A money market fund (MMF) is an open-ended investment fund that holds short-term debt issued by governments, banks, and large corporations. MMFs play an integral role in the global financial system as pools of short-term funding for organisations such as governments, pension funds, insurers, companies, local authorities, and charities.

Money market funds have also acquired a secondary function as a cash reserve for ordinary ‘retail’ investors (that’s us!) chasing a better rate of interest than they can get from a bank account or cash ISA.

But is the higher yield potential of a MMF worth the extra risk that comes with them? We’ll aim to answer that question – and more – in this guide.

What are the main investment objectives of money market funds?

The primary investment aims of money market funds are:

• Stability
• Daily liquidity
• Credit risk diversification 
• Returns aligned to the prevailing money market rate

Because MMFs are relatively stable investments they’ve been marketed to ordinary investors as ‘cash equivalent’ products. 

However while money market funds are low volatility, their extra yield does come with additional risk strings attached. 

Moreover, those risks are most likely to materialise during a period of heightened market stress, when ready access to cash is paramount. 

Are money market funds considered to be cash?

Money market funds should not be thought of as cash. The Financial Conduct Authority (FCA) makes this point crystal clear in its Resilience of Money Market Funds paper:

As an investment, MMFs do not guarantee principal, and the investor must bear the risk of loss. MMF investments are equity liabilities, unlike bank deposits which are debt liabilities whose value is supported by equity capital. 

It is true that money market funds are low-risk in comparison to equities and bonds. 

But MMFs are riskier than cash because: 

1. They offer same-day redemptions to their investors
2. But the majority of their assets are less liquid than cash and may not be immediately sold 

This means there’s the potential for a liquidity mismatch if too many MMF investors make a ‘dash for cash’ during a market shock. 

Under extreme conditions, money market funds can struggle to meet investors’ demands for their money back. That is exactly what happened during the Global Financial Crisis and the Covid crash. 

It’s an extra dimension of risk for investors who think of their money market fund as a cashpoint. 

What’s inside a money market fund?

It becomes obvious that money market funds aren’t just cash when we look at the list of financial instruments they typically invest in:

• Commercial paper (unsecured, short-term corporate debt)
• Corporate and sovereign floating and fixed-rate bonds
• UK Treasury bills (ultra short-term government debt)
• Repurchase and reverse repurchase agreements (short-term borrowing and lending in government securities via the repo market) 
• Bank certificates of deposits (CDs)
• Cash deposits

This chart shows the break down of assets held by GBP money market funds:

Source: FCA. Resilience of Money Market Funds.

And here’s a typical list of the top ten holdings from a single money market fund: 

Source: Vanguard. Sterling Short-Term Money Market Fund.

As you can see we’re not just talking about cash. 

Do money market funds pay interest?

Money market funds do pay interest, but the rate is variable and not guaranteed. You won’t see an annual interest rate attached to a money market fund as if it were a bank account. 

Typically, GBP money market fund interest payments resemble the Sterling Overnight Index Average rate known as SONIA. 

The benchmark SONIA rate is supervised by the Bank of England. It is aligned to the overnight borrowing costs of banks. 

You can check out the latest SONIA rate for yourself. 

The next chart shows how SONIA has risen in the past year. Interest rate fans should notice that SONIA is closely tethered to the UK’s official Bank Rate:

Source: Bank of England.

Estimating money market fund interest rates 

We can use SONIA to approximate the annual rate of interest available from a GBP money market fund. 

However, SONIA can only ever be a rough guide to MMF income payments because:

• SONIA fluctuates daily
• Payouts from a money market fund are net of fees  

So we must deduct all our investment fees from SONIA as part of our interest rate estimate.

For example, let’s say today’s SONIA rate is 3.92%. 

From that you would deduct your following investment costs: 

• The MMF’s Ongoing Charge Figure (OCF) – e.g. 0.11%
• Transaction costs (the fund’s underlying transaction costs, applicable spreads, and your broker’s dealing fees, if any.) – e.g. 0.01%
• Your broker’s platform fee – e.g. 0.25%

Your potential money market fund interest rate is thus:

3.92% – 0.37% = 3.55% 

Money market funds are actively managed so some may beat SONIA periodically, or even over long periods of time. That’s hard to gauge with reasonable certainty, and isn’t guaranteed. Personally, I’d treat anything extra as a bonus.

Comparing your estimated money market fund interest rate against a bank account 

Pop your estimated money market fund interest rate into a compound interest calculator such as this one. Match your inputs to the calculator’s fields like this:

• Initial investment = £1
• Interest rate = 3.55% yearly (or whatever is your estimated MMF annual interest rate)
• Years = 1 (this ensures the calculator gives us an annual compound interest rate)
• Compound interval = Daily
• Effective Annual Rate = 3.614% 

The calculator’s Effective Annual Rate is the figure to compare against the Annual Equivalent Rate (AER) touted by your bank account. It gives us an apple-to-apples compound interest comparison. 

Both rates assume you reinvest your interest throughout the holding period. 

However you won’t get exactly this rate if you hold your money market fund for a year. Your MMF may not track SONIA perfectly. And SONIA varies daily in any case.  

But at least this calculation provides a way of estimating if a money market fund offers any kind of interest rate advantage over a bank account. 

Other money market fund yields 

On a money market fund’s webpage you may see a percentage rate called something like ‘dividend yield’, or ‘net yield’, or ’12-month trailing yield’, or similar. 

Such yields are typically calculated by summing up the last year’s worth of interest paid divided by the fund’s current price or Net Asset Value (NAV). 

• If interest rates are rising then a trailing yield will probably underestimate your near-term income from the fund. 

• If interest rates are on a downward trend then a trailing yield is likely to overestimate your expected income. 

This assumes that your principal remains absolutely stable. We’ll explain why you can’t take that assumption to the bank shortly. 

Note: your interest is automatically reinvested if you choose an accumulation fund. 

An income money market fund will pay out interest at the frequency indicated on the fund’s webpage.  

Are money market funds taxable?

Yes, any interest or excess reportable income earned is taxable at your marginal rate of income tax as per normal cash savings. 

Money market funds will often describe their income distributions as dividends. However they are taxed as interest. 

There’s no tax to pay if you hold your money market fund in a stocks and shares ISA, or pension. 

Your Personal Savings Allowance might also shield your MMF interest payments earned outside tax shelters from tax, depending on how much you have saved. 

The Personal Savings Allowance enables non-taxpayers and basic rate taxpayers to earn £1,000 of interest tax-free. The amount is £500 for higher-rate taxpayers. 

Low earners may be eligible to earn another £5,000 in tax-free interest using the little-known starting rate for savings. 

Does your money market fund pay interest gross or net?

If your money market fund is registered as an OEIC or Unit Trust then check if it pays interest gross or net.

If interest is paid net then you’ll receive it with 20% income tax already deducted.

• So a basic-rate taxpayer has no more to pay. (Yay!)
• A higher-rate taxpayer owes another 20%
• A non-taxpayer is due 20% back (Double yay!)

This is only an issue if you’re holding the fund outside of an ISA or pension. It’s also not relevant if your fund pays interest gross – that is, with no tax already deducted. 

Scan the fund’s webpage or other documentation for the info. Or contact the fund manager directly for clarification.

Capital gains tax (CGT) applies as usual. 

If you invest in a foreign-domiciled money market fund then check its webpage or factsheet to ensure it has UK reporting fund status. If not, then any CGT liability must be paid at your income tax rate. 

Money market funds tucked safely inside an ISA or pension are exempt from CGT.

Can money market funds lose money?

Money market funds can lose money. They typically invest in low-risk assets and are subject to close regulation. But you’re still not guaranteed to get back all the money you invested. 

The clearest warnings come from the money market fund managers themselves. 

BlackRock’s Cash Fund explicitly states the risk on its webpage:

Capital at Risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.

A Money Market Fund (MMF) is not a guaranteed investment vehicle. An investment in MMFs is different from an investment in deposits; the principal invested in an MMF is capable of fluctuation and the risk of loss of the principal is to be borne by the investor. 

BlackRock goes on to list some of the risks that money market funds are exposed to:

Loss of Capital: an automatic share redemption may occur which will reduce the number of shares held by each investor. This share redemption will result in a loss of capital to investors. 

Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss. 

Credit Risk: The issuer of a financial asset held within the Fund may not pay income or repay capital to the Fund when due.

These risks are not merely theoretical. A huge and reputable US money market fund called the Reserve Primary Fund faced a run on its assets during the Global Financial Crisis in 2008.

Reserve Primary suspended redemptions and was eventually forced to liquidate its assets at a loss that impacted its investors. 

The lessons of the Global Financial Crisis led to widespread reform of the $4.8 trillion money market industry both in the US and in Europe. 

The MMF sector was again severely tested at the height of the Covid crash. Major institutional investors pulled their money as they scrambled to solve their own liquidity problems. 

Money market funds subsequently faced massive redemption demands. And these were amplified by the unintended consequences of the previous round of reforms. 

Fortunately, central bank action alleviated the pressure. Another wave of reform is now underway.

Cash crunch

The significant takeaway for ordinary investors is that – despite successive attempts by global regulators to strengthen money market fund resilience – what seems to be a low-risk vehicle in normal times can become unstable in extreme conditions. 

The fact is that money market funds are not primarily designed to serve the needs of ordinary investors.

And the two most recent global crises illustrate that adverse feedback loops could restrict your access to cash at the worst possible time. 

“Help! My money market fund is losing money” false alarm  

If you do invest in a money market fund and you see an apparent capital loss shortly thereafter, check that you’re not being misled by the fund’s standard dividend payment operating procedure.

The following chart shows what looks like a repeating cycle of gains and losses by the Vanguard Sterling Short-Term Money Market Fund. 

However, these share price fluctuations are just the regular monthly accumulation and distribution of interest from an MMF:

Source: Vanguard. Sterling Short-Term Money Market Fund.

Every month, the fund’s net asset value (NAV) rises above its £1 par value due to the accumulation of interest paid into the fund from its assets. 

That accumulating interest temporarily fattens the fund’s value before it is distributed to investors. 

The fund falls in value on its ex-dividend date. That’s when the interest payments are set aside by the management team in preparation for payment to shareholders. 

Hence the apparent loss is entirely compensated for by the income you receive from the fund on its distribution date. 

This cycle repeats as the money market fund continually harvests and pays out interest. 

Note that despite the dramatic scale of peaks and troughs on the chart, the differences in NAV amount to a tenth of a penny on the pound.  

(With all that said, your investment would be much more volatile if you held a MMF in a foreign currency as you’ll then be exposed to the gyrations of the FX market, too.)

Are money market funds safe?

Money market funds are not as safe as cash. The additional risk inherent in their operation subjects them to pressures and rules that don’t apply to a simple bank account product. 

The Financial Stability Board (FSB) spells out the two main MMF vulnerabilities in its 2021 report Policy Proposals to Enhance Money Market Fund Resilience:

• “They are susceptible to sudden and disruptive redemptions”

• “They may face challenges in selling assets, particularly under stressed conditions”

A wide range of large financial institutions use money market funds for cash management. 

But some money market fund holdings have relatively limited liquidity, especially when markets are stressed. 

This means that MMFs cannot guarantee daily redemption under all circumstances. 

The cost of liquidating harder-to-shift assets can rise during a market slump, or dry up completely. This creates an incentive for some money market funds and their investors to redeem early in a crisis – before the cost of doing so increases, or the regulations impose firebreaks on selling. 

The FSB comments that:

Taken together, these features can contribute to a first-mover advantage for redeeming investors in a stress event and thus make individual MMFs, or even the entire MMF sector, susceptible to runs. 

The FCA spell out how this contagion spread during the Covid Crash:

In March 2020, financial markets reacted to the unexpected effect on economic activity of the Covid pandemic and the public health measures introduced to contain its spread. This shock exposed underlying vulnerabilities in the financial system, which catalysed an abrupt and extreme dash for cash. As a result, financial markets experienced increased selling pressure, volatility and illiquidity. 

MMFs also came under severe strain across major currencies, including in sterling, as investors quickly sought access to cash. Investors redeemed their units in MMFs to make necessary payments elsewhere, such as margin payments. 

However, some investors may also have redeemed or made additional redemptions partly due to fear of being unable to redeem at a future date. 

Some MMFs struggled to maintain the required liquidity levels as set out in law and regulations, which increased the perceived (and actual) risk of funds being suspended, which in turn may have increased investor outflows from some MMFs.

I think that conclusively answers the question: “Are money market funds safe?”

UK and European regulation can impose the following penalties on MMF redemptions:

• Additional liquidity fees
• Restrictions on the amount you can withdraw (known as ‘gating’)
• Suspending the fund 
• A low-risk MMF must transform to a riskier type if it’s suspended for more than 15 days within a 90-day period

These penalties could make life more difficult for an ordinary investor who needs cash in a hurry. 

As citizens, however, we should be reassured to see such measures that aim to protect the wider financial system from the systematic vulnerabilities of MMFs. 

Money market fund classification 

There are four types of money market fund available in the UK and Europe.

From the most conservative type to the least, they are:

Public Debt Constant Net Asset Value (PDCNAV) MMFs 

• 99.5% of assets must be invested in public sector debt issued by central government, local authorities, and quasi-governmental bodies.  
• Investors are able to buy and sell at a constant NAV price of £1 calculated to two decimal places. Volatility should be minimal under normal circumstances. 

Low Volatility Net Asset Value (LVNAV) MMFs 

• Can invest in private debt as well as public sector securities. 
• Otherwise, liquidity requirements are as stringent as those that apply to PDCNAVs.
• The fund’s price is maintained at a constant £1 NAV under normal circumstances.

Short-term Variable Net Asset Value (STVNAV) MMFs 

• Liquidity rules are looser than with the first two MMF types.
• Pricing is variable, meaning capital gains and losses are possible under normal circumstances.

Standard Variable Net Asset Value (VNAV) MMFs

• The least restricted money market fund type. 
• Enjoys the wider liquidity bounds of a STVNAV but adds longer maturity assets to the mix.
• Variable pricing. 

The FCA produced this table summarising the liquidity and maturity restrictions governing the four different money market fund types:

Source: FCA. Resilience of Money Market Funds.

• DLA = Daily liquid assets – the percentage of assets that can be disposed of in 24 hours
• WLA = Weekly liquid assets – as above but disposal is allowed within a week
• WAM = Weighted average maturity – the average time taken before the fund’s current holdings will be repaid by their issuer 
• WAL = Weighted average life – the average time taken before the fund’s holdings will repay the amount invested. Similar to Macaulay duration for bond funds

Risk is all relative

Compared to the differences between, say, equity funds, all MMFs are so conservative that it’s like comparing four Mrs Thatcher clones by the colour of their headscarves.

However, the FCA draws out this key distinction:

As noted, evidence from major MMF domicile jurisdictions strongly suggests that in a large-scale market stress, private sector-backed MMFs suffer large outflows, while public debt backed MMFs receive large inflows. LVNAV MMFs invest predominately in private sector assets, while the PDCNAV must invest almost entirely (minimum 95.5%) in public sector assets. The evidence also indicates that public sector debt markets are less likely to become seriously illiquid in large market stresses than private sector debt markets. 

Your money market fund provider may mention what type it is on the product’s webpage or somewhere within its documentation. (Burying the info somewhere within a 200-page prospectus is a favourite wheeze. World’s. Worst. Word search.)

You can find more detail about the money market fund classification system here.

Does the FSCS compensation scheme apply to money market funds?

If a money market fund provider defaulted then you’d be entitled to a maximum payout of £85,000 per authorised firm – including their sub-brands. Sadly, the restrictions of the FSCS compensation scheme means that limit is the most you’re entitled to. That’s regardless of how many investment funds you own from that provider. The £85,000 does not apply per fund. 

Moreover, the FSCS scheme does not cover investments – including money market funds – that are domiciled outside the UK.

If you own investments in Ireland or Luxembourg then you’re subject to the statutory compensation scheme followed by those countries. This limits compensation payments to a meager €20,000.

Best money market funds

You can buy and sell money market funds from investment brokers like any other fund. 

Not every broker makes it easy to find MMFs on their platform, however. Your best bet is to drop the name of your favourite money market fund into your broker’s search bar. 

But how do you compare money market funds in the first place?

For money market ETFs, use justETF’s ETF screener switched to the money market category.

There’s only a handful of prospects. You can easily compare them using justETF’s tools. 

Note that some of the products are synthetic ETFs that use a financial derivative called a total return swap to match the SONIA rate. 

For a broader trawl, go to Morningstar’s Fund Screener.

Flip the screener’s Morningstar Category to GBP Money Market – Short Term or GBP Money Market.

Compare the characteristics of your candidate MMFs using Morningstar’s Investment Compare or the slicker FT Fund Compare. 

Personally, I’d concentrate on:

• Long-term performance – Morningstar show up to 10-year annualised returns where available
• Fees – Money market funds are typically actively managed and costs vary a great deal 
• Assets under management – big is beautiful
• 12-month yield – to gauge how generous previous interest payments have been 
• MMF classification – this will require a deeper burrow into the fund documentation 

Still want a money market fund? 

The pros of a money market fund are typically advertised as: 

• More diversified than cash in bank 
• May offer juicier interest rates 
• No early withdrawal penalties (not entirely true as we’ve seen)

Yet having done the spadework on money market funds I can’t imagine why I’d choose one over a decent instant access savings account, except where tax comes into the equation and for some reason you don’t want to use a cash ISA. 

There’s another narrow use case for someone who wants to earn a little more on cash that would otherwise be parked in a SIPP at derisory rates. 

But I can’t see that the extra smidge of interest is worth it versus the additional risks you’re running with a money market fund. 

If you want the simplicity and safety of cash then put your money in a bank. 

Take it steady, 

The Accumulator

What caught my eye this week.

Will house prices fall, steady, or crash? I’d say a decline was the consensus view as we closed the door on 2022, with memories of Liz Truss still swirling about the porch like a frightful CGI spirit.

Yet having competent technocrats back in Downing Street after a multi-year hiatus has had such a calming effect on markets that the prospect of a proper slump seems to me to be abating fast.

PM Sunak and chancellor Hunt still can’t offer much in the way of growth. And that’s a problem in the long-term.

But even the slow puncture Brexit economy doesn’t seem quite so bad after October’s multi-lane pile-up.

Choose your poison

The major reason that if we’re going to economic hell in 2023 it’s on a Stannah Stairlift not a handcart is lower mortgage rates.

Declining swap rates had suggested there was room for lenders to reprice their mortgages cheaper if they wanted to play for market share.

And happily for anyone needing a mortgage, they’ve done so.

Massive lender Nationwide is the latest to cut rates across the board and join the sub-4% five-year fix club. Recent Weekend Reading links have flagged previous entrants including Virgin Money, Natwest, HSBC, and the Yorkshire Building Society.

Hardly universal, but far better than average five-year rates above 6% following the Mini Budget.

Getting the best rates does typically require lower loan-to-value ratios of 60% or less. Across the spectrum, lenders seem to be being more judicious about who they lend their cheapest money to.

Whether you’re buying or remortgaging, putting in a little extra cash might save you a lot of money if it unlocks a cheaper rate band.

Resetting the game

For sure lenders aren’t chucking money around like its confetti again. The days of less-than 2% five-year fixes have gone, at least for the foreseeable. Hence the froth is coming off the pandemic-era price pop.

But while employment remains strong – and with many of those who are leaving the workforce apparently doing so because they can afford to, to the dismay of the chancellor – it’s hard to see rates at today’s more reasonable levels being a catalyst for a ginormous crash.

Maybe we’ll even stumble into what the UK economy both needs and fears – stagnant prices.

More young people would then get a chance to move out of the chillingly expensive rented sector sooner, and start building housing equity instead.

Inflation will have to abate though for the economics of stable prices to work for home builders, if we’re to avoid the knock-on of even fewer new homes being built. Workers are too scarce now for a big government house building program. We need to the commercial sector to keep at it.

And of course mortgage rates could start to rise again. The US stock market wobbled this week as various economic stats have suggested it will be longer before interest rates can be cut there.

Rates remains the greatest guessing game in town. Which is very unfortunate for anyone having to make long-term choices about paying for the roof over their heads.

But everyone would suffer in a big slump, and after the past few years we can do without one.

Have a great weekend!

[continue reading…]

Welcome back to the Monevator snug! Settle in for another interview with a reader who has achieved financial freedom (aka FIRE). This month we learn how moving to a cheaper part of the country – or geo-arbitrage – enabled Jake’s young family to live their dream.

A place by the FIRE

Hello Jake, how do you feel about taking stock of your financial life today?

It’s the first time I’ve publicly discussed our story. I’m a little nervous and excited. I’m also happy that hopefully I can give something back to the FIRE community.

How old are you?

My wife and I are both in our mid-40s. We’ve been married for 16 years.

Do you have any dependents?

Two children who are both at junior school.

Where do you live and what’s it like there?

During 2020 we relocated from the Home Counties to East Anglia.

It was a big decision and move for us, as our children had to leave their friends behind and start again at new schools. It was difficult at the time with the lockdowns and schools closing. Thankfully they’ve settled in well.

The move was a lifestyle choice. My wife and I agreed we would like a slower and more relaxed pace of life, so we could spend more time with our children. It was also part of our FIRE strategy – specifically, domestic geo-arbitrage.

Property prices and the cost of living are lower in East Anglia than in the Home Counties.

When do you consider you achieved Financial Independence (FI)?

Using the 4% rule as guidance, we reached our FI number during 2022. That’s based on living costs of between £34-35,000 a year, suggesting a required net worth of between £850-875,000.

Of course, our net worth can fluctuate by large amounts on a monthly basis. But so far, after every big dip the market has recovered enough for us to remain comfortable with our plan. We’re aware this may not always be the case.

There is also the mental side to consider. Self-doubts as to whether we have enough. The nagging feeling that we could do with a little more, and a little bit more after that.

It can be scary – even overwhelming. You question if you have made the right decisions.

How do you deal with such doubts?

We try to block out as best we can the external noise and not compare ourselves to others.

At some stage you must take action based on your circumstances. Otherwise progress will not happen, and you will continue being fearful.

We feel we are in a good place and have enough. We’ve talked about the need for us to be fluid, and adjust if required.

Did you retire when you achieved FI?

I left employment towards the end of 2022 and currently have no intention of returning. But that is not to say that I will never work again. One day I may find a part-time role that suits me.

After I discovered the FIRE community in 2017, my wife and I discussed how we wanted our future to look. I was commuting into London daily and was physically and mentally exhausted and frustrated. For a long time I had wanted out of the rat race. The discovery of the FIRE community was a glimmer of hope.

I find it strange to label myself retired. I dedicated a lot of my energy to the Financial Independence part of FIRE. The retiring early part is an option that becomes a real possibility if you wish.

I had become disillusioned with my employer. Reaching our FI number when we did in 2022 allowed me to end that relationship. It can be hard to take a step back and understand how unhealthy a work situation is for you and your family.

Assets: overweight America

What’s your net worth?

Our net worth is £874,500; additionally our house is valued at £475,000.

How is it comprised?

• Two ISA accounts (invested in S&P 500 passive index funds) £175,000
• Two ISA accounts (invested in a UK bank) £119,000
• Two taxable general trading accounts (invested in S&P 500 passive index funds) £128,000
• Three pensions (two are SIPPS invested in S&P 500 passive index funds) £441,000
• Cash and Premium Bonds £18,500
• Debt is on a credit card (charging 0%) -£7,000
• Total net worth (excluding house) £874,500
• Total net worth (including house) £1,349,500

Your allocation towards the S&P 500 jumps out…

Our investments are not as diversified as is usually encouraged in the FIRE community. It could be argued though that the bigger companies in the S&P 500 have operations worldwide. Thus a reasonable percentage of the revenue and profit is diversified.

But why not a global tracker?

It was probably partly the influence of the American FIRE blogs that I spent time reading when we started investing in passive index funds. I also wanted to avoid any more exposure to the FTSE 100 as we had our investment in the UK bank.

For some unknown reason I am not attracted to the European markets.

Through my research the S&P 500 appealed on many levels. The large global companies, the high global market share, the strict regulation, the global revenue exposure, the historical returns. I also think that the American markets have a very good reputation worldwide.

Rightly or wrongly, I arrived at the conclusion that American companies are diversified international companies with global reach. But I am not closed to the idea of a more traditional approach to diversifying. I’ve been thinking about moving some money into a global tracker in the future.

What about that single company holding?

A legacy holding built up over many years before we discovered the FIRE community. It’s a bank that pays out dividends, which we automatically re-invest.

As it’s in an ISA we don’t have to worry about the dividend allowance.

You have no mortgage…

We own our home, and it is mortgage-free due to our domestic geo-arbitrage. We sold our house in the Home counties for more than the purchase price in East Anglia.

Do you consider your home an asset, an investment, or something else?

This is a more complex question than it initially seems.

There are a lot of people who consider their home an asset. Some even refer to it as their pension. I guess the definition is in the eye of the beholder.

In my opinion it’s a mixture of all the above. It is partly an asset, as it has a value – the price that someone is willing to pay. And in our case there is no mortgage.

As an asset it is not immediately liquid. The selling process will normally take a couple of months, at least. But you can realise the value once it’s sold.

On the flip side it costs us money on a monthly basis via council tax, electricity and gas, water, broadband, and general upkeep.

We don’t include our home in our net worth when we calculate it every month.

Earning: doing it the hard way

What was your job?

I worked in the commodities industry and my wife in the fashion industry. We both had various roles in different industries over time. Neither of us had clear career paths.

What was your annual income?

When I finished at the end of 2022, it was a base salary of £68,000 plus a yearly bonus, which varied between £3-5,000.

My wife gave up work approximately eight years ago, when we had our second child. She was earning £24-25,000. We lived on a single salary after that as a family of four.

How did your career progress – and was pursuing financial independence part of your plan?

I’ve worked full-time for 24 years, but it was only for the last 12 years or so that I earned over £40,000. Before that I earned between £12-30,000.

My most important career move was when I moved within the same industry but to a different department. That increased my salary by £10,000. It was huge to us – going from £30,000 to £40,000. I’d been trying to make the move for several years, both internally and externally. But it was very competitive and my employer placed a lot of new graduates into the role I was aiming for.

Fortunately, I persevered. I found out an external company was looking for someone in the role that I wanted. Interestingly, I’d interviewed there previously. I contacted the person who interviewed me the first time. This time I was offered it. Looking back it was a pivotal point on my way to a higher income.

Intentionally pursuing FI only became our plan in 2017, so it did not affect my career.

Did you learn anything about building your career you wish you’d known earlier?

In the first half of my career, I had to be very patient regarding progressing into higher-paying roles.

I switched industries a few times – mostly for potentially higher earnings. The tradeoff I discovered was that with higher earnings came higher levels of stress and pressure. Having to deal with volatile, aggressive and sometimes untrustworthy individuals higher up in the food chain.

I struggled with this more once we became parents. I felt guilty that I was not spending as much time at home with my family. Even when I was there physically, mentally I was consumed by work.

I wondered if I should have worked for myself rather than a corporate machine. If I had my time over again, I would probably either try working for myself or be more intentional at the start of my career.

In the first ten years of my career, I had more energy, motivation, and desire. I would have been better suited to working longer hours then – to arrive at a certain level before I became a father.

Do you have any sources of income besides your main job?

No. We did raise some extra cash to invest by de-cluttering our home and selling unwanted items online. Almost £2,000 after costs.

Did pursuing FIRE get in the way of your career?

It didn’t get in the way, but I was spending a lot of time thinking about it and researching.

After discovering the FIRE community, I spent months reading the different FIRE blogs. There was so much information, amazing content, and thought-provoking ideas. My head was spinning. I was in a daze, I could not stop thinking about this amazing discovery. I had found like-minded individuals, who had a similar mentality and way of thinking.

This community wanted to save and invest in an optimal way, working towards a better future – a flexible one with choices. I had been trying to do it my own way for years, with mixed success.

Saving: Automatic achievement

What is your annual spending? How has this changed?

We have tracked our expenses over many years.

Our annual spending has crept up a little. Based on our 2022 expenses – the highest we’ve had, and what we expect to maintain – we require between £34-35,000 per year.

This includes a little bit of wiggle room for price increases or an unexpected bill or two.

Do you stick to a budget?

We have a good understanding of where our money goes. We don’t have a specific monthly budget, but we’re aware of our spending habits. We will know how we are doing as the year progresses.

As a family we have never been extravagant with our spending and have always made sure that our basic needs are taken care of first. In addition, we make sure our children have opportunities to learn and enjoy different activities. We sign them up for after-school activities and trips, and pay for them to follow their interests and hobbies. They enjoy birthdays and Christmas.

We very rarely make impulsive purchases. If we decide we want something, we research prices and sometimes wait until the item is on sale or we can purchase a slightly older model.

Occasionally after waiting patiently, we decide we do not need it!

What percentage of your gross income did you save?

I didn’t track our savings rate early on. Even when I attempted to, I wasn’t sure I was doing it correctly. I was unsure whether to include my employer’s pension contribution, and the mortgage repayment after interest.

After some conflicting research, I settled on a calculation method.

I’ve had a look through some old spreadsheets, and it appears our saving rate was around 60%. I would guess even in the earlier part of my career my savings rate was approximately 50%.

Impressive. What’s your secret?

I’ve always been good at avoiding impulse purchases. Also, I automated savings and investments. These would be taken from my bank account when I received my monthly salary.

I didn’t consider that this was money available to spend. It was taken like tax.

Do you have any hints about spending less?

I believe mindset is very important when it comes to cash management. It may be you become bored or impatient easily, or you fear missing out. Try to learn to be disciplined and strategic. Put a basic budget in place. Automate, and avoid impulsive spending.

Do you have any passions, hobbies, or vices that eat up your income?

I’ve been slowing reacquainting myself with fishing. I still have a lot of equipment from my youth and I purchased a few secondhand items. So currently it’s not costing me too much.

I hope to find some new interests now I have more time. But surprisingly so far it hasn’t felt like I have had much! Our days are still structured around the school runs.

Investing: pick up a pension

What kind of investor are you?

Originally I was an active investor through individual companies and active funds. There was not a great deal of transparency regarding the fees. I was not aware of passive index investing.

Now most of our investments are in index funds. We are still invest in the one individual company, but have not made any additional purchases for years (except for the dividend re-investment).

What was your best investment?

One oil company share I made a profit of £9,000 on years ago. I am not sure I could classify it as an investment as it was short-term. I didn’t have a well thought out investment strategy back then.

My investments in my pension have probably been my best long-term decision. Especially when you consider the employer contributions, the tax relief, and the years of compounding still to come.

Did you make any big mistakes on your investing journey?

My biggest and most costly mistakes were investing in individual companies.

At the beginning I was influenced by day traders and the potential profit that could be made quickly. I read article after article about oil companies. The money they could make, the new discoveries of oil fields all over the world, and the expected oil reserves each field could contain.

Even though I made a profit out of one, I lost a lot more on the other companies I invested in. It taught me a valuable and expensive lesson.

I always remember losses much more than any profits!

What has been your overall return?

I didn’t track or record percentage returns. I have partial records that I have pieced together from the first part of my investing journey. I made a profit on my active managed funds that were in an ISA, but losses on most of the individual companies. I calculate I made an overall loss during this period of around £10,000.

At the same time, I also had money in premium bonds and savings accounts, I had started paying into a pension, and we had taken out our first mortgage – which we overpaid on each month.

Did you fill your ISA and pension contributions?

I’ve invested in ISAs since early in my career. Most years I was not able to use the full allowance. We also sold a large portion of our ISA investments to help with an earlier house deposit.

In the last few years we have used our full allowances. Our domestic geo-arbitrage house move enabled us to do this with the money that was left over. The rest is in our taxable trading accounts.

In my first few roles I didn’t have a pension, so I didn’t start as early as I should have. But over the last 15 years I have invested heavily in my pension.

I couldn’t contribute the full allowance of £40,000, although I was able to increase my contributions for a few previous years via the carry forward rules. I normally contributed between £15-22,000 a year, including employer contributions.

My wife has a small pension from her time working. In recent years we’ve invested £3,600 a year in it. (That’s the allowance for a non-taxpayer, including the tax relief received).

Did tax influence your strategy?

It played a major role once we truly understood the full tax incentives on offer with a pension (especially for a higher-rate taxpayer)

In the last six years of my career, I increased my pension contributions every year. Including the employer contribution, it was 33% of my salary by the end.

We also invested in our ISAs where possible.

How often do you check or tweak your portfolio or other investments?

We track our net worth once a month via a spreadsheet. Occasionally I’ll check certain parts more often.

I have a further spreadsheet split into pre and post access to pensions. This models different growth scenarios for our investments. For example, a low assumption of 2% average growth per year – up to 7%. I also include the withdrawal of our living costs as part of the calculation in the same forecasts.

It’s not perfect but it gives us a starting point, allows us to see how we’re progressing, and assists with forecasting. Hopefully it will flag any potential issues so we can be pro-active if needed.

Wealth management: dealing with de-accumulation

We know how you made your money, but how did you keep it?

As my salary grew, we tried not to give into lifestyle creep. Bonuses were normally invested as lump sums.

One intentional tactic we implemented from our very first mortgage was to overpay every month. We continued with every mortgage we had. This enabled us to build up a large amount of equity and pay less interest, as we reduced the term of our mortgages with the overpayments. I understand this was at the opportunity cost of investing that money in the markets.

Also, as mentioned previously an important part of our FIRE strategy was domestic geo-arbitrage.

After we relocated, the money left over was invested in passive index funds. We made a lump sum payment into my pension, using the carry forward rules. We also transferred some older pensions from higher-fee companies into SIPPs with lower fees.

I continued to work from our new home until the end of 2022. Those two and half years of working from home saved us around £10,000 on commuting costs.

We decided to spend money on our new home from my salary, before I left work. This way the large, planned-for costs were paid for while I had a monthly salary.

Which is more important, saving or investing, and why?

They are both important. I’ve placed more importance on investing. But it must be the right type of investing for your own circumstances.

Long-term investing is key so that you benefit from compounding. You need to be disciplined and patient to see the rewards. It’s probably best to get into the mindset of forgetting about the money invested – especially if you are young, with a passive index tracker – so you’re not tempted to fiddle. This is how I approached paying into my pension.

Was financial freedom a goal with a timeline?

I always had a dream of some form of financial freedom in the future. A desire to break away from the path much-travelled. But I was unsure if and how this was achievable, until I discovered FIRE.

I made plenty of mistakes in my younger years. I was lacking relevant knowledge, direction, and intentional decision-making. These missing components are exactly what the FIRE community has provided me with, and so much more. Once we came up with our FIRE plan in 2017, I was hopeful of achieving freedom before we were 50.

For us the pivotal part of our strategy that allowed us to reach financial freedom by our mid-40s was domestic geo-arbitrage. This unlocked the home equity we had built up.

Can you share more of your thinking on your domestic geo-arbitrage?

I realised we would need to release the large amount of equity we’d built up in our house in order to be financially independent before we were 50.

I’d read about international geo-arbitrage, but we wanted to stay in the UK. My wife and I discussed the possibility, and we were both open to a new adventure and lifestyle.

We started by considering cheaper areas or houses in the Home Counties. But we were unable to find anything in the right price range that would work for us.

It was at this point I mentioned the possibility of East Anglia. As a boy I use to spend some time with family that lived in the area. I had very fond childhood memories – maybe slightly rose-tinted – and suggested it might be the right place to start our new life.

We did a lot of research online and came up with a list of potential areas. My wife and I visited these areas and later took our children along. The rest, as they say, is history!

Working from home really helped with the transition, as I was not wasting hours a day commuting. This allowed me to be more involved with our children.

We did move further away from family and friends, but fortunately they come and visit. We have also made new friends, mostly with other parents.

There is not anything else we miss from our old life. We’re looking forwards rather than backwards. Now that I’m no longer working, we can slowly piece together the lifestyle that suits us.

Did anything unexpected get in your way?

The biggest challenge was the psychological aspect of re-locating our family to a new area away from family and friends.

Looking back our worries were unnecessary. It is easy to say that now, but it turns out our children are very resilient. They just got on with it!

How are you de-accumulating your pot?

The de-accumulation stage is a scary prospect when you’ve spent so much time saving and investing. It feels like an unnatural shift in mentality. One that I’m not completely at ease with yet.

We’ve split our costs into two sections. Costs that have to be paid out of our bank account by direct debit – council tax, electricity and gas, water, costs for children’s activities – and all other costs that can be paid for by credit card.

This is because we have some 0% interest credit cards that don’t have to be paid back until 2024.

We have enough cash for approximately 16-18 months’ worth of costs. These are paid out of our bank account by direct debit. Most of this cash is in an easy access savings account paying interest of 2.75%. When we need to top up our bank account, which will be on a monthly basis going forward, we will transfer some cash from the savings account.

I believe this strategy – earning interest on cash we’ve saved and using 0% credit cards that are not charging interest – is called ‘stoozing’. The 0% cards will be paid off by selling units of our funds.

Sequence of return risk is a danger. We plan to sell some units of our funds from our taxable general trading accounts by the end of March 2023 (for the current tax year). We will then re-invest this money to utilise our ISA allowances for the new tax year, starting in April 2023.

We’re also planning for the reduction in the Capital Gains Tax (CGT) allowance over the next few tax years. We’re considering selling more units of our funds from our taxable general trading accounts by the end of March 2023. There is a strong possibility we may be selling these additional units of our funds at a lower price than we would have wanted.

Any cash raised will probably be split between savings accounts and premium bonds, until we can use it for the next tax year’s ISAs or to pay off the 0% credit cards or our living costs.

Do you have any further financial goals?

We may have to help our children financially in the future, so we’d like to maintain or even grow our pot as best we can.

It’s a fine balancing act, and we don’t have all the answers. It’s like being a parent. You do the best you can and adapt to the circumstances.

What would you say to Monevator readers pursuing financial freedom?

Monevator readers are very knowledgeable, and share interesting, helpful, and thought-provoking comments on the articles. I hope some will find our story inspiring! I always find real-life examples helpful, and so I have tried to be as open and transparent as possible.

There are so many moving parts to consider when deciding upon your strategy. I would say make a start as soon as possible – even if you are unsure or scared. Taking action is important. You can spend too much time researching, putting a plan together, and worrying about the right decision. If you are not actually taking any action, you are holding yourself back from progressing and the future you want.

You can evolve your strategy. You do not need everything to be perfect from the first step.

Learning: from the US to the UK

When did you first start thinking seriously about your finances?

In my early 20s after starting my first job. My father encouraged me to save and invest. He introduced me to ISAs and explained how they worked.

Did any particular individuals inspire you to become financially free?

My parents played an important role. I could see from their example that working hard, having a strategy, and trying to make the right decisions could provide you with future opportunities.

Can you recommend your favourite resources for anyone chasing the FIRE dream?

I split my time between US and UK websites, blogs, and podcasts.

Initially when I first discovered the FIRE community it was via the American websites and blogs. The first one I ever read was Millennial Revolution. I saw Kristy and Bryce being interviewed on a television program. A podcast I found interesting and helpful was Choose FI with hosts Jonathan and Brad. I also spent a lot of time reading the stock series on the J L Collins blog.

I then progressed onto the British blogs. They were directly relatable to my circumstances.

Monevator is a great source of information. I especially like the comments as you can learn so much from the different opinions and debates. I also enjoy Banker on Fire and Alan Donegan.

What is your attitude towards charity and inheritance?

We make donations to our local school and donate unwanted clothes, toys, and household items to charity shops. At some stage I would like to volunteer at a local organisation. Maybe give some of my time to people who are lonely, or who don’t see their family.

Regarding inheritance, we plan to leave everything that’s left to our children.

What will your finances ideally look like towards the end of your life?

Depending on market returns and our spending, we hope to have enough to see out our lives on our terms. We will leave our investments as they are for now. We hope there will be enough in the pot for it to keep growing in the long-term. We’re both due to receive state pensions, though not for the full amounts. They have not been included in our FIRE planning, so may add a little extra buffer.

Finally, we want to create many happy family memories and have a life well-lived.

Nice, eh? FIRE by your mid-40s, mostly on one (sizeable, but not sky-high) salary – and with kids! Clearly moving helped mightily, but saving and investing for 20-odd years was crucial. Questions and reflections welcome. Please remember Jake is just a reader and a one-time poster sharing his story to inspire others. Constructive feedback is fine, personal attacks will be purged. Thank you!