Thursday, 8 December 2011

Inflation Ignored in Public Sector Pension Reforms Furore

I wanted to mention the effect of inflation. It's well covered on the web, but still so many people are ignorant of this transfer of wealth away from savers that I thought yet one more post on the subject wouldn't hurt.

This ignorance has been evident in the recent uproar over public sector pension reform. Perhaps I should have said ignored rather than evident. One of the changes implemented has been that the inflation linking has been moved from RPI to CPI, capped at 2.5%. This has been applied across all pensions, both public and private sector.

Both the cap and change of index are unfair to pension savers and something that both private and public sectors can unite over. With RPI at 5.4% and CPI at 5.0%, the cap is in effect. Your UK pension is not really inflation linked. It is guaranteed that your pension savings are losing value.

The graph below shows what happens to the spending power of £10,000 in the case that these rates were to stay the same over 30 years.

Your £10,000 will lose 57% of its value.

The change of index does not in itself guarantee that your pension will further lose value, but over the last decade or so CPI has been consistently lower than RPI*. Both indices are significantly lower the the rise in costs of the basics - energy and food. It is likely that your pension will buy you a lot less of what you need by the time you come to retire. Be prepared!

Now you may think that the inflation target is 2% and we'll get back on track soon. That's certainly what Mervyn King has been telling us for years. However, I have little faith in this. Here's the historical RPI since 1960. With the new rules, whenever that blue line is above the red your "index linked" pension would lose spending power. It wouldn't gain spending power when the blue line is below the red (unless we get deflation).

*The main difference between the indices is housing costs, so it may well be that these indices do move closer over the coming years. However, it does appear that government policy is to protect the value of  property. Should we experience a property crash like the US, Ireland, Spain and other countries have seen, the balance sheets of our banks would look very dodgy.

Wednesday, 7 December 2011

Savings Rate and Early Retirement (warning: some equations follow)

Yesterday I mentioned Jacob's blog at I'm going to look at his idea that saving ~75% of your income will let you retire in 5 years.

I'm sure the mathematics are in there somewhere, but the only figure I recall is that his assumptions are based upon a 4% draw down rate. I'm not sure exactly what this means. I'm currently reading up on investment so may understand better in the future. My "plain English" interpretation is that it means that you withdraw 4% of your capital each year to live off. Obviously there must be more to it than this, as either your income diminishes year upon year (4% of £200,000 gives you £8,000 in the first year, leaving you with only 4% of £192,000 = £7,680 in your second year of retirement), or you plan to die after 25 years of retirement having had an £8,000 annual income (not a great prospect if you retire at 35). Clearly he must have assumed some above inflation growth in the retirement fund.

Last night I did some calculations, using the assumption that your retirement pot keeps up with inflation (more on inflation later). To keep things simple I tried to keep the variables to a minimum (I assumed no savings, assets or debts at the starting point) , but there are many factors involved so it does get a bit untidy.

On the income side:

I = your net income. This is your take home pay after all deductions.

On the expenses side:

W= your work expenses, e.g. commuting, work wear, socialising that you feel is necessary
L= your other living expenses

On the time side:

A = your current age
R = your planned retirement age
E = the age at which you expect to end your reitrement

Your total savings before you retire come to (I-W-L)(R-A). This is your net income, less all your expenses multiplied by the number of working years you have left.
Your expected expenses after retirement total L(E-R) . This is your living expenses multplied by the number of years you expect to live after retirement.

If you have guessed your lifespan perfectly you need the first amount to be at least equal to the second amount.

With a little algebraic manipulation we get L <= [(R-A) / (E-A)] (I-W)

So what does this tell us? Let's take the case of a 40 year old who spends 10% of his or her net income on work expenses, wants to retire at age 50 and expects to live to 80.

We get

L <=  0.25 x 0.9 x I
 or L <= 0.225 x I

So this tells us that this 40 year old needs to cut their living expenses to 0.225 = 22.5% of their net income. In other words, allowing for their work expenses, they need to save 67.5% of their net income.

Say they were on £20,000 net per annum, they would need to save £13,500 of it.

That's not as bad as it may seem. It's likely that a 40 year old would have some form of pension and savings and they would need to adapt this calculation to take this into account.

You may still think that it's ridiculous and the 40 year old would be doing well to save 25% of their net income per year. Well here's the alternative. Rearranging the earlier expression we get

I >= L[(E-A) / (R-A)] + W

For that same 40 year old with work expenses of 10%, i.e £2000, with living expenses of £13000 and currently saving the rest, the expression becomes

I >= £13000 x 4 + £2000

i.e. their net income would need to immediately jump to £54,000!

That would typically require your gross salary to increase overnight from £26,000 to £82,000.

Which of the two statements in bold is the most do-able for you?

Even if neither of these situations seems valid, it should be clear that reducing your living expenses is far more likely to allow you to retire early than increasing your income.

Tuesday, 6 December 2011

Television, The Drug of the Nation

Part of what inspired me actually do something with regards to writing a blog was a chance visit to Quite why this triggered me to start I'm not sure, but it certainly had an effect. Jacob writes clearly on the subject of reducing expenditure in order to fund an early retirement. I like a lot of what he has to say, and though not agreeing with it all, it has certainly made me think about my current situation and lifestyle. I also take an ironic pleasure from the fact that, the day after I discovered his blog, he announced his return to employment.

Regardless, day 19 of Jacob's 21-day plan discusses television. The following paragraph struck a chord with me.

"When TV was invented it was thought to be a great opportunity, a great teaching tool for quickly reaching the masses. However, ironically, it turned out that TV was much better employed to keep people from learning. This fits perfectly with the focus on specialization. During the day, professionals attend to their jobs. During the evenings, they vegetate in front of their TVs, thereby preventing them from learning anything, and this effectively keeps them in their jobs. Actually, the closer you get to middle class values and neighborhoods, the greater the preponderance of silent streets; all you see in the evening are empty streets with a faint blue hue emanating from behind the curtains of every house."

Although not considering myself a TV addict - not being part of the soap, X-factor, Strictly Come Dancing brigade - I realised that I did spend most evenings zonked out in front of endless repeats of QI, Mock the Week or Grand Designs. On Friday, I therefore resolved to cut down on my passive TV intake. I don't want to stop watching TV entirely. There are programs that I genuinely enjoy. I do, however, want to watch what I want to watch rather than what is on. So far things are going well. Since my resolution I have only had the TV on for a couple of hours. I watched a couple of episodes of Monty Python's Flying Circus on DVD, the news on Sunday morning, the week's weather forecast on Sunday night and Black Mirror last night (recorded).

The extra time that this has freed up has been liberating. I managed to sort out all the junk in the loft, have invented a couple of (successful) vegetarian recipes that I cooked for my girlfriend and rediscovered my music passion. Between us, my girlfriend and I have a substantial record collection. We both consider ourselves massive music fans, but of late music has rarely been the entertainment of choice. It's been great listening to all those albums from the late 70's/early 80's alongside some more recent stuff like Brett Anderson's new album (ex-Suede singer) and Die So Fluid (a great metal three piece I'm lucky enough to have seen live a few times this year).

Another terrible phone photo follows. I must start carrying my camera.

Die So Fluid at The Classic Grand, Glasgow, Nov 2011

I may have more time now, but it is not infinite. End of today's thoughts!

Monday, 5 December 2011

Newsflash: Ageing Student Joins Digital Age

I've always felt I should write. I'm more of the technical type and writing well does not come easily to me. It is a skill I wish to develop. So here is my first post in my attempt to improve my skills.

I'm not sure exactly what I will write about, but at some point it will no doubt explore my opinions and theories about trends in modern life. Hopefully, it will be occasionally entertaining and sometimes thought provoking.

However, today it will be brief!

In lieu of words, I'll leave you with some pictures of sunny Scotland, taken today. Please excuse the quality of the photos; they were taken on my phone.