a rubbish goal, ill-suited to most who can reach it.

The Accumulator, on the other hand, is living it.

And loving it, apparently.

FIRE in the hold

Of course, both of us are full-square behind achieving financial independence – the FI component of FIRE.

That goes without saying!

Being so ill-versed in the FIRE community and lingo I only just discovered that the kids call my version of reaching it ‘Slow FIRE’.

Monevator reader Ian pointed me towards an article from Business Insider, which explains:

Slow FIRE practitioners focus on designing and achieving their FIRE lifestyle now.

This may include working remotely in order to create more flexibility in their lives.

It’s also a nod to the fact they will work longer in order to hit their FIRE number.

There’s no work-shaming because work factors heavily into Slow FIRE.

Yes! This is what I was trying to get at in You Don’t Have To Go Nuclear On Working For a Living. (In retrospect not such a catchy name for a movement, compared to Slow FIRE.)

Back then I wrote:

I often read retirement bloggers saying they quit work because they couldn’t take kowtowing to The Man anymore.

Yes – The Man sucks – but it’s not a good reason to quit working.

Especially if you’re impoverishing yourself for the rest of your life to do so.

I believed that mostly working from home, mostly on projects I enjoyed, and on my own schedule was a more sustainable way to spend my life than:

• killing myself in the rat race, or

• jumping off a cliff like an exhausted lemming as soon as I believed I could meet my minimum spending requirements from some vast pool of cash I’d accumulated, just out of sight of my bedsit or RV.

I’ve got nothing against people retiring in their 40s after 20 years of frugality if they choose.

I don’t think it’s morally wrong, or anything silly like that.

You do you.

I’m just saying be sure you’ve thought about all the options first.

Not so shy and retiring

Someday I’ll make my case for this Slow FIRE business more coherently.

In the meantime, Party at the Moontower this week explained why he too is against the ‘retire early’ part of the mantra.

Despite his apparently just now retiring early!

Like me he’s sceptical that sustainable withdrawal rates (SWRs) are a golden bullet to ‘the hardest problem in finance’:

Solving for how much you need to save and for how long, solving for how much you can withdraw annually and for how long, all so you don’t outlive your money.

If you have walked through the Moontower Retirement Model you learned the levers — savings rates, longevity, and post-tax inflation-adjusted returns.

Every one of those terms is impossible to forecast. The problem suffers from intractable amounts of garbage inputs.

The value of the exercise is not the outputs, it’s for articulating the problem in the first place and gaining a low-res appreciation for the sensitivities.

Thinking about your likely SWR is indeed super-valuable. It makes you consider all the variables.

Also, if you’ve never encountered the idea of living off your investments before, then applying 4% to a pot of ‘some number’ can be mindblowing.

Fighting FIRE with fire

However beyond their thoughtprovoking, SWRs only do a perfect job of telling you how you would have done in the past.

Worse, they crumple the edges.

Their fans declare “of course you wouldn’t actually spend your money if you saw it was running out”…

Um, okay.

I’m practically a dinosaur in that I believe investing for income is a more intellectually credible way to prep your finances for a long period of living off them. I also hate the idea of spending my capital.

This means more money is needed, and perhaps some active management. Again, more on that some other day.

But none of this is to discredit The Accumulator’s wonderful work on SWRs.

I think his is probably the most readable deep take on the Internet.

The Accumulator has read widely – proper academic research papers and all . In contrast, as ever I’m a bundle of notions and hunches.

So you should certainly read through everything he says on the subject – it’s a goldmine – even if you reach a different conclusion.

Fee FI fo fum

The other solution to getting an income in your later years is to keep doing some work for money.

RE goes out the window, but FI remains front and centre in giving you options and buffers.

To again quote Moontower:

The idea that you can work until you are 75 or 80 is freeing IF you can do it on your terms. If you can take a break for a year sometimes. If you can work 4 days a week, or from wherever you want. If you actually enjoy bringing your uniqueness to the job to be done.

The definition of a sustainable life is one you actually want to sustain.

Nobody wants to sprint forever, and sprinting for a short while doesn’t make the scarcity mindset go away even if you “win”.

This is partly why rich people fear inflation. They thought they were “done”. What is “done” anyway?

Past experience tells me that plenty of you will disagree (which is fine!)

Smart and articulate people tell me they couldn’t do work they half-like on their own terms, although I’ve done just that for 20 years. Their only option is to cane it at a job they hate for the best years of their life, and to smell the roses at the weekends. And then to hope their SWR doesn’t blow up.

Again, okay…

Just be aware what you’re saying: can’t, won’t, will.

You’re just saying it in a different order to me.

Maybe it’s all a question of where we choose to put our limits and our faith and to see the uncertainties.

Happiness is a warm run in the stock market

I’m no zealot. The truth is after quitting my ‘big gig’ last year I’ve not put a lot of effort into ramping up my hours and income to replace it.

So maybe I’m leaning a bit more towards RE than I care to admit?

To his credit The Accumulator has also shifted over the years. He is at least trying out doing some work post-retirement.

Again, financial independence lets us both look for our middle ground.

I suppose I’m saying that 40-50 years is a long time to plan to drop out. I doubt even Lennon would have managed that, though sadly he never got the chance.

Too much leisure time is probably counterproductive, anyway. Studies suggest there’s a sweet spot:

Employed people’s ratings of their satisfaction with life peaked when they had in the neighborhood of two and a half hours of free time a day.

For people who didn’t work, the optimal amount was four hours and 45 minutes.

Working for just a couple of hours a day – or a couple of full days a week – leaves you abundant time to learn Swahili or to see your grandkids.

And a small amount of income is worth a lot. Many years ago I pointed out that £5 a day was worth around £90,000. Today it’d be even more.

Earning to keep FIRE burning

Consider planning to earn a couple of hundred quid a week indefinitely. I suspect you’ll be happier.

It doesn’t have to be working from home or side hustling, either.

A sociable friend of mine wants to retire in her 50s to do a couple of days a week in an independent coffee shop. Some of her fondest memories are of part-time work at Starbucks as a student.

There was seeing the regulars, the free coffees, the short walk to the ‘office’, the lack of responsibility, and being usefully whacked at the end of the day.

It’s not my bag. But then, writing this post on a sunny Saturday morning in bed wouldn’t be hers.

Let’s all find our own way.

Have a great weekend (and Cymru am byth!)

[continue reading…]

You’re too late to get into buy-to-let. It had a good run, but the party’s over.

I graduated from university in the early 1990s. I got a job in The City, moved down to London, and shared a rented house with a few friends.

After a year of renting – and spurred on by a combination of parental pressure, MIRAS1, and (ludicrously) a mortgage interest subsidy from my employer – I bought a house.

Did I have a big inheritance? No. I saved up for the deposit in my first year of work.

Okay, that’s not actually quite true. I also had some profits from punting my student loan on the stock market, the proceeds of a systematic building society carpet-bagging operation, and a well-timed cash withdrawal on my credit card.

Combined this took me over the line into buying my own house.

And yes, I do mean a house – as opposed to a flat, let alone a bedsit.

My deposit plus salary secured a three-bedroom, freehold house with a garden and garage, in Zone 1, 30 minutes walk from my job in the City.

Even I cringe a bit as I write this. Sorry, millennials.

I paid £130,000 for this house and spent the autumn weekends decorating it to the incessant radio play of Whigfield’s Saturday Night.

Then, for a while, I just couldn’t get enough of the things.

My property portfolio balloons

I got my first ‘proper’ bonus (two figures!) soon after I bought that first property.

While my colleagues were spending their windfalls in Clerkenwell dives doing shots from lap-dancers’ bellybuttons, I was at home eating toast, reading about newly-launched buy-to-let mortgages, and perusing the property section of the Evening Standard.

And so, barely two years after buying my first house, I bought a second.

This one was an ex-local authority three-to-four bedroom property. I picked it up for £75,000. After a lick-of-paint I let it out for £600 a month.

That’s a starting gross yield of nearly 10%. 

Soon afterwards, newly married, I left London for a pointless dormitory town in the commuter belt. I moved into a house I bought with my wife, for which I paid – cough – less than I earned that year.

And of course I kept my original home in London to let out.

Because why would I not? 

Buy-to-let boom

In those open and liberal Blair years London was booming. As the de facto financial capital of the European Union, it sucked in talent and money from all over the world.

From American investment bankers and French derivatives traders to Polish plumbers and Italian waiters, everyone wanted to be in London.

Which meant London property prices were going through the roof:  

Shortly after leaving London, I bought three more properties in a single year. My wife still reminds me of the time I went out for a newspaper one Saturday morning and came back with a two-bedroom flat.

By this time I’d worked it out. I raised equity against my steadily appreciating London properties for a deposit on the local ones. This way I put no money down.

It was like I’d discovered a perpetual money machine!

Only… the machine started to sputter a bit. The problem was that while house prices kept going up, rents did not. Starting yields were decreasing.

This was largely a story of falling interest rates. Property was like a very long duration lightly-inflation-linked bond. Prices moved accordingly.

The landlord game was also getting more competitive because more people were doing it.

Buy-to-let had become… a thing.

Too late to get into buy-to-let for big bucks

You know the old adage that an optimist is someone without much experience?

Well, that was me.

I started out on my property ‘journey’ as YouTube pundits call it by guessing that my costs would be about 10% of the rent. That wasn’t far off, to begin with.

But as rents increased more slowly than my expenses, the economics got steadily worse.

Then there’s the ‘exceptional’ costs that nobody warns you about. Or, if they do, you don’t think they’ll happen to you.

What sort of expenses? This sort of thing:

Double-crossing agent

The agent for a London property reports the tenants aren’t paying the rent. Letters and threats of  legal action are (supposedly) sent to the tenants. Rent is received sporadically over the next couple of years. It turned out the tenants were paying the rent all along. The agent kept it himself. Agent declares bankruptcy, directors leave the country. Loss to me? About £18,000.

Shit happens

Tenant moves in, pays deposit and the first month’s rent. Never pays a penny more. Takes 14 months to get them out of my property through the courts. On taking possession I find their dog has eaten all of the internal woodwork. And when I say all, I mean all: doors, skirting, architrave, even the window sills. The back garden had been destroyed. It was like some combination of a First World War trench and 14 months worth of dog shit. I still wake up in a cold sweat, thinking about that day I spent in a HazMat suit digging out two-foot of shit to replace it with topsoil. Loss to me? About £15,000 (not including sleepless nights). 

Size matters

That first rental I bought in London, which I’d always let to three sharers, is suddenly designated a ‘HMO’ by the local authority. (It’s not). So obviously I have to pay them £500 and spend several hours filling in pointless forms. Oh, and I can only let it to two people now – because of some arcane bedroom size restrictions. (Ironically it was the local authority that built this property…) Perpetual rental income reduced by a third. It’s hard to quantify the loss here – what discount rate to use? It’s a lot, anyway. 

Party walls

My personal favorite – not because of the cost, but because of the timing. A builder is completely refurbishing a London property for me. It’s a big job, including moving walls and bathrooms and so on. Randomly I get a bill, in the post, from the police, for something like £300. They’ve attended an ‘incident’ at the property. Turns out that unbeknownst to me the builder’s laborers had been sleeping on-site. They’d got drunk one night, had a fight, and the police were called. When did this bill arrive? I think you can guess – the day after I’d paid the builder his final payment. 

Once you factor this sort of thing in, along with the more regular stuff – the boilers, the double-glazing, the roof replacement, the damp that just WILL NOT go away – my 10% expense estimate was hopelessly naive.

Too late to get into buy-to-let – and too much hassle

I can now look back at more than 25 years of accounts from my modest buy-to-let empire. Starting with one property, with seven at the peak and with three remaining today.

Which means I can tell you, exactly, how much the non-interest costs were as a fraction of the rent:

31.4%!

Call it a third. Wow.

I do use agents to fully manage the properties, and they are expensive. But I will not be being phoned in the middle because of a blocked toilet. Not when I’m working 16 hours a day at an investment bank. (Okay, I don’t do that anymore, but I’m still not going to field those calls).

And this is why it is too late to get into buy-to-let. Along with falling rental yields, the trend in costs is only rising.

There have been lots rule changes over the years that have made things worse:

• Higher CGT rates
• Abolition of the Indexation allowance
• The pointless requirement to pay CGT outside of the tax-year cycle
• Annual Tax on Enveloped Dwellings (ATED)
• Extra stamp duty
• Elimination of the wear-and-tear allowance 
• Deposit protection schemes
• Tenant fee ban
• Section 24 (tax on rental turnover not profits)
• The PRA’s CP11/16 (which means you can’t borrow as easily)
• Arbitrary and retrospective ‘HMO’ rules
• All-sorts of safety and environmental regulations 
• So called ‘right-to-rent’ law that compels landlords to be a tool for the government’s cruel and damaging immigration policies

That was all off the top of my head – I didn’t even need to consult a list.

Now, don’t get me wrong. In isolation there’s nothing inherently wrong with most these rules (the exception being the last one) and the health and safety aspects are especially reasonable.

But the mood music is pretty clear. The government believes it can impose these costs on landlords because we are all loaded.

It’s not 1994 anymore

How loaded?

The average gross yield on my property portfolio is now – checks notes – 3.4%. Which implies that the long-run post-cost (excluding financing) yield is about 2.3%.

That is… not enough. Especially as there’s no tax shelter. 

My property portfolio has been an enormous accelerator of my wealth over the years. But the easy times are over. My success came about almost completely as a result of falling interest rates.

I simply got leveraged lucky. 

Some newcomers may try to make the maths work by getting into buy-to-let via a limited company or whatnot. I’d question whether it’s worth the hassle. In my view it’s too late to get into buy-to-let to make a killing. It’s not 1994 anymore.

Whigfield is more likely to have another global hit than you are to get rich investing in property at today’s starting yields. “Da ba da dan dee dee dee da nee na na na” indeed.

If you enjoyed this, follow Finumus on Twitter or read his other articles for Monevator.

1. Mortgage Interest Relief At Source, a defunct tax relief scheme to encourage home ownership in the UK. [↩]

This dissection of an ESG index is by The Scientist from Team Monevator. Check back every Monday for more new perspectives from the Team.

People like to throw the ‘ivory tower’ label at scientists like me. And it’s true, we can be guilty of making what we do inaccessible to everyone else.

But for inaccessibility of language made into a true art form, nobody beats the financial industry.

Environmental, Social and Governance investing (or ESG for short, because acronyms always help…) is not a new fad. Nor is the concept very complex.

Yet I had no end of difficulty digging into the background of ESG indexes.

Introducing the ESG index

The core idea of ESG investing is to grow your wealth whilst trying to do some good.

Back in 1990 a group called KLD Research & Analytics started the first Socially Responsible Investment index (or SRI, because one acronym is never enough).

MSCI took over KLD’s index at a later date. MSCI now offers some 1,500 ESG indexes. There’s an ESG index for everything from human rights and climate change to the fallout from the COVID-19 pandemic.

The purpose of investing is to build wealth. And as it happens, since 1990 that first US-focused MSCI KLD 400 Social Index has bested the US market.

But the motivation behind ESG/SRI investment is not to outperform.

ESG investors choose to invest in such a way as to encourage business practices that have a positive impact on the world.

An ESG index dissected

I decided to look under the hood of an ESG index to see how it worked. I chose one closer to home: the FTSE4Good Developed Index.

The FTSE4Good index series is “designed to measure the performance of companies demonstrating strong ESG practices.”

The index I’ve chosen is an ESG take on the FTSE Global Developed World index.

Companies are screened for inclusion in this ESG index. The screen employs a convoluted algorithm containing about three layers. I say ‘about’ three layers, because the algorithm gets pretty complex, pretty quickly.

First, the relevance of the three ESG ‘pillars’ are considered with respect to a given company. These are: Environmental, Social, and Governance.

Then, within each pillar there are further ‘themes’.

Environmental:

• Supply Chain: Environmental
• Biodiversity
• Climate Change
• Pollutions and Resources
• Water Security

Social:

• Supply Chain: Social
• Labour Standards
• Human Rights and Community
• Health and Safety
• Customer Responsibility

Governance:

• Anti-Corruption
• Corporate Governance
• Risk Management
• Tax Transparency

Finally, within each theme are ‘indicators’.

Over 300 indicators are considered, with each theme containing 10-35 quality and data-driven indicators. For any given company, on average 125 indicators combine to calculate its ESG score.

Source: FTSE Group

Points mean prizes

Based on the indicators, a company gets a score out of five. Zero is totally rubbish, from an ESG perspective. Five is industry-leading best practice. Each theme and pillar is scored.

Theme and pillar scores are then weighted based on their relevance to a given company. Enter another scoring system – this time out of three. Zero is irrelevant and three is high.1

The relevance weighting reflects how responsible a company ought to be with respect to a certain theme. It’s determined by industry.

For example, you wouldn’t expect an insurance company to undertake many activities directly related to water security.

Super, smashing, great

Confusingly, the calculation of a company’s ESG score works backwards from how it is presented in the FTSE4Good documentation. It runs from indicator to a final ESG score.

But there is yet another step. A company’s ESG score is also weighted relative to the performance of other companies within its ‘supersector’.

What’s a supersector? Well, there is a supersector ‘taxonomy’, according to FTSE Russell’s Industry Classification Benchmark:

1. Technology
2. Telecommunications
3. Health Care
4. Banks
5. Financial Services
6. Insurance
7. Real Estate
8. Automobiles and Parts
9. Consumer Products and Services
10. Media
11. Retailers
12. Travel and Leisure
13. Food Beverage and Tobacco
14. Personal Care, Drug and Grocery Stores
15. Construction and Materials
16. Industrial Goods and Services
17. Basic Resources
18. Chemicals
19. Energy
20. Utilities

Their index, their rules, but scoring a company’s ESG rating relative to a supersector seems counterintuitive to me.

Why? Well let’s say everyone in the Energy supersector burns coal. Just because you burn less coal than others in your supersector, for me that doesn’t diminish the fact you burn coal. Or use slave labour. Or manufacture cluster bombs.

Worse, some of the indicators used to calculate the ESG scores are “tailored for different industrial sectors”. So sector-relative scoring is already at the heart of the ESG calculation. It is potentially accounted for twice.

No score draw

After all this accounting alchemy, a company has a score out of five.

The company needs to score 3.3 or higher to get in a FTSE4Good index, in a Developed market. (2.9 or higher in an emerging market).

But wait, no, actually there is one more consideration!

Some kinds of companies are actively excluded. This includes those that manufacture or produce tobacco, chemical and biological weapons, cluster munitions, nuclear weapons, conventional military weapons, firearms, coal, or are investment trusts.

Personally, I find this the most concerning. It suggests the long, complicated ESG calculation we described above doesn’t already work to exclude companies that partake in these naughty list activities.

So what was the point of it all?

Indeed, what is the point of ESG?

Again, the point of ESG is not to outperform the market.

Just as well. As recently reported in the Financial Times [search result]:

“There is no ESG alpha,” said Felix Goltz, research director at Scientific Beta and co-author of the as yet unpublished paper, Honey, I Shrunk the ESG Alpha.

“The claims of positive alpha in popular industry publications are not valid because the analysis underlying these claims is flawed,” with analytical errors “enabling the documenting of outperformance where in reality there is none”, he added.

Financial Times, 3 May 2021

Deciding to invest by considering ESG scoring should instead be a decision to allocate capital towards companies that do ‘good’.

For me, ESG indexes are not a perfect means to that end. Perhaps more convoluted than effective. But they’re better than nothing.

What’s the alternative? You could instead investigate every single company you invest in. But then you’re an active stock picker. That does not go well for most people.

Passively investing via index funds is the best way to go for nearly everyone.

And if you want to include ESG considerations in your passive investment strategy, then choosing funds that follow ESG indexes is a simple way to do this.

Two cheers for ESG index funds

Choosing to invest in ESG funds is a bit like shopping for Fair Trade coffee, carbon offsetting your gas bill, or buying an electric car. You’re making a choice with your spending power to try to make some small difference.

Investing in the status quo means you will only ever get the status quo. We have to start somewhere.

It may be hard to understand the rationale behind any given ESG index, but alternative ways to invest in an ESG-friendly way don’t work most of us.

By buying ESG funds, you at least indicate to the market that there is a demand for ESG products. Hopefully they’ll get better and clearer in time.

In time you will be able to see all The Scientist’s articles in their dedicated archive.

1. FTSE calls relevance ‘exposure’. [↩]