How to stay wealthy. Inequality or the rich vs. the poor

Looking back home Americans believe that hard work is essential to become rich.  The study shows that it is quite unlikely that somebody from the poor background will make it. Two the most common ways are: have the rich parents or get married to a rich person. The third is get into Harvard or Yale university and into finance industry.  The universities prefer the kids from the rich families.  This goes back in time and the example below can show how the rich are staying wealthy.

Tax efficient account in the United Kingdom

In the United Kingdom there is provision to open Individual Savings Account (ISA) for children and adults.  After income taxes are paid, you can invest either in cash savings account or shares into one of the two ISAs. As long as the money stay on the account any income (interest or dividends) is tax free and no capital gains is paid on the sale.

Currently the annual allowances are:  4,368 GBP per child and 20,000 GBP per adult. From 2020 the kids’ allowance will go up to 9,000 GBP per year. When the child turns 18 years old the Junior ISA converts into adult one automatically.  I put the British currency (GBP) for the reference, but please ignore throughout the text, as it is of no importance (for facts hungry, current exchange rate GBP to USD is 1.25 and GBP to EUR 1.1).

Ability of an average family’s to use the tax efficient account

Let’s look who benefits from the ISAs in the United Kingdom.

Average salary for a full-time worker in the UK is 35,423 GBP per year (27,623 GBP after taxes).   

Assuming a family with two children and both parents are working.   You need to have 48,736 GBP savings left to keep the ISAs full this year or 58,000 GBP from 2020 onwards.

Average of living of our family is 3,500 GBP per month, including rent or mortgage and the house taxes (council tax).  The family will be left with 13,000 GBP a year of potential savings.

How is benefiting from the tax efficient accounts?

How much do they need to earn to keep their ISAs full?  The family need combined income of 90,736 GBP this year or 100,000 GBP next year. This is after the income taxes are paid. 

To have 50,000 GBP after taxes you need to earn 72,000 GBP per year (double the average salary). This needs to happen for both parents. To earn single handedly you need to have salary of 170,000 GBP per year.  This assumes no pension contributions or any other investments.

70,000 GBP salary is top 5%, and 170,000 GBP is top 1%.  The reality is that people earning 170,000 GBP a year do not live on 3,500 GBP a month while taking 8,500 GBP home.  The actual threshold is even higher.

Why is it important?

The income from the ISAs is tax free. If you receive an average salary of 35,423 GBP, you will have 2,300 GBP a month after taxes. To have 3,300 GBP a month your gross income should go up by 18,577 GBP before taxes or 1,548 GBP a month.

 Imagine if you had rich parents and they used Junior ISA from your birth until you are 18 years old.  Even if you put no additional money, at age of 40 you still can get extra 1,000 GBP a month just as dividends tax free, while earning the average salary.   It gets even better in case you maximized your ISA allowance from 18 onwards.  In this case by the age of 39 you are getting the average salary for life tax free.

See the table below which has two scenarios: Investing maximum amount allowed by ISA through the life and stop investing at age of 18. I assumed 3% inflation adjusted income on investment. The money is in thousands GBP.

February 2020 update ($523,663 -$42,905 or -%7.6)

↑ Financial independence savings for two months $4,000

Grand total additions: $4,000 USD

↓ Emerging Markets Stock Index Fund is down by $5,600 or -4.5%

↓ Eurozone Stock Index Fund is down by $9,654 or -7.8%

↓ US 500 Stock Index Fund is down by $11,585 or -8.3%

↓ Global Small Cap Index is down by $10,996 or -9.2%

↓ EUR is down USD by 2% or $4,266 for my portfolio

↓ GBP is down USD by 1.4% or $789 for my portfolio

Grand total losses: $46,905 USD 

January 2020 update ($566,569 -$8,517 or -%1.5)

↑ Monthly pension plan investment $2,293 (outstanding tax rebate on the investment)

↓ Emerging Markets Stock Index Fund is down by $4,623 or -3.5%

↓Eurozone Stock Index Fund is down by $2,199 or -1.7%

↓ US 500 Stock Index Fund is down by $119 or -0.1%

↓ Global Small Cap Index is down by $3,443 or -2.8%

↓ GBP is down USD by 0.8% or $425 for my portfolio

Grand total additions: $10,809

Are mutual funds pave the way to mediocrity?

Recently Vanguard mutual funds assets reached $6tn in value and its rival BlackRock has about $7tn to manage.  On one hand index and pension funds manager have enormous voting power over the companies.  To put this into prospective, total capitalization of S&P500 is $28tn (as a comparison British FTSE 100 and FTSE 250 combined are $3tn and German DAX is about $1.5tn).

On there other hand there are more voices, which are echoing my concerns raised back in March 2018, that index fund strategies are essentially a piggy back on stock pickers and a handful of people manage the large number of companies. This is not how capitalism traditionally works and the risk is that stock market will become inefficient.

Vanguard is doing some things other funds don’t do: it is owned by its own funds, allowing it to use profits after covering costs and business investments to lower its fees, rather than reward outside shareholders with dividends and buybacks. 

The Vanguard does a lot of good - average expense ratio in the US is 0.1 percent ($6 billion in fees), while average in the US is 0.58 percent.  The Vanguard overcame bureaucracy and corruption in the UK – its going to launch is first Self-Invested Personal Pension (a pension plan that enables the holder to choose and manage).  This is equivalent of 401K in the USA.  I escaped the robbery of my “hundred years old” bank which was charging me 1.25% for the privilege of   keeping my pension to a corporately negotiated scheme with 0.26% annual fees. The Vanguard SIPP will charge an annual account fee of 0.15%, capped at $500 per year (No fees increase as soon as you have over $333K on the account).  It will be the cheapest option for anybody in the UK who has more than $55K in pension savings (even with the corrupt and misleading reporting practices).

Still there is an unease. Is it becoming too big to fail? Who is going to build S&P500? It used to be done by stock pickers and analysts.  Passive index funds exploited a hole in the stock pickers business model.

Although I am still shocked that 80% of the market still controlled by the stock pickers. In twenty years top three index fund management companies will control 40% of the S&P500 (by 2040).  In practical terms it will mean than ten to twenty people will set agenda for the US corporate world.  The Vanguard founder before he passed away in 2019 wrote that that if index funds owned more than 50 per cent of the stock market it would not “serve the national interest”.

What is the practical take for me? I feel that I adequately diversified my assets over S&P500, emerging markets and western europe. The remaining risks as I see them: keeping everything with one investment company and all in the investment funds.  On of the possible solutions is to think about different investment and the holding company.  Partially I did it with my pension, but the volume is about 9 percent of my financial independence nest egg size outside of Vanguard.

Do you share these concerns? What is your view on the index fund dominance and few big mega players in the industry?

2020 Financial Independence Goals

The reliable road to financial independence goes through savings and financial markets speculations avoidance.  I would enjoy trading as mental competitive exercise, if I have spare money I don’t mind to lose. To do the same with core savings is too much risk for me.

Previously, one of my blog readers stated that I played "golden past, bleak future" song. This indeed how I felt myself in everyday life for the past three years. In the job I held my income was reduced by 40%, I was traveling 50% of my time without any compensation for it (people who worked in the office at the same level were paid the same). I gained 10kg in weight. I used to run 10 km in 35 minutes, I could only run 6 km in the same time now.

   Another reason is that immigrants are not accepted as socially equal.  Through my company I had a private medical insurance (almost useless in the UK, as you will see later). I could do one health assessment per year free.  After all the changes I had diagnosed with high cholesterol level and was told to manage it medically. When I went to my family doctor (general practitioner) to get the medicine I brought her results and the doctor’s contact details. She spent less than 5 minutes and said that there is no need.  Without further advice on what to do my appointment was over. Later I released that it is impossible to complain anywhere about medical mis treatment in the UK.  

The turning point was an appointment system at the general practitioner’s – when it is your time, they put your name on the screen in the hall and machine would read it. If you have an English name, lets say “Henderson” the machine would read it correctly.  If you happen to have “Janssen”, “Hwang” or “Gutierrez” it will start spelling it out letter by letter very loudly.  The system is designed to abuse foreigners at every corner (unless you are very rich). Although this service is paid by me (as taxpayer) the concerns of equal treatment are largely ignored.

Combination of all of the above with the Brexit, moved me towards looking for a job elsewhere. I was successful in it.  The new job will enable me to save more money towards the financial independence.

Financial goals:

- Save 20% on the income - Accumulate $25 K a year and invest it either in one of the existing funds or new one.

Portfolio:

- Develop additional income source in full, potential reward about $2,000 a year. Target sites to be developed in full this year.  This make it or break it. If I am not able to do this year, I will wind down niche sites and focus elsewhere.  My personal preference is to make it, despite disproportionate amount of time I might spent.

Blog:

- Regular monthly updates.

- To cover 6 themes on financial independence, including mortgage one.  

 

Educational:

- Read 12 books from the list.

- Publish the books reviews.

- Corporate finances to study in detail.

- Be happy.  Run 1,000 miles during the year. BMI at 26.3 by December. Loose 2.5 pounds a month.

What are your 2020 goals? Is it something you recommend I do more or stop doing?

2019 Financial Independence Goals

Financial goals.

- Save 20% on the income. I would like to follow financial advice on an index card and save 20% of your money (Currently this is around 12%.  I will try to save any extra bonuses I receive and trim some of our expenses.

How am I going to save 20%:

- Accumulate $10 K a year (tax deferred contribution) in the private pension fund – equivalent of 401(k) , $10K to the tax efficient account.

- Accumulate $4 K of them towards long term house maintenance and make two additional monthly payments on the mortgage.

Financial goals have been complete in full. I saved additional money towards pension fund ($17 K vs. $10K before the tax relief or $21K after receiving tax relief).

Portfolio

 – No changes. Keep investing in the pension/retirement fund.  – The easiest goal for 2019. Complete. I did not get distracted and kept on investing in the retirement fund.  Which is now $52K USD after three years.

- Develop additional income source in full, potential reward about $2,000 a year. Target sites to be developed in full this year.  – This has not been done. There are many excuses but a few good ones.

Blog:

- Regular monthly updates. – Complete. This is happening.

- To cover 6 themes on financial independence, including mortgage one.  – Covered four  (67%) “Opportunity cost”,  “Mortgage”, “Enough wealth”, “Family budget”.

 

Educational:

- Read 12 books from the list.

- Publish the books reviews.

- Corporate finances to study in detail.

This has been not very good. I gain some unique insights into corporate finance as part of my role on the job but underpinning knowledge gains by reading the books lagging.

Family Budget:

-          As long as the savings goal is made I do not mind the rest. Aim to stay under previous year budget. –

-          Be happy.  Run 1,000 miles during the year. BMI at 26.3 by December. Loose 2.5 pounds a month. –

Running wise it was worst year on the record. I only ran 250 miles  or once a week 5 mile run. This needs to be changed following year.

Overall, I completed my immediate the most pressing goals, but to break through financial independence ceiling I need to do more home work and self-studying. As a foreigner I am not receiving equal benefits as my colleagues working in the same roles.  “Equal pay” concept does not apply in the European Union.  

Instead of using my time wisely I discovered an old computer game, which still has is adepts in online battles and spent 60 hours playing in 2019. This is such a waste of time, although very pleasurable.

How was yours 2019 year? Did you achieve what you wanted? What were the challenges and how did you overcome them?