The dangers of lifestyle inflation

The English Investor

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A friend of mine went on a sabbatical last year and returned to work a few months ago. We were having a long day and decided to step out to grab coffee.

My friend joked that, at the current pace, he might quit again and go on a new backpacking adventure. He then went on to tell me “after all, I now have more money than at the time of my resignation last year. I could totally do it again.”

My immediate reaction: “Wow, how is this possible?” Sure, I have saved quite a bit but I do not think that I would have reached his milestone as quickly. I’ve always known that I spent more than he did but not in significant amounts. Yet, I questioned myself and wondered whether I was not falling into the lifestyle inflation trap despite my best efforts.

After all, I was the one who purchased a very expensive engagement ring.

What is lifestyle inflation?

Lifestyle inflation is essentially the practice of spending more as you earn more. As a result, the amount you save each month never increases. If you don’t save at all, then you continue to live pay check to pay check although your income increased. Seems wrong, doesn’t it?

According to Investopedia, “lifestyle inflation refers to increasing one’s spending when income goes up. Lifestyle inflation tends to continue each time someone gets a raise, making it perpetually difficult to get out of debt, save for retirement or meet other big-picture financial goals.”

In other words, you can never escape the rat race. You are stuck working to simply pay bills without any chances to achieve financial independence. It’s a depressing situation.

What lifestyle inflation is not.

It’s also worth noting what’s not lifestyle inflation with two very specific examples.

Increase in costs of living: if rent increases and you need to pay more to your landlord, that’s not lifestyle inflation. It’s just straight up inflation. The same goes with groceries and public transportation. On the other hand, if you move from a studio to a two-bedroom apartment all by yourself, that’s lifestyle inflation.
Primary needs: if you now make enough money to purchase health insurance, that’s not lifestyle inflation. It’s just being smart about basic necessities. Everybody should have health insurance in one form or another because if you don’t have one and become sick, it could bankrupt you.

Avoiding lifestyle inflation

Avoiding lifestyle inflation is a necessity to achieve financial freedom. It’s important that when you receive a pay rise or a bonus, you don’t spend everything away. Unless you are satisfying an essential need, do not increase purchases and come up with a plan for that extra money. So if money is burning a hole in your pocket, then try the following tips to stay in control.

Become aware of lifestyle inflation

It’s hard to become conscious of a problem when you do not know about. If you reached this sentence, then you know what lifestyle inflation is and you should be conscious about it.

When I started my current job in London, I received a significant pay bump compared to what I used to be making. Sure, London is expensive and some expenses were bound to go up. But blowing up almost £7,000 in a month was clearly not a necessity. I upgraded my apartment, bought an expensive watch and completely failed at saving any substantial sums.

It’s only when I started to discuss finances with some of my colleagues that I realized I far behind I was falling.

Once I became of the dangers of lifestyle inflation, I had to shake off two preconceptions that only encouraged lifestyle inflation.

From then on, I took decisive steps to correct the situation.

“I can” does not mean that “I must”

Lifestyle inflation only becomes an issue when the increased income allows you to have more freedom. You think that you have available money to spend and therefore you naturally contemplate what you could spend that money on. And with so many choices available, it can be quite difficult to resist, even with the best of intentions.

The issue I had was that I could essentially spend the money on whatever I wanted. Suddenly, I had the ability to go to the restaurants and never check the bill before paying. I knew I could do it so why not? The same reasoning applied to purchasing musical instruments or going on weekend trips. Soon enough, I would have more “goods” but at the cost of not making progress on more important investments such as buying a home.

Once I realized that my savings were not increasing at least as quickly as my income, I took a cold-hard look at my spending habits and hit the brakes. To do so, you need to change your mindset from “I can/I must” to “I could/I’ll wait.”

“I work hard so I deserve it”

If you have friends working for a big law firm in New York or London, then you know that their work schedule can be intense. The same applies to people working at prestigious investment banks. It’s not uncommon to regularly clock 70 hours a week with peaks at 100 hours. This is especially true when there are active transactions.

I’ve been there. You make more money than your friends who are teachers or journalists but the hours are objectively worse. It’s very easy to slip in the mindset “I work more so I should be entitled to enjoy myself a bit more.” This misconception is also known as “work hard, play hard.”

Again, you could do that. In the end, you will have little savings and possibly health issues due to a burn-out. Instead, enjoy the high-income salary by stashing half of it in a locked account to give yourself the freedom to live.

Track your spending habits on a net basis

This will sound obvious but there is nothing like running the numbers on a piece of paper.

Most people know that a £10,000 salary increase does not amount to a £10,000 lump sum that you can spend. There are taxes and national insurance/social security contributions that reduce disposable income. Part of your increase will also be absorbed by inflation: you will spend more just to keep the same living standards.

Once you have deducted those costs, the amount you end up with is a lot closer to reality. That number is the theoretical disposable income gained from that salary increase. The amount of disposable income could easily be half the gross amount of your salary increase. Depressing? Don’t worry, everybody has the same conundrum.

Chances are that by running the numbers, you will truly appreciate how much you gained and how much you have to spend. Realizing that the increase is not that significant on a net basis should make you think twice before splashing large sums of cash during your next visit at Selfridges!

Cover the basics first

What will you do with this new money?

I find that one of the worst things in life is to have regrets. I’m talking about spending your money because “I only live once and money is meant to spent.” That’s true but there is a good way and a wrong one.

The right way is to cover the basics first. Here are a few examples in no particular order:

Contribute to your pension pot: if your pension contributions were lower than anticipated or did not match your expectations, it’s time to remedy this and boost the value of your pension. You know that your future self will hate you for not doing it.
Spend to save money: it’s better to carry out repairs as soon as possible before the situation gets worse. If there is a leak in your bathroom, get it fixed now. If your car needs revisions, do it now. Those costs will not disappear overtime and dragging the issue could cause further damage, which could require more money to fix the same issue.
College fund: school is expensive. Students loans are a ticking bomb. Direct some money into a college fund or dedicated savings account. You might not have kids now but this cash will become handy sooner than you think.

The idea is to use that extra cash to cover some essential expenditures that you have so far neglected for one reason or another.

When I started receiving a year-end bonus, my first step was to save the full amount. That was a good step and an improvement from spending everything! But I realized that I could fortify my financial situation by taking advantage of unused allowances for pension contributions and tax-free savings accounts. I also paid down expensive debt I had taken out to buy a car (which was a completely unnecessary purchase).

Do not take more debt

Higher income means that you can take on more debt. Banks view you as richer and therefore your credit worthiness increases.

Or at least, that’s the theory.

In reality, taking debt will be a step back. You should not have too as you are now making more. Start by paying the most expensive debt and then build a cash buffer. The only debt you can take is a mortgage. And that’s only when you have at least a 20% downpayment and you stick to a reasonably sized-house (do not increase your budget to purchase a bigger home because you just got a pay increase).

When taking on new debt, things can easily spiral out of control. First, few people actually take into account the interest costs and reduced cashflow in assessing the true impact of debt on a budget. Second, if you can truly afford something, with the exception of a house, you should be able to pay it cash.

I made a few financial mistakes in the past but that’s one that I have always avoided. I never took a personal loan or increased my credit card spending because I could “afford it.”

Gradually improve your lifestyle

It can be hard to stay motivated and to perform at work when you are not enjoying the rewards of your efforts. Paying debt and then saving are not particularly fun activities.

While this is the right way to spend your cash, it should not result in undue pressure. You don’t want to feel so stressed about financial commitments and obligations that you just decide to quit and spend everything. In other words, you have to gradually release some of the pressure and indulge yourself moderately.

This is where the balancing act can become difficult. A strict but solid rule of thumb is to spend money on an item if your pay increase is at least 10 times the amount that you intend to spend. Therefore, you should only buy the latest iPhone, which approximately costs £1,000, if your pay increase was £10,000.

And this treat should only come once you have paid down debt and met your other financial obligations.

More material things do not increase happiness

Good news, there is light at the end of the tunnel!

The older you grow, the higher your income, and the more you realize that your happiness is not a function of how much stuff you accumulate.

There is an enormous difference between making £25,000 and £200,000 a year. The difference from £200,000 to £400,000 does not provide you as much relief, happiness and sense of a purpose.

Don’t try to prove that you are more successful or wealthy to your friends and neighbours by showing off and flaunting your expensive possessions. It just shows that you are unsecure, it attracts problems and it causes jealousy. A bad mix.

As soon as you stop measuring your happiness and success in terms of purchased goods, you will experience a sense of relief. What matters is spending time with friends and family, being nice to other people and maintaining a good health. It sounds cliché but that’s what most people want. The few people who would rather take the money are likely to be ones thinking that they can buy those things. Unfortunately, they are very wrong.

How do you budget for a £500 weekly income in the U.K.?

The English Investor

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How do you budget for a £500 weekly income in the U.K.?

This question came from someone on Quora. I respond to a few questions on Quora every month. You can follow me here.

There are two critical assumptions that are not clarified here.

The first issue relates to geography: are we talking about London or any other town in the United Kingdom? London is significantly more expensive than the rest of the country.

The second issue is whether the weekly £500 paycheck constitutes gross or net income. Again, a basic rate taxpayer would pay 20% of its income above the personal allowance, which is substantial.

Budgeting for the sake of budgeting is meaningless. What matters here is identifying how much is left after deducting taxes and other national insurance contributions.

What is disposable income?

According to the ONS, “disposable income is the amount of money that households have available for spending and saving after direct taxes (such as Income Tax, National Insurance and Council Tax) have been accounted for.”

Disposable income includes earnings from employment but also private pensions and investments as well as other cash benefits provided by the state.

Therefore, the real question is:

How much disposal income can one expect to have when living with £500 every week before taxes in London and how would a financially responsible person spend such an amount?

£500 of weekly income amounts to £26,000 each year or approximately £2,166.67 each month.

Earning £26,000 in 2017/2018 and your take home pay is £20,961. This means £1,747 every month.

Over the year, you will pay £2,898 in income tax and £2,140 in National Insurance contributions.

With the Chancellor’s reforms announced in his Autumn Budget, for the fiscal year 2018/2018, you can expect to take home £1,755 a month, pay £2,828 in Income Tax and £2,109 in National Insurance contributions.

Let’s deduct Council tax also. Here, we assume a charge £840 per year. This amount corresponds to the lowest band for Newham Council, which is where the apartment rented in our assumptions is located. This results into a monthly expense of £70.

Therefore, our disposable income is £1,685 a month, with £2,828 in Income Tax, £2,109 in National Insurance contributions and £840 in Council tax.

Based on the most recent ONS data, the UK median disposable household income was £27,300 in the financial year ending 2017, which was up 2.3% on the previous year (after accounting for inflation and household composition).

In our example, we are therefore below the median and mean disposable income in the UK.

You will not become millionaire but it is still possible to live in London on that income. The real question is whether you can both live in London and contribute to a pension pot, save in an emergency fund and invest?

A tentative budget in London

I acknowledge that budgets can be very subjective. Note that there are many assumptions in the numbers below. And feel free to disagree or correct me in the comments section!

Monthly disposal income (starting point): £1,685

Pension contributions: £250 (topped up by 20% by the Government, so a net contribution of £300).

Rent (studio flat on Springfield Road, East Ham, E6): £600 (you could also find a flat share in a slightly more central location for that amount).

Travel card: £153.60 (zone 1-3)

Food: £250 (mostly home-cook meals, very limited take-outs)

Internet: £22 (Relish or equivalent)

Electricity SSE: £25

Water bill: £22

Savings: £300

Mobile phone: £15

Miscellaneous: £47

This budget assumes that you have no children and that medical insurance is either covered by the NHS or by your employer. I appreciate that readers may think that the amount dedicated to savings and pension contributions is too high. I disagree. The idea is not to live paycheck to paycheck but to build some capital, no matter how small it is in the beginning.

10 tips to save money in the UK

It can be difficult to live on budget. To help you, below are 10 tips to save money.

Stop smoking: seriously, it’s a very expensive habit. One packet of cigarettes costs approximately £10. According to the NHS, if you smoke an average of 5 cigarettes each day, this will cost you £912.50 per year. Also, that is only the immediate cost. In addition, if you factor the increased chances of getting a severe disease such as lung cancer, then there is no limit as to medical costs and expenses.
Buy return tickets: if you are taking the train to go somewhere, always buy a return ticket as it will be less expensive than buying two one-way tickets. I’m thinking about people who take the (rather expensive) Gatwick Express or Heathrow Express.
Pack your lunch: it’s a well-known hack and yet nobody does it. True, there is tremeduous social pressure to follow colleagues and mimic behaviors to fit in the workplace. This comes at a cost. Unless you think you can get back your money in the form a pay increase or promotion, it’s probably not worth it. I’m always shocked that a burrito at Chilango costs £10 (yes, I add guacamole). I almost never go there now because £10 for a single burrito without drinks or a dessert is simply too expensive.
Walk or use the bus: the tube is the fastest means of transportation in London. But a single ticket can cost up to £4.90! Walking or taking the bus is cheaper. Avoid paper travel cards at all costs.
Shop online: if you shop on Ocado, you can collect coupons and benefit from a price match guarantee. It ends up being cheaper if you avoid branded food and it saves time. If you still want to go to a store, opt for Tesco instead of Sainsbury’s or Waitrose. Always bring your own bags.
Buy everything at once and in bulk: buy in bulk as it is cheaper per item. Avoid paying in installments whenever you can: it usually ends up being more expensive than paying everything at once.
Manage your coffee habits: I’m addicted to coffee and I find it difficult to function without it. But it’s an expensive habit. A cappucino at Taylor St Baristas will cost you £3.50! Aim to go to coffee shops that give you a discount if you bring a reusable cup such as Pret or Patisserie Valerie (50p off at pixel time).
Get cheap tickets: in Leicester Square, ticket booth TKTS sells returned tickets for West End shows today, tomorrow and the next day for a discount. If you really want to see Hamilton, then wait a bit or enter the lottery to grab a cheap ticket.
Be careful with bank fees: I was charged over £100 by HSBC this week for a non-sterling transaction fee when booking flight tickets in Euros. I’m still fuming. No foreign transaction fee credit cards are harder to come by in the UK compared to the US. But they exist (check out Nationwide or Santander).
Save on your mobile deal: with Wifi readily available in London and other majors cities, there is no reason to pay the extra money for that 30GB data. Stick to the minimum data pack to reduce your phone bill. Turn on all data caps and any settings allowing you to make or receive phone calls from non-EU countries. For those that are on a monthly subscription, this could amount to a nasty bill without prior notice.

Conclusion

Living in the UK, and especially in London, is expensive. I appreciate that I often discuss topics that involve making significant investments. It can be hard for some readers to relate.

Here’s what I want you to know. Yes, collecting coupons and saving on food can be ways to increase your savings. But you need to think further along. Be more ambitious. You need to realize that those savings are not meant to stay in cash and must then converted into investments to make you more money.

Saving is only step 1. It is not an end in itself. If the objective is to live comfortably and be financially secured, then increasing your income is the key. For some of you, this will be harder to achieve. But it’s not impossible at all. It’s been done before.

When will the stock market recover?

The English Investor

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I was randomly checking the Google Search Console and noticed that the following was the most searched query in the past few days: “When will the stock market recover”

And no, there was no question mark or at least Google did not indicate that there was one.

The first question is what are we recovering from. To me, it is obvious that the people searching for an answer are referring to the recent S&P 500, Nasdaq, Dow Jones, FTSE 100 corrections. Pick your index; the situation is pretty much the same except for Chinese stocks, which are in a prolonged bear market.

Graph Nasdaq one month period — A nice plunge in October. Source: Yahoo Finance

Therefore, I can only assume that the question is when will stock markets return to their pre-October correction levels? For the Nasdaq, the question would be: when will the index return to its 8,000 point-level?

The concern is only natural. The people who are looking for answers have likely lost money. They may even have lost substantial sums in a reasonably short amount of time. And to make matters worse, they may not have experienced a correction or significant downturn because we have been in an unstoppable bull market for the past ten years or so. This makes the experience of losing money even more frightening, especially if it includes money that was meant for retirement.

In one of my pension pots, I had lost approximately £2,000 at one point. Now, I am “only” down £1,750 or so. My pension contributions currently average £1,800. For this particular pension pot, I lost a month worth of pension contributions earned from hard work.

Rich people have higher chances at successfully timing the market

People who are interested in personal finances and other finance-related topics know that it is generally a bad idea to time the market. But why is that?

Markets are imperfect

The reality is that market-makers, large financial institutions and high net worth individuals have an informational advantage. Let’s call them the sophisticated investors. They just have more information than the average guy buying and selling Apple stock or an ETF.

It does mean that those sophisticated investors are trading on insider information. Some definitely are and they may or may not end up in the crosshairs of a regulator such as the Securities Exchange Commission in the U.S. or the Financial Conduct Authority in the U.K.

What they have is a real-time insight into what is going on in the markets. They lead transactions and trades on a daily basis. Therefore, they know investors, they know what investors are looking for and pushing back on. They have a better sense of market conditions before anything gets printed in the Financial Times or the Wall Street Journal.

Even if sophisticated investors sat behind a desk without talking to anyone, they would still have access to information before the average retail investor (like you and me). They would have access to a Bloomberg Terminal, a special computer used in the finance industry to process trades and receive live financial information. Whatever you read in the Wall Street Journal or even on a Twitter at any time of the day was probably published an hour before that on Bloomberg. A subscription for one computer is thought to cost at least $30,000 a year. The price may vary based on the number of terminals you own and your subscription.

Therefore, you can be as smart as one of those sophisticated investors, the odds are still stacked against you. The game is essentially rigged. It’s just best to acknowledge it and move on. At least the decisions you make from now on will be slightly more informed.

It’s easier to time the market when you do not need the money

Sophisticated investors are rational individuals. They are not going to bet 20% of their net worth to buy the dip after a correction in the hope of making a quick profit. So then, why would you do it? When I read stories about people putting their entire worth in one stock, I wonder if they have inside information or if they are just naïve.

If we assume that such sophisticated investors are rational and do not have inside information, then any big bets they make is likely to be with money they do not need. At the very least, they know that whatever amount the loose will not dent their lifestyle or investment strategy because they expect other returns to generate sufficient cash flow elsewhere.

Ironically, you have higher chances of being successful in risky investments/bets. As you don’t need the money, the stress levels are significantly lower. If you make a profit, great. If not, too bad and let’s move on. Therefore, you are less likely to make emotional decisions when the trade starts losing money.

Asking the right question

“When will the stock market recover” is not the right question. It implies that you are desperate for stock prices to return to their previous levels in order to recoup some lost money.

It might be obvious to most of you. The mindset is not “how do I recover my money” but rather “how can I seize this opportunity to make more money.”

Catching a falling knife is hard. However, unless you are using options or other instruments with time decay (theta) built in, it is still somehow doable if you take a very long horizon for the investment made during the dip.

To give you an example, I did not wire £20,000 in my brokerage account after the October crash. For a month or so, I did nothing, which allowed me to notice that markets have not recovered and remain fidgety. For what it’s worth, I believe that markets will remain volatile with a downward trend if U.S. tariffs over Chinese imports increase to 25% on January 1 and if the Fed signals that it intends to continue to raise rates. In addition, add that corporate earnings are artificially boosted with possibly unsustainable tax cuts due to the ballooning deficit and you are starting to get a toxic cocktail.

From a European standpoint, Brexit remains an unknown until March 2019. More importantly, the concerns surrounding Italy’s budget will be frankly displayed after May, therefore risking an escalation with the European Commission. Why May? That’s when the next European elections are to be held. The European Commission will refrain from taking any action against Italy that could fuel Eurosceptics and boost their chances of winning more seats at the European Parliament.

Disclaimer: those are only some quick thoughts of mine. They represent my personal views and should not be considered investment advice. You need to talk to your financial planner and/or take a view on the market and act accordingly.

While I don’t expect an immediate meaningful rebound, I could be wrong. Donald Trump could make a deal with Xi Jinping, therefore removing the threat of a trade war. Renewed confidence in the outlook of the economy could prompt additional investments from businesses and additional spending from households. Stocks would get a boost.

As a result, I decided to increase my pension contributions by 1%. My employee pension contributions now represent 4% of my annual salary. This comes on top of the 5% contributed by my employer. This is a temporary measure as I am subject to the tapered allowance limiting me to £10,000 a year. I have primarily using carry-forward from previous years when I had failed to make sufficient contributions.

As my pension contributions are primarily directed to purchase a mix of equity and bonds, I should be buying the dip in both asset classes. The tax wrapper is simply an additional benefit to ensure that I get to keep a maximum of profits – should I be right.

Conclusion

I suspect that some of you will be disappointed in this post. I can’t tell you for sure when will the stock market recover because no one knows.

It’s worth noting that the recent correction is only a minor pullback in light of the recent surge in valuations of those past two years. There is room for things to get worse. Any buy-the-dip strategy should be qualified with a long-term view of markets: buy the dip but buy it slowly. You do not want to arrive at the party too early.

There are plenty of investment strategies. The ones that I tend to be mostly interested in are momentum investing and fundamentals. In terms of fundamentals, valuations are still quite high so it will be difficult to find good bargains. In terms of momentum, you need a catalyst for stock prices to be propelled higher. There aren’t any at this stage and that’s my concern.

The London housing market will continue to fall – buyers beware!

The English Investor

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The London housing market will continue to fall – buyers beware!

My view is that London house prices will continue to fall in real terms within the next 12 months. If the Brexit transition is not as smooth as anticipated, prices could significantly fall in nominal terms.

As a first-time buyer, I continually monitor the housing market in London because this is where I am located. It’s not just a matter of viewing places in the hope of finding a bargain. I am seriously considering a purchase and I have the advantage of having plenty of times to make the big move. As time is on my side and I do not need to sell an existing property to finance the purchase of a new one, I have no reason not to try to find the best deal out there. It might take me an extra-year but I am fine with this.

House prices have outpaced wage growth for many years

Based on data from the Land Registry, the average price of a property in London in January 2009 was £253,093 compared to £482,241 in September 2018. That’s a 90.54% increase in only ten years.

Average price by type of property in London — Source: Land Registry

Wages did not grow as fast. According to the ONS, wage growth suffered declines of -2.6% in March 2009 and -0.3% in June 2014.

As a result, affordability has been the number 1 constraint to jump on the property ladder.

Based on data from 2007, the ONS notes that on average, full-time workers could expect to pay around 7.8 times their annual workplace-based earnings on purchasing a home in England and Wales in 2017, an increase of 2.4% since 2016.

The situation is worse for households based in the Southeast of England and those purchasing a newly-built property. In 2017, full-time employees in England and Wales could typically expect to spend 9.7 times their median gross annual earnings on purchasing a newly-built property. Housing affordability worsened significantly in London, the South East, and the East.

According to the ONS, in 2017, seven of the 10 least affordable local authorities were in London. All but five London boroughs had significantly worsening affordability since 2012.

Kenginston and Chelsea – one of the priciest boroughs in the country, if not the priciest – was the least affordable local authority in 2017. Median house prices were 40.7 times the median workplace-based annual earnings. To put some hard numbers on this, the median house price was £1.3 million for a median gross annual salary of £31,950. To explain such a massive gap, it is likely that many homeowners in Kensington and Chelsea work in other areas where earnings are higher, and that those people have additional income that does not count as “workplace-based annual earnings.” Work-place based annual earnings would not typically capture capital gains, dividends and rental income.

The London housing market is slowing

According to the website Rightmove, house prices fell by more than £5,000 on average in November. The slide was even worse for the county’s wealthiest boroughs. House prices in inner London are down 2.5% year on year. Bexley and Bromley are the exceptions as they are up by 2.8% and 2.1% respectively.

Note that Rightmove’s price figures may differ from the prices recorded in the Halifax and Nationwide indices as they reflect asking prices instead of mortgage data from lenders or sold prices from the Land Registry.

Nonetheless, the data point in the same direction: the London housing boom is over. According to the upmarket bam Coutts, price central London remains “in limbo” with prices down 14.7% from their peak in 2014. Transaction activity has also fallen about a third.

It, therefore, appears that London property prices are decreasing at least for now. It remains to be seen if the trend can last. I think it will.

So why is the London market slowing?

There are a couple of reasons why house prices are no longer increasing.

The affordability issue: people just don’t earn enough to pay that much money for a house.

As mentioned above, house prices skyrocketed over the past few years while salaries overall stagnated. For civil servants, salaries actually decreased due to a freeze on salary increases due to austerity and an attempt from the Government to balance the books.

As a reminder, public sector pay was frozen for two years in 2010 (except for those earning less than £21,000 a year) and rises have been capped at 1% since 2013. A few months ago, the government announced that pay rises would be implemented but those still hover around 1% (police) – 1.7% (prison officers) only depending on the sector.

According to the ONS, the Consumer Prices Index (including owner occupiers’ housing costs) 12-month inflation rate was 2.2% in October 2018, unchanged from September 2018. The Consumer Prices Index 12-month rate was 2.4% in October 2018, unchanged from September 2018.

Therefore, even if we take into account the recent pay bumps, the public sector workers have seen their salaries decrease in real terms as the inflation rate exceeds their pay increase. As stated by the ONS, “because of the restrictions on pay, inflation has generally outpaced public sector pay growth since 2011, meaning that public sector workers have grown poorer in real terms over the last six years.”

Private sector workers are slightly better off but not by much. While pay in the public sector has risen by an average of 1.1% per year since April 2011, private sector pay rose by 2.1%, which is only slightly higher than inflation, which stood at 1.9% over the period. Therefore, private sector workers have seen their pay slightly increase in real terms but the increase has fallen well behind the tremendous growth of property prices.

The composition of public sector jobs has also changed over time with differences over wage growth amongst public sector workers. For instance, the earnings gap between education and other public sector areas has grown over time. While some public sector workers might be slightly better off than others due to their field, the outcome does not change: property prices skyrocketed while wages stagnated in a best-case scenario.

For existing landlords and potential buyers, affordability is the number one issue. Unless wages dramatically increase, we won’t see sustained demand for the extremely expensive luxury properties that have been the focus of homebuilders in the past few years.

The buy-to-let issue: the Government murdered the buy-to-let market

The Government clearly stated that it intends to get people on the property ladder. This means putting in place incentives for first-time buyers while penalizing landlords who own multiple properties and intend to remain active in the market.

I wrote an article on this exact topic not so long ago. You can find the full blog post here.

A toxic combination of higher stamp duty for additional properties, curtailed tax relief on buy-to-let mortgage costs, tougher lending criteria and increased regulation have dampened demand for buy-to-let properties across the country but especially in London.

While rent increased quite a bit these past few years, the increases did not match the surge in property prices. Rent is the main source of income for a landlord. Therefore, the annual rent divided by the purchase price will give a rough idea of the expected returns – or rental yield – of the property.

According to the ONS, London private rental prices fell by 0.2% in the 12 months to October 2018; unchanged from the 12 months to September 2018.

All things being equal, reduced annual income will amount to a lower yield if the property price remains the same. The worst combination for a landlord is to see property prices falling (after purchasing the property) and rents falling at a faster pace than the fall in property prices.

The arbitrage issue: properties located in the north of the country have more potential

Properties in the north of England are currently more reasonably priced but also are more likely to appreciate faster than London properties in the future.

The first proposition is a bit of a no-brainer: you can barely buy a studio for £500,000 in Westminster while you evenly purchase a five-bedroom townhouse for the same price in Manchester.

Property for sale - Rightmove — A property for sale in Manchester – Source: Rightmove

Of course, London is more attractive because the jobs pay better and foreign investors, including ultra-rich individuals from Russia and the Middle-East, prop up prices. While still dynamic and economically consequential, more regional hubs such as Birmingham and Manchester sill lack those drivers.

I also personally believe that there has been a concentration of talent towards capitals and big cities. Young graduates flocked in masses to London but also New York, San Francisco, Paris or Berlin. They also drove up prices in their search for better professional opportunities while leaving suburbs behind them.

Prices in the North have barely recovered from the financial crisis. Investors focused on investing in cities and completely ignored properties in more remote areas.

According to the ONS, the North East is the only region in which house prices are yet to surpass their 2008 peak. Flats in this region lost 20% of their value between 2007 and 2013. As a result, house prices in the North East are amongst the most affordable in the country. The price to earnings ratio in the North East is 5.2 compared with 7.9 for the rest of England.

I’m not saying that Manchester necessarily falls in that category. I used Manchester to have a regional city with strong business dynamics so that the comparison to London would be realistic.

Therefore, in both nominal and real terms, those properties are very reasonably priced compared to London properties.

But this is changing. Investors have noticed that London is overpriced and are going north to seek reasonably priced properties ready to go at a bargain. This is partly why property prices are increasing in the North while London prices continue to trend downwards.

The Brexit issue: EU citizens are no longer flooding London

Before the referendum on whether the UK should leave the EU, the number of EU citizens arriving in the UK was massive.

Today, the state of play is very different. The Financial Times reported that net migration from the EU to the UK in the year to March fell to its lowest level since 2012 thanks to a significant decline in western European arrivals and a small outflow of people from eastern European countries such as Poland.

Net EU arrivals have more than halved compared with the peak of 189,000 net arrivals for the year to the end of June 2016.

The decline in EU arrivals is partially offset by non-EU arrivals. Presumably, employers now have to look for talent further as EU citizens deem the UK to be a less attractive destination.

To be clear, the fall in EU nationals does translate to a fall in the number of EU nationals in employment in the UK. The EU nationals leaving are not students but people working in the UK, paying taxes and national insurance contributions. According to the ONS, from there were 2.28 million EU nationals working in the UK, 86,000 fewer than a year earlier. This is the largest annual fall since comparable records began in 1997.

Both skilled and low-skilled EU workers contributed to some extent to the surge in prices in London, which tends to be their primary destination. Skilled workers took jobs in finance, consulting and law in the City of London. Those workers can command high salaries and therefore are able to either purchase properties or rent larger properties than other workers.

On the other hand, low-skilled workers still had to find accommodation in London and its outskirts, which presumably also contributed to increased demand for housing, although probably at the lower end of the scale.

In the end, the math is clear. Given that the supply of homes does not decrease (we don’t really knock down buildings, and when we do, it’s to rebuild them), fewer people arriving in London means less demand for the same supply. If jobs are actually relocated in the EU due to EU regulatory requirements, the outflow of highly-paid EU workers would have a detrimental impact on London property prices.

The effect is not just on property prices. This also means fewer people buying their morning coffee at £3.50 in the City, which therefore has an impact for local businesses and retailers.

The quality issue: the quality of newly built properties in the UK is crap

There are multiple reports – or horror stories – about the quality of newly-built properties in Britain. According to the housing charity Shelter, over half (51%) of new homeowners have experienced major problems with their properties, including issues with construction, faults with utilities and even unfinished fittings.

Some homebuilders like Bovis Homes have seen their reputation torn to shreds and had to issue profit warnings given the mounting costs of repair.

Property prices dramatically increased and homebuilders had no issue reflecting such increases in their final prices. Worse, final prices sometimes even reflected price increases of the next two years based on optimistic forecasts.

Inflation cost is probably an issue, especially since the referendum as the pound plummeted and therefore the value of imports and materials increased. Still, given the magnitude of the defects, this can hardly be the only explanation.

Unless the quality of newly-built properties suddenly improves, I suspect that many buyers will ask for a further discount on the sale price to account for potential extra repair costs. Nobody wants to pay a property at a “fair price” if you have to invest a further 10% of the price of the property in repairs and refurbishments.

As a result, poor build quality could push prices lower.

The loan issue: interest rates are expected to increase over the next year

The latest decision of the Bank of England’s rate-setting committee unanimously voted to keep the base rate at 0.75%. On the assumption that there will be a smooth Brexit, market participants and the monetary policy committee indicated that they expected rates to rise gradually from their current level to keep inflation in check, close to its 2% target.

Even in the event of a disorderly Brexit, the governor of the Bank of England, Mark Carney, noted that he would not necessarily cut rates to support the economy. For one, the pound is expected to drop if there is no negotiated deal with the EU. A drop in the value of the pound would push up the cost of imported goods. It turns out that this impacts the vast majority of goods. Consumers would be the ones to foot the bill as it is often the case.

Other factors such as the demand for goods and services and the supply-side potential of the economy would also have to be taken into account.

Therefore, the base rate is only likely to move in one direction, and that’s up. Higher borrowing costs mean that financing a property is more expensive, even if the property costs the same price. Historically speaking, higher borrowing costs tend to push property prices downwards because whatever extra money that was supposed to go towards the purchase price is now re-allocated to borrowing costs.

Conclusion

There are definitely strong factors that will push down the prices of London properties in the short term, especially after taking into account inflation and looking at prices in real terms.

Some of the issues such as affordability and Brexit are here to stay. It will take a few years for wages to pick up meaningfully while the relationship with the EU is far from settled as we go from one transition period to another.

Loosening lending criteria would provide a temporary boost. At what cost though? We walked down that road in the past and we saw how it ended in 2008.

So does that mean everyone should stay away from buying property in London? Not necessarily.

First-time buyers working in London and who do not intend to relocate elsewhere within the next 7 to 10 years may go ahead, but only after a Brexit deal has been secured with the EU. If there is no deal, there might be a bit of panic-selling and then it would be a good time to buy the dip.

This is the only category of people who should buy. Although rents are relatively cheap compared to property prices, they will save significant amounts of rents over a seven-year period, in addition to building capital through mortgage repayments.

I’ve heard that foreign buyers would buy more properties because the pound is low. Therefore, property prices are cheaper for them. This is especially true for people with earnings in U.S. dollars.

The issue is that most foreigners interested in London have already bought property. They are also sophisticated buyers and are fully aware of the state of the buy-to-let market and worsening rental returns. If this wasn’t the case, why have foreign buyers failed so far to step in and scoop up properties at a bargain? Because given current valuations and the dim outlook of the market, it’s not a really a bargain at all.

How to survive a sudden stock market correction?

The English Investor

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How to survive a sudden stock market correction?

With the S&P 500 down 10% from closing highs and the Nasdaq erasing all of this year’s gains, we are now well into correction territory. A correction is a 10% decline from recent highs.

Actually, if you bought FANG+ stocks, you are now in bear territory. The NYSE FANG+ Index closed down at 2377, which marks a 22% decline from its all-time time high of 3045.95 reached on June 20. Facebook, Alphabet, Amazon, and Netflix have each lost more than 20% each in market valuation.

We know that the stock market can take a dive. It is well-documented and people even make movies about it. Yet, we tend to forget that it can happen to anyone, especially after a winning streak.

The FTSE also plunged in October and has yet to recover.

When there is a sudden correction, experience is the best tool to cope with the surge of volatility and sense of panic that tends to come with those situations. If you do not have that experience, here are some tips to help you out.

A quick guide on how to avoid stupid mistakes during a sudden correction

1. Stay calm and carry on

Do not frantically log in your online account and start selling everything.

Unless you bought bitcoins, and then you might want to sell all of them. Even then, it is not a given. Personally, I believe that a cryptocurrency will emerge as the king of cryptocurrencies. It won’t be bitcoin, that’s for sure. But that currency is out there.

Bitcoin’s plunge over one month against the US dollar

It is important to remember that your financial safety net is still active. Of the five steps, only two would potentially involve stocks.

The first one is your pension pot that probably involves a combination of stocks and bonds. This pot is off-limits. You had no intention of selling when the stock market was beating records so there is no reason to sell now that it is taking a nose-dive.

This rule holds true for everyone who is below 50. Even if you are over 55 years old, the managers running the pension fund may have dialed back your equity exposure to minimize losses as you near retirement. Most people now retire around 62 in Europe so you still have 7 years to catch the rebound. There truly is no need to worry. 7 years was enough to recover from the 2008 financial crises, which was the worst financial meltdown since the Great Depression.

Transferring your pension pot at the last minute to take a shady advisor and then take out lump sums will be more harmful than selling during a correction.

The second step that may involve an equity component is the ISA account. This assumes that you opened a stocks and shares ISA. If you opened a cash account, which is the easiest version to start with, then you have no exposure to the stock market. With a stocks and shares ISA, you could potentially rebalance the portfolio but I would not recommend it. Wait a couple of weeks or months for the dust to settle, and then rebalance based on your new markets outlook.

The main point is that your financial safety net is intact. If you fall sick, you still have medical insurance. If you paid off your debt, then nobody is coming after you. Not all is lost.

2. Reassess your objectives

You now know that the correction will not lead to your financial ruin. However, the financial safety net is more about survival than living and enjoying your life. Money is meant to be used as it should serve you. Not the other way around.

As someone turning 30 next year, I have had the following financial objectives:

Save enough to put down 20% plus all costs for a £1,000,000 house in London;
Save enough to pay for a $50,000 plus engagement ring;
Save cash aside to pay for a wedding;
Maximize my pension contributions, which are capped at £10,000 per year because of the tapered annual allowance;
Fully use my ISA allowance as I hold a cash ISA that will be used for the house downpayment.

I do realize that those objectives might be very ambitious. That’s because they are. Besides the amount spent on the engagement ring, the sad reality is that the other objectives are pretty standard:

£1,000,0000 for a house in London zone 1 will not even get you a three-bedroom. I favor a central location because that’s where the work opportunities are and commuting in the UK is incredibly expensive.
Save for a wedding is fairly self-explanatory. It does not have to be anything grandiose but you still have to pay for the venue and catering at a minimum.
Pension contributions are of course non-negotiable. The tax incentives are too important: even if your pension contribution goes towards a stock that suffers a 10% correction, you are still making money due to the tax relief granted by the government. This remains true for basic rate taxpayers and is especially true for high-earners.
Saving in a cash ISA account really is meant to fulfill the other objectives. This should be considered in conjunction with my other targets.

Notice how cash intensive those objectives tend to be. As a result, I have a very little invested in the stock market. It might feel good right now when markets plummet and struggle to recover but this is not the way I feel. I actually wish that I had more money invested in the stock market. I missed out on a great bull market over the last few years. To be fair, I was busy paying back debt and establishing my career. Still, it might take some time for a similar opportunity to pop up.

Over time, I intend to buy as many dips as possible to build up a sizeable stock market position. I intend to start in earnest once I have bought a place in London. That rent is really is a waste of money.

3. Determine your appropriate risk tolerance level

If you have properly determined your objectives, you have a rough idea of what available cash you have to invest in the stock market.

When you invest, you will have hopefully assessed your risk profile, which includes your risk tolerance. I don’t invest much but when I do, I take insane risks. This is why I have a YOLO account. For larger amounts, I take a more conservative approach.

If you invest larger amounts, it is worth remembering the following:

The amounts invested in the stock market should not be earmarked for other purposes. Obviously, mortgage payments should not be invested in the hope of making some quick cash. The same goes for your wedding fund unless you are ready to find a new partner…

Ensure you have enough cash within your brokerage account to buy the dip. Stock markets are like rollercoasters but you should not be powerless and strapped in your seat forced to endure the ride. Give yourself some leeway to buy the dips if you invested too much too quickly.

The allocation of your portfolio should be continually reviewed. Take a view on the market, readjust your positions and then stick to it for at least a few weeks. Anything sooner than a few weeks is almost like day trading in this environment.

People tend to over-estimate their tolerance to risk. It is only when you start losing thousands of pounds in a month that your tolerance to losses is put to a test. As a rule of thumb, reduce by 10% to 15% the risk tolerance that you determined was appropriate for yourself. Another way to think about this is to increase by 10% to 15% the amount of cash that you had originally decided to set aside to buy dips.

Your risk tolerance may end up being different depending on personal circumstances. If you are single without kids, you probably have a higher tolerance to risk than someone with a mortgage nearing retirement. Continually review your risk exposure to make sure that you are comfortable with it.

A good rule of thumb to determine your tolerance to risk relates to how long would you last without checking your positions in your portfolio. If you can have your portfolio on auto-pilot for more than a month, then you are either (i) uncomfortable with the amount of money you invested and (ii) invested in financial instruments that are extremely volatile because they require constant monitoring (like short-term options).

If you are losing sleep at night over your risk exposure, then you did not assess your risk profile properly. The stress and anxiety will prove to be significantly more costly over time. Address this issue as soon as possible!

4. Continue to save and maintain strong cashflow levels

Mistakes and bad investments happen. All great investors have had at least one deal where things turned sour. Warren Buffet’s investments in Tesco is a good example. That investment cost him $444 million!

What matters is less the loss itself but how long do you need to get back on your feet. If I lose a £1 million this week, most people will tell me my life is over.

However, if Iknow that I can generate £4 million within the next three months, things are not as bad as they look like. Losing 25% is not great but this is not 25% of my net worth. This is only 25% of the cash-flow that I generate on a quarterly basis.

Let’s take a more realistic example: you saved £1,000 this month. You lost £250. Two observations must be made: you still have £750 readily available to buy the dip if you choose too. Second, and more importantly, you know that you have another £1,000 coming in next month.

Cashflow generation is always more important than net worth. You might have a high net worth because you purchased lots of properties. However, if you do not have sufficient income to pay taxes and maintain those properties, they will lose in value and you may be forced to sell. The net worth will, therefore, diminish due to weak cash flow. If you are interested in reading more about this topic, check out this great article from Sam at Financial Samurai: How A Big Expensive House Can Ruin Your Life and Path to Financial Freedom.

A strong saving rate will allow you to buy the dip. Even taking modest action will boost your confidence and self-esteem because you will have the impression that you are doing something to mitigate losses. Without a strong cash flow, you are stuck on that roller-coaster.

5. Get a side hustle

If you noticed that your ability to generate a strong cash flow was weakened due to a poor investment, then it is time to remedy this. Do not take comfort in thinking that bad investments happen to everyone and that less income may be normal as a result, even on a temporary basis. If you think this, you are not giving yourself a chance to reach financial independence. You are just postponing the hard decisions.

Get a real side hustle to improve your income level and, preferably, do something that you own and control. Riding for Deliveroo or driving for Uber are only short-term emergency measures for situations where you gambled your rent on the stock market. You should not have to resort to such desperate measures.

Not all side hustles are equal. Some are just second jobs. They might not be very inspiring but at least you get some form of medical insurance and maybe even pension contributions from your employer. Others are worse: you are essentially working for some big tech company in Silicon Valley with no fixed salary based on the demand there is for a given day.

Finally, there are side hustles for which you start a small project. Starting a blog, selling niche products in small quantities on eBay or incorporating yourself as a tutoring business. Those are the side-hustles that require you to build some capital. It does not matter how small it is at the beginning. With those side-hustles, you have a chance, a possibility to generate semi-passive income. It might not be much in the first few months. But it can only pick up from there.

Focus on building capital to generate further income in the long run. This is what you meant to do with that poor investment that weakened your cash flow. It is now time to start again.

6. Enjoy your life and try new things (i.e. do not check your balance every 10 minutes)

It’s not healthy to check the balance of your Interactive Brokers account every 10 minutes. In a correction, all you will see is the color red. And also larger numbers in red. Lots of red, you get it.

Life is short. I’m barely 30 years old and I’ve already realized that. Hang out with your partner, exercise, call your mom, buy a beer to a friend, and enjoy playing guitar or try something new. The possibilities are endless. These are the moments to remember in a few decades.

It sounds cliche. Above a certain income level, the marginal benefit of additional income becomes very small. You might not be able to buy a penthouse in Mayfair. But you are not lacking anything, you can travel whenever you want to and you have a reasonably stable situation. More money is not going to change much. The thrill of starting something to make more money is a different story…

Checking how much money you are losing will only bring more anxiety, more stress and the worst is that there is nothing you can do about it. It’s just not a rational attitude.

What are the benefits of starting a side hustle?

Lifestyle

The English Investor

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What are the benefits of starting a side hustle?

There are plenty of examples of people out there with a side-hustle. Everybody thinks it’s great to have one and it seems that most people do not regret starting one (or at least so they claim).

The stories are also enticing. If you listen to everybody, a side hustle can bring you in hundreds of thousands of pounds, help you land a book deal with a famous publisher and even meet angel investors to kick-start your next venture.

Some of these statements must be nuanced. While having a side-hustle can be a great thing, it is equally important to know why you are pouring so much of your time into it. Remember, time is your greatest asset.

What is a side-hustle?

I like Chris Guillebeau’s definition of a side-hustle.

“A side hustle is not a part-time job. A side hustle is not the gig economy. It is an asset that works for you.”

Let’s review each sentence. Carefully.

“A side hustle is not a part-time job.” Getting another job at the local store to pay a few extra bills is not a side hustle. That’s just a second job. It is incredibly hard to do. The hours are long and the marginal cost of time, exhaustion and anxiety that accompany a second job is prohibitive. If you already work from 9 am to 5 pm, you don’t get another 6 pm to 12 am for a similar pay (at best) unless you absolutely have too. Sure, students might get one or two jobs here and there. But not a mother of two unless she has no choice.

The bottom line: if you are working a second job (as an employee), you do not have a side-hustle. You have a second job and you are just working more. There is nothing wrong with working more but that’s not what side-hustling is about.

“A side hustle is not the gig economy.” This one is trickier. If someone tells you that he or she “Ubers” a couple of hours a week for some extra cash, then most people would see that a side-hustle. Most people would, however, be wrong. To some extent, working for the gig economy is almost worse than having a second job because you are not eligible to employer pension contributions, paid vacation, medical insurance to name a few work-related benefits. An Uber worker is entirely dependent on the company that runs the platform connecting drivers and passengers.

The bottom line: what you have is also a second job. Instead of working for the boring local store, you are not working for a technology company. It’s sexier but it is not necessarily better (unless you can show me those stock options).

“It is an asset that works for you.” Here is the key feature of a side hustle: capital. All side-hustles aim at creating and building capital in the hope that such capital will passively generate returns (without significant input). The capital aspect is critical to understand. Capital is not necessarily cash in a bank account or stocks in a brokerage account. Blogs with partnerships and advertisement are a very common example. Another example is selling niche products online for a certain foreign market, and take advantage of price discrepancies between countries.

The bottom line: All side-hustles have one common component: develop and grow capital (i.e. your product, a blog, a marketplace), which will eventually generate returns (i.e. sales, blog income etc). You have ownership and control: two key features that are absent with part-time jobs and gig economy work. A good question to ask to determine if your side hustle is one: “can I sell my side hustle?” You can sell your position with the local store or the hours spent driving for Uber. You can sell your blog, your marketplace or even the books you are writing.

What are the benefits of starting a side-hustle?

Get extra-income

Most people start a side-hustle to generate extra-income and pay off debt faster. It’s a good reason because it is one that will keep you motivated for a while. It’s not sufficient either because to generate meaningful income, it is going to take a really long time. You could have a lucky break, and if you do, congratulations! But we can’t rely on luck to chart a reasonable course of action.

Switch jobs

Very successful bloggers have left their day jobs to entirely focus on blogging. One of the best examples is Financial Samurai, a US-based personal finances website. Sam used to be an investment banker at one of the elite Wall Street firms before engineering his layoff and focusing full-time on Financial Samurai.

There are plenty of other examples, including outside the personal finances community. In the world of fashion and blogging, everybody knows Chiara Ferragni. Prior to becoming an Instagram celebrity and being endorsed by the likes of Dior, she started more humbly with a fashion blog in October 2009. Two years later, she was introduced by the New York magazine as “One of the biggest breakout street-style stars of the year.” Remember: it was around that time that the first digital influencers figured out that the social media trend was here to stay. To some extent, Chiara was already early to the party as Instagram only launched in 2010.

Do realize that if you end up switch jobs to focus on your side hustle, then your side hustle becomes your primary job and you no longer have a side hustle. This is not necessarily a bad idea but it’s not for everyone. It’s one thing to muster the courage to start a side-hustle, it’s a very different matter to be a serial entrepreneur. Move with caution, calculate the income you need to make ends meet and try not to stress too much.

Acquire new skills

I went to graduate school to become a lawyer. I wasn’t quite sure in which exact field I would end up in but at least the destination was reasonably clear. Being a lawyer would be my primary job. The same reasoning applies to most people with a career. Of course, there can be changes in someone’s career but the base case scenario is that you study to qualify for a certain profession. The rest is experience and hard-work.

Learning how to build and improve your side-hustle. If I take blogging as an example, you will not enroll in engineering school to become a WordPress coder. Similarly, you won’t crash a marketing class in business school. Yet, figuring out why your site is down and the best distribution channels are key competencies for a blogger. As a result, you must be capable to learn on the fly without the benefit of a structured curriculum. You will virtually google everything first and then sometimes reach out to fellow bloggers (be nice to them!).

Your side hustle doesn’t have to be your passion but it helps

The journey will be a lot more enjoyable if you have a genuine interest in your side hustle. It does not have to be your “passion” – you may not even know what that is. It will still feel like work if you are trying to build a real side hustle (it’s not called “hustle” by mistake!) but it should not feel like carrying a burden. If that’s the case, then please stop and find something more enjoyable to you. You tried one side hustle, it didn’t work out, then move on.

I cannot emphasize enough how important it is to enjoy the journey. Statistically speaking, your side hustle is a start-up, and most start-ups fail within two years. Give yourself at least two years and enjoy the journey and the progress you are making. Do not get discouraged because someone started a similar project two months ago and they already appear to be more successful. And think about that quote from Seth Godin, an incredibly talented and well-known blogger:

“Twelve years from now, your future self is going to thank you for something you did today, for an asset you began to build, a habit you formed, a seed you planted. Even if you’re not sure of where it will lead, today’s the day to begin.”