How to avoid lifestyle inflation to achieve Financial Independence

House and bicycleHousing, Transportation and Food are the big three categories to control in order to maintain a relatively high savings rate. To achieve financial independence (FI), the most important thing is your savings rate as I explained in a previous post here.

A lot of people try to find investments or other means with a high return rate. However, this may turn out futile if the necessary capital available to invest is not substantial. Good returns do not have a big impact if you intend to be financially free at a young age, considering that the stock market typically returns nominally 10% a year.

I am in the process of looking for a new place to live in January 2020 and this has made me to seriously consider my lifestyle costs in future. When I moved to new places previously, I did not  do the math well, particularly for housing and transportation costs in relation to my new lifestyle. In a number of cases, this has resulted in me being worse of either financially, by quality of life or both.

For example, when I moved for my current job (from Cambridge to London outskirts) my salary went up by 13%. This seems great but I ended up living 11 miles from work compared to 4 miles previously. This seemingly innocuous change turned a simple 20 minute commute into a gruelling drive of over an hour in rush hour traffic.

The new job meant that I lost many hours a month plus cash due to the long commute and I was generally more tired. It felt like I had already been to work when I got to work.

Housing and Transportation

I see management of these two elements as being critical in propelling me towards financial independence at this stage. It is not wise to find a cheap place to live which is very far from work, costing time, an arm and a leg to get there. For this reason, I have decided to find a rental within walking distance of the office. Costs will be roughly the same as the previous place but the commute by car or train will be completely eliminated, resulting in cost savings and 7 hours a week freed each week. That would be effectively gaining an extra work week each month! 

55% savings rate

To be financially free by my target date I have estimated that at least an average 55% savings rate will be required. This has been over 53% so far. I will also need to maintain the progress made by maintaining my core living expenses or even better by reducing them. To do this it is important to know current and expected expenses which will guide the search for new accommodation.

Housing and Transportation to gross income ratio

People often wonder how much they should spend on housing in relation to their income. It will depend on what you can afford and what you value in life. I was a bit shocked when the estate agent said that I could afford a place which is my gross salary divided by 30. This would mean that 53% of net pay would go towards housing which is ridiculously high. Admittedly I would get a nicer place but my financial independence progress would drop to only 29% and future savings to 35%. Achieving freedom would become practically impossible, leading to many more years in the cubicle.

Housing and Transportation to gross income ratio

With these facts in mind how much should one allocate towards housing and transport. I have been tracking how much I spend on these two since 2007 as shown the the graph above. When I started my first job in 2007 I lived in shared accommodation with very low costs and a 20% spend. However, within a year I got a small pay rise and had a huge bout of lifestyle inflation by moving to my own studio flat.

Now with a hefty 30% expenditure I managed to save absolutely nothing after a three year period and remained with even more credit card debt while having a negative net worth.

Over the next few years I moved locations for new jobs and back to shared accommodation. This enabled me to pay off the credit card and start the fi journey in 2012.

The housing and transport expenditure proportion has been steadily decreasing due to some some pay rises and is expected to get back to near 20% when I move to the new place. I find this to be an acceptable amount to pay. It may mean sacrificing a little luxury but will not derail progress towards financial independence within a few years.

*It is also important to stick to a budget while tracking your other expenses as these will affect the overall picture.


In summary, to maintain a 55% savings rate I would need to spend roughly 20% of my gross income to housing and transport to achieve financial freedom within 3 years. This is based on my current level (52%) of expenses covered by passive income.


I have found this to be the most comfortable scenario for me in relation to my goals. Everyone’s situation will be different.

Geographic Arbitrage

As I am currently based in one of the most costly areas of the UK (South East), applying some Geographic Arbitrage almost anywhere would definitely have a positive impact. Quality of Life could be increased and Cost of Living reduced readily so this will definitely be on the cards soon. In fact I realise that I am already 70% FI for less costly parts of the country.

Also, renting a place rather than owning is beneficial as one would be far more flexible to take advantage of opportunities and overall expenditure on housing and transport would be far easier to limit.

Things look set to get more exciting in the next couple of years as the snowball keeps gathering speed and size, opening up more possibilities and options.

The enduring strength of Index Funds and fallacy of active investing

The demise of Neil Woodford has been coming for a long time and has ended in a bloody nose for the active investment fund management sector. As long been explained by investing legends such as Vanguard’s John Bogle and Warren Buffett, investing using index funds is the only sensible way to go for most people.

Tough time for active investment funds

Active investing is going through a roller coaster ride which started when investors holding the Woodford Equity Income Fund were locked out of their assets. Things did not feel right and it was not a surprise when a few months later it was announced that trading the fund would be shut down. It was a shock for those who did not take time to educate themselves sufficiently about investing, rather deciding to go with the “British Warren Buffett”.

When this active fund was set up in 2015, I was still a novice at investing and followed the hype, buying some shares as part of my portfolio. However, within months I switched the shares to passive tracker funds, taking in the advice gleaned from books such as A Random Walk on Wall Street by Burton Malkiel. This was fortunate, as people who remained in the active Woodford fund have made huge losses.

Performance of the actively managed Woodford fund is shown in the chart below. In this relatively short period the passive FTSE All Share Tracker outperformed both the active fund and all funds within its category.

Woodford Equity Income Fund Performance (Morningstar UK)

Woodford Equity Income Fund Performance (Morningstar UK)

Focus in Costs

Achieving Financial Independence would already be impeded by the very high fees charged by active fund managers (0.75% per year in this case) compared to passive tracker funds which can be as low 0.06% – 13 times lower! This can easily run into hundreds of thousands of pounds over an investing lifetime. Additionally, it is highly unlikely to identify a star fund manager who can beat the market consistently over the long term.

Vanguard is leading the way by cutting costs while active managers are raking in millions for underperformance.

Performance is further degraded by frictional costs due to the frequent trading by active managers; typically selling when prices are low and buying when they are up.  

Low information diet

It is best to not succumb to the heavy marketing from the City and have a low information diet. Talk about asking the barber for a haircut, and getting a bad one at that.

As active fund managers are experiencing vey high outflows in the wake of the Woodford scandal, it is not a coincidence that the S&P 500 index has almost crossed over its all time high. Diligent long term passive investors will be disciplined and not worried about all these shannanigans.

This episode proves what has been outlined time and again on this and other platforms which seek to educate about the benefits of investing in index funds.

Time in the market works, rather than Timing the market. Financial education and staying the course are key to long term success.

Interesting reading:

Why I am Optimistic about future investment returns

New York City Skyline at DuskFuture stock market investment returns are likely to be very substantial, even more so than past returns. This is an interesting topic as I have had a few conversations recently with people who believe that future returns will be lower than before or even negative. Their reasons do not seem logical to me; particularly because they are mainly based on short term thinking, ranging from a few months to a few years and lack of understanding of how the stock market works. 

A crash is coming!

The most common reason for pessimism about future returns is that a stock market crash is imminent because the market has sharply risen to very high levels recently. Having been a stock market investor for nearly 10 years I have heard this all the time but it has not deterred me from investing.

In fact, I have often taken advantage of this negative sentiment by buying more shares at depressed prices. Without fail prices have always come back to where they were, sometimes after what felt like forever, but the end result is an outsized gain.

The key is to believe in “reversion to mean” of stock prices and remaining invested by not touching yourlong term investments when volatility happens. It is best to take the long term view, typically 5 to 10 years or more.

Dow Jones Index Chart (1985-2019)

The chart above of the Dow Jones Industrial Index shows investment returns since 1985. Red bars are years of negative returns. It is clear that over the long term, buy and hold investors have benefited, despite a few short term shocks along the way.

Here are a few reasons why the future of investments is bright.

The rise of new industries

The S&P 500 index is packed with great companies which have thousands of workers striving everyday to bring value to Shareholders. Over time we have seen new industries come, becoming bigger and superseding what was there before. It is hard to imagine that Amazon, Facebook, Netflix and Alphabet did not exist 30 years ago.

New industries are always developing according to the needs of the time and the new companies providing the required services or transforming accordingly will surely reap the benefits. In-order to participate  in this, the intelligent investor will realise this fact and construct a portfolio which invests in the stock indices that will hold such companies.

Billionaire Space Race

A good example is the new Space Race. Private entities like SpaceX, Blue Origin and Virgin Galactic are jostling for stakes in this space and the potential is huge. Space tourism would be highly profitable and take various forms. Governments are already contracting such companies for International Space Station missions. Mining operations in far off places like Mars may become possible. Establishing a true industrial base in space is another objective. Reusable rockets drastically reduce mission costs, accessibility and time.

Innovation

The pace of technological innovation in this Digital age is staggering. Take investing for example. A few decades ago the process was very cumbersome as one needed to hold and mail a lot of stock certificates. Information was not readily available therefore very few people had access to this and brokers charged astronomical fees to everyday investors. Today one can research and buy global stocks instantly on a handheld device.

In this and other sectors, automation is increasing productivity and has potential to drive up returns. It is certain that innovation will continue to happen, offering new opportunites, products and services.

Population growth

I remember a time when the World population was hovering around 6 billion. Today this has jumped by nearly 2 billion and is trending higher.

World Population data estimate - 8 Sept. 2019

World Population data estimate – 8 Sept. 2019

The graphic above from here is very interesting. Net population growth appears to be very high. This fills me with optimism; many more potential users of goods and services than ever before. Astonishingly it took 200,000 years to reach 1 billion; and only 200 more to 7 billion. More importantly, these bigger markets will be more and more prosperous than ever before, fuelling the growth of current and future corporations. 

Too much Information

Every time I turn on the news it seems like the world is about to end. From trade wars, geopolitics, questionable economic forecasts to severe weather events it is not hard to see why some believe that a recession is around the corner. The facts outlined above lead me to believe the opposite. It is best to have a low information diet and focus on the facts.

Gaining financial independence requires discipline in saving and investing so staying the course is vital. Staying optimistic will provide motivation over the long term.

50% FI (Financial Independence) in 7 Years! – What it took to get here

net-worth-chart-2019

Today marks a significant milestone in my journey towards Financial Independence (FI). According to my calculations I have reached the halfway point of achieving this goal. This endeavour started almost exactly 7 years ago in June 2012. The purpose of this blog and my book is to document how I am striving to complete this task within 10 years.

Motivation

There are many factors which have motivated me to embark on this journey. I moved to the UK from a developing country which was facing a severe economic crisis and went on to study engineering at university. This was particularly tough due to the very high international student fees, living expenses involved and having to adjust to a new culture.

Uncertainty and job security in the workforce were other major factors. Money was always scarce when I had to work all throughout my studies which was not ideal. It was therefore no surprise that when I got my first professional job I thought I had made it. I was thinking in terms of income rather than net worth. This led to an episode of lifestyle inflation in my mid to late twenties. 

The Big Three – Housing, Transportation and Food

2007: £1,000 Debt

In order to get your finances on track you need to keep the big three (housing, transportation and food) under control. I did the opposite while working at that job. Moving from shared housing to my own rented flat greatly diminished my savings rate as I faced an explosion of monthly bills.

On the food front I was equally terrible; I never prepared my own work lunch, instead opting to buy costly unhealthy food every lunch break. Anything from burgers to fish & chips and kebabs. Life was good I thought.

I wasn’t done yet! As if all this was not enough I decided to embark on my next wasteful adventure: car ownership. At that time I lived in Manchester where commuting to work by bus was incredibly cheap. A bus pass which I used was something like £5 a month. I convinced myself that I needed to drive so did a lot of lessons and got my licence. Soon after I went car shopping. I barely did any research into this and quickly bought a used Peugeot 206 for £2,000 in 2009. 

This car turned out to be a real lemon. It was dangerous and very expensive to keep. I remember at least three times where the car left me stranded on the motorway due to major mechanical faults. One situation was the clutch snapping during heavy snowfall and the other was parts falling from underneath the car in the dark. Such breakdowns are often accompanied by other extra costs such as repair bills, recovery and using alternative transport. As a new driver, the insurance was ridiculous at over £1,200 a year.

Recession and plugging the hole

2010: £2,000 Debt

In the height of the global recession in 2010, along with many others, I had to leave my first job as the company was facing big financial problems. Obviously this was not good but it turned out to be the greatest thing to happen to my situation. Immediately I left Manchester to go and stay with my mother as I had managed to save exactly nothing in three years due to the above. In addition, I had maxed out my £2,000 credit card. I managed to get a new job soon after though so did not need to sleep on the floor for too long.

Seeing the light

2012: 0% FI

It was as if the reset button had been pressed. Realising that my previous lifestyle was unsustainable I moved back to shared accommodation and started to keep spending under control. I also started aggressively paying all of the credit card debt. However, I still did not have a good financial education and lacked long term thinking.

The only thing I was saving for was a car. When the Peugeot finally died I bought a used BMW.  This one final major mistake ensured that 5 years after starting my first job my net worth dipped back to zero. I consider this the beginning of the journey to Financial Independence as I have not made any drastic purchases since. The BMW was a nicer vehicle which i kept until it was written off in a crash in 2018. Again, after massive ownership costs (estimated £470 monthly over 6 years) there was nothing left to show for it. 

2014: 5.52% FI

In 2014 I came across Financial Independence by reading a few blogs; in particular Dividend Mantra and Mr Money Mustache. I did not need any convincing at all and hopped on to the movement. I learned about Vanguard investments and the Bogleheads, reading a few investing books such as The Millionaire Next Door and listening to several podcasts along the way.

2017: 25.87% FI

Going through all of Warren Buffett’s letters to Berkshire Shareholders and watching the live stream of the meetings on Yahoo Finance was fascinating, giving me access to the mind of the greatest investor in history. By applying these principles and living frugally, my net worth has been increasing exponentially.

Lessons learnt

July 2019: 50.04% FI

Car ownership is very expensive.  By only looking at the purchase price it is very easy to ignore the true cost of car ownership when making a purchase. It is more useful to look at total ownership at around £0.50 per mile. More detailed typical costs are provided by the RAC here.

I would recommend to avoid car ownership if you have access to other reliable means of transport. This is very difficult for me as I enjoy researching the latest cars, watching Top Gear and going for a Sunday drive. In future I will ensure that such a purchase is made from a position of strength and once all options have been thoroughly vetted.  Going car free has boosted my savings rate by more than 10% which can drastically reduce the time to FI.

Automation and consistency are critical to building wealth. I find it very useful to budget every month by estimating upcoming expenses as accurately as possible. Once done the projected amounts can be directed to investment accounts while aiming for a 50% plus savings rate. Tracking net worth is also a good motivator (see example chart above); it gives a snapshot of where you are in relation to the goals.

It takes a long time to see big gains. During the first few years of investing seriously little or even negative progress will be experienced. It is only at this point that the effects of compounding can be noticed. Giving up early is not an option.

Take advantage of market crashes. When the stock market is down it means prices are cheap. It is best to invest as much as possible during such times. If I look back 5 or 7 years ago I am astonished at how low prices were compare to today. Keep calm and do not sell.

Don’t get too excited in the good times. As stocks hit an all time high today (The S&P 500 closed at 2,995.82 points and the DOW at 26,966.00) it is tempting to claim to be an investing genius. However, we should aim to be rational and not start investing more now when there is irrational exuberance. Focus on the long game not day to day market movements.

Keep learning and building skills. I am amazed at how much knowledge is out there. Just pick up any good book to find out. Try out many new ideas; most will fail but you will learn a lot. I have picked up a lot of skills from running this site including SEO, Analytics, Adsense, graphic design, improved writing, web design and digital product creation. I did not know most of this stuff a few years ago. it may come a time when one is FI that such skills will be useful in a new occupation where you are self employed.

Avoid keeping up with the Joneses. It is tempting to acquire flashy material possessions (cars, houses, clothes etc.) to appear successful or impress people you don’t care about. This can backfire and you will be the one left to pick up the bill. Best thing is to obtain what you actually value and is affordable to you.

The point of Financial Independence is to open up more life options, not necessarily early retirement. I look forward to covering the next half of the journey. I know that this will not take as long and the gains will be ever bigger as the snowball keeps rolling bigger and faster.