Looking out of my window I can see a neighbour’s pear tree in their front garden, heavily laden with fruit.
It’s a fine tree, and along with Macs observing how much better his graden investment has been doing compared to his ISA it seems a good time to think more widely about investment.
Money is a claim on future work, and when we think of savings, or indeed retiring, we think in terms of setting aside a certain amount of money to enable us to do later what we fund today from earnings.
I just can’t do what Monevator is saying there – to replace my salary from investment income, assuming a 4-5% return isn’t possible for me. Think about what it means for a moment. At a 4% return, you need a capital stake of 25 times your annual income. That means if I saved my entire gross income and lived on fresh air, I’d need to save the next 25 years worth of salary. It ain’t going to happen. It isn’t quite that bad as I have significant pension accrued and of course you can lob some of the proceeds of earlier investments into the pot, but I’d still need a long time!
Needing to replace your salary is a simplistic notion, however, which we can easily fall into. The fact that as employees we fund our lives from money we earn blinkers us, so we think in those terms post retirement. We need so much money to be able to retire and live comfortably. That money buys us our heating and food, and hopefully our leisure trips to the Mediterranean, or perhaps to the Moon for the more sci-fi dreamers.
It’s not the only way to have enough to live on. The problem with saying “I need £X to live on in retirement” is that there is a hidden assumption there – that the only way to service your life is by exchanging cash for goods and services.
You can divide your spending into wants and needs. Needs are typically non-negotiable, for instance you don’t normally have much choice about paying for food, or heating, or rent/mortgage. Stop servicing those and the result is ill-health or death. Wants are elective, such as whether to buy a Kindle or an iPhone, or if you are going to holiday in the Seychelles or stay home and read a library book instead. In general, you have to use money for wants, there is no real alternative. You can’t make an iPhone in your garage, or grow a round the world cruise or even a decent restaurant experience in your backyard. However, a surprising number of your needs are amenable to enlightened self-provision. Not necessarily in terms of hard-core survivalist off-gridding, but you can replace some of your needs with home-grown produce and fuel wood.
That means the money you’d otherwise spend out on needs becomes available for wants. For instance, I am a fair-weather cyclist. I save more money on petrol in the summer than in the winter, but it still reduces my annual getting-to-work costs.
It was Mrs Ermine who first articulated to me the concept that any time you can squeeze out of the money economy is valuable. It gives you resilience, and more money to spend on wants or to invest. She learned this since leaving university, because she has a passion for horticulture, and you spend a lot of money on food.
Reduce your dependence on the money economy for needs
In her case, growing vegetables on an allotment was her first introduction to getting away from the money economy. It costs £30 a year to rent an allotment in the UK, which is 1/16th of an acre, which a skilled gardener could feed a family of four on. Now if I tried it I would have a glut of tomatoes in Summer and then a load of stinging nettles, but fortunately Mrs Ermine has the skill and inclination. Only she has upscaled this big-time.
So as long as you grow more than £30 worth of food on your allotment and recover the cost of inputs, you are in the money. As an incidental benefit your veg will taste far better than the same thing would from Tesco, and be better for you as the vitamins won’t have degraded from storage/transit. Field to fork in 24 hours just isn’t possible from a supermarket.
Food is a need, and for every £1000 you don’t spend on food, you can let your cash income fall by £1300, since you neither need to earn that money and nor do you need to pay tax on it.
This extends to other things. For instance, Gumtree tells me that if I want to rent a house like mine in the area I live in, that will be £700 per month. That’s £8400 a year I don’t have to find because I own my house outright, and that means my gross income could drop by £11000 compared to if I didn’t have it because I don’t have to fund that. Remember that 30% of that is the tax I don’t need to pay on what I don’t need to earn.
My 12-year old pushbike saves me a little bit – it is fuel I don’t have to pay for. Other ways to get out of the money economy include a wood-burning stove, we grow biomass willow on a flooded allotment site and also have some firewood from our land elsewhere. That’s again getting out of the money economy – this is money that doesn’t need to be earned to be paid to EDF for gas. In our case it reduces the heating bill.
All these are non-financial investments. Not all non-finanncial investments are Stuff – some are skills. A zone valve on my central heating system failed. We troubleshooted the fault and I replaced this myself, for a cost of £8. To have a heating engineer come in would have cost about £100, and they would probably have taken the opportunity to shoot for a change of my 15 year old boiler. This again is money I don’t have to spend or to earn, but having earned it I will put it to work in financial investments.
Non-financial investments save you more than just money
They give you independence and resilience, because you are doing more for yourself. The Ermines’ nest is less susceptible to the price of veg, because we don’t buy it. However, we are still exposed to food prices for non-veg items, so we have reduced out exposure to food price inflation, not eliminated it. We are a lot less exposed to higher fuel costs, because we have reduced our gas bill with the wood burner. If the Russians turn off the gas to Europe this winter we will still have some heating. I will even still have light, because of a solar-powered LED light project, which has enough capacity to run over the short days.
Non-financial investments are very different from financial investments.
They are illiquid, and hard to analyse. You mustn’t use the same criteria to evaluate them as you would for a stock market investment or a savings account. If you buy a stock, you know how to evaluate its performance – either the total return compared to your outlay, or the income you get from it, depending on whether you target net worth or income.
Most stocks have some residual value after you’ve bought them, whereas most non-financial investments are almost depreciated to zero or negative once you have bought them. So they must be evaluated differently. The clearest case of this was when I was evaluating whether to buy solar PV panels. I could use the money for that, or invest in the stock market. The subsidies are such that you have a break-even point of 8 years hence. However, the equipment has virtually no secondhand value, and would be labour-intensive to recover. So it’s not the same as buying a stock with a 12.5% yield, as this is often presented. There is no return of capital, merely a return on capital. I passed on the solar panels, I’d rather take a return of 4-5% in my ISA and a good chance of a return of capital, or even a long term appreciation.
Likewise a wood-burning stove – the installation as about £5k, only £1000 of which is the stove itself. If I move I don’t think the stove would add £5k to the value of the house. I could take it with me, I suppose, but then I’d have to pay 80% of the cost again to have it installed and the chimney lined in the new house.
Non-financial investments reduce your cost base, save taxes but you need a fairly stable life
As the wood-burning stove and the farmland show, this sort of investment ties you down somewhat. It’s a old man’s game, not a young man’s game. I most likely won’t need to up sticks and chase work all over the country, and if I did some of these investments would be either not useful to me, or a positive liability. Look at the number of accidental amateur landlords Britain has, when redundancy meant a family had to move for work but they couldn’t sell their house.
Non-financial investments often tie you down, so you probably want to avoid them till you are in your 40s. Until then the stock market is probably a better friend if you want to escape the rat race. ERE Jacob is probably the canonical example of how to make financial investments work for you and quit young. On the other hand, he lives in a van, and I live in a house. That’s an advantage for him, because he likes change, but it would hack me off no end. But I’m not moving counties, never mind countries, any time soon. Which would hack him off. On the other hand, I get to dig my plants into the ground, whereas Jacob has to futz about with containers.
At the moment I am reflecting on my asset allocation, and marshalling resources for stock market investment. At the same time, however, I am also looking at wider diversification. Trees, for instance – you plant trees in the early winter, when the sap is down, at least if you want to get them cheaply as bare-rooted stock. So the time for ordering is soon. Like other non-financial investments, trees are depreciated to worthless as soon as you get them, and they also do nothing for you for the first three years. But after that you get fruit, and again, fruit that tastes of something rather than the bland visually perfect simulacrum the supermarkets sell us. There’s no substitute for fruit that has ripened on the tree in the summer. But you have to eat it sooner that the typical supermarket fare.
One of the other things that non-financial investments do is hold their value outside of the stability of money. Land and property do not depend on the currency for their value. Curiously enough, nor do shares, as opposed to bonds, though at first glance shares seem to be the quintessential financial investment. This enabled the courageous investor to survive the German hyperinflation with some value intact.Whether nominee accounts would have the same staying power as real share certificates is a different matter. And it’s not to say that the value of shares won’t change – the sort of social and financial maelstrom that would accompany a disorderly currency collapse could well do for many firms. However, the price printed on a share certificate only has meaning at the initial IPO – after that it is the number of shares as a proportion of the total capitalisation of the company that determines the value, even if we are using the gold New Deutschmark to value Tesco in rather than the now worthless old Great British Pounds 😉
The stock market isn’t the first place I’d go for a tin hat if I felt there were a currency annihilation brewing, however…
Simple Living In Somerset 
You hit the nail on the head. I do not think that one needs 25 x salary to retire, this is certainly not something I have achieved. Is this a throw back from the old outdated school of thought that you need a million or so to retire? This is because people want 50k plus to live on a year??? It seems to me that it is far easier to try and live a different way of life, like you say, own your home and self sufficiency of some measure etc.
Now on to my next rant, inflation. Now I am not saying that inflation does not exist but I believe that everyone has their own personal rate of inflation. Also bear in mind that inflation has been relatively low over the last few years. From my own personal perspective I can say that I am spending less now than i was 10 years ago. Some of this may be due to lifestyle changes and downsizing but not everything has gone up in price, in fact some things have gone down in price due to competition/globalisation etc.
Living differently from others means that you have more control over your own personal rate of inflation, ie ride a bike instead of buying petrol all the time, if bread has gone up in price, make your own or buy a cheaper brand. It does annoy me when people bang on about inflation, that we are all doomed.
Personally I see the cost of housing as the greatest problem in the UK, I fear it will only get worse.
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Yes, I am not sure why this 25x salary figure is always trotted out. The more pertinent figure is 25x actual expenditure. The latter can typically be screwed down by: paying off the mortgage; giving up any savings plan; reviewing general expenditure and lifestyle; developing practical skills; exploring the non-monetary economy.
Most people do at least some of these things. Thanks, as slways, for the insight into your semi-self-sufficiency.
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@ermine,
Easily this one’s going to be in my Best of 2011 posts. In India, we are dangerously inching closer and closer to the Anglo-Saxon style of one “cash-based” economy to rule us all (Sorry Tolkien).
It is certainly eroding the kind of barter and goodwill that had been fostered until even the late 80s faster than one could imagine. Unrolling a ball of thread analogy comes to mind!
Anyway, much as I sing paeans to this thought like the others, we are still a frightful minority. Which is kind of sad because, while fuel for heating is not a big thing here (at least for us soft, southern nancies) fuel for cooking is, and whith our sizeable population, we will denude our forests in less than 3 months…. Still, we continue to hurtle down the road.
There is a lot of discussion on “alternative” economies in the West, which is interesting. Here JMG musing on alternative healthcare, and then there was Walter Russell Mead on death of the American dream! Let’s hope sanity , Schumacher (EF) and Gandhi prevail before it is too late!
P.S: Don’t ask now, but I think Jacob ol’ boy might be ready to put down roots 😉
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Hi Ermine,
“That’s £8400 a year I don’t have to find because I own my house outright, and that means my gross income could drop by £11000 compared to if I didn’t have it because I don’t have to fund that.”
Aha! I am glad you have now realised the value of your house, and that it *is* a financial asset. I suppose this means I will no longer be able to bid for it in pints of beer, but I’ll take that on the chin. 😉
Thanks for the link through to my article. That article was a monster size already, and I didn’t want to go into more on that page, but I certainly agree there are various permutations.
The biggest is the tax mix. You will be being pretty heavily taxed on £40K, with at least an effective rate of 25% and perhaps nearer 30% (I haven’t worked it out recently).
With a judicious mixture of cash and dividends, that could be 0%, which will reduce the size of the pot required.
Obviously you can spend less too, but I believe there are traps in this way of thinking. I’ll detail them in a post soon (it’s half written).
Obviously it depends what stage of life you’re at though, too.
You didn’t mention a side income, either. Personally I suspect someone of your talents will find it much easier working one day a week on something profitable than mucking about growing cucumbers in barrels (from a cash perspective, I would love to do it from a holistic POV).
There’s a danger of conflating multiple dreams/goals here, IMHO, which is fine if that’s what you want to do. But decoupling from the money-grid is different from unplugging yourself from the day to day grind.
Good luck as ever!
Monevator
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@Dreamer the 25x salary isn’t true in your or my case because we weren’t using all our salary to live on. It looks stupendous to me (I’m considerably better off than average UK wage but I’m nowhere near paying 50% tax 🙂 ) For that average UK wage of 22k, I guess the capital needed would be in the £400k region.
Even before cutting back to save my lifestyle inflation stopped about two promotions ago. That was because I swithced to paying down the mortgage, and also the shift from Stuff prioritisation as I got older made that easier.
You’ve got as point that inflation has varied widely across the spectrum of Stuff. I remember spending £1200 on a 286 computer years ago, now I’d struggle to justify paying more than £800 on a computer. Unfortunately there does seem to be more inflation in Needs as opposed to Wants, hence some of the desire to become self-sufficient-ish in some needs. Which would free up income for Wants…
The price of housing – well, I think when interest rates rise we will see things change on that front, so hang in there! There is probably going to be a lot more unemployment soon which will amplify that, for non-London places at least.
@SG, I fear the 25x gets repeated because a lot of people don’t pay down their mortgages, relying on interest-only operations so that plus won’t work for them. And they live up to, or beyond, their means. In that case then you do need that much. There is also an emotive part in people that gets into thinking “I am worth this much” that takes a hit on that changing, some colleagues can’t imagine needing less, and won’t even consider the theory. So they’ll work till they drop…
@Surio fuel for cooking is (or should be!) a lot less than that for space heating. We use far less gas in the summer than in the winter, but there’s not big difference in cooking. You can also improve heat use with cooking, if you cook things from scratch which tends to use long heating times, by using insulation, such as the haybox and more modern variants. So there is hope that industrialisation might bring better technology to bear. The loss of community is sad 😦
@Monevator I’m _still_ not sure that the house is a financial asset 🙂 It gives me options in reducing costs, so yes, you can measure the rent I don’t have to pay. What puzzles me is I’ve never paid £700 pcm as a mortgage, my worst case was half that about 10 years ago, which the bank of England inflation calculator tells me is £454 in today’s money. So I am still not sure how to evaluate it. As a tenant I only ever rented rooms, never a house unless shared with a bunch of others, because I was too tight to stretch to more than a room, either in London or in Ipswich.
I’ll be interested in the spend less post, I agree that there are traps there, which could lead to tough constraints further down the line. Some of Jacob’s ERE moves work fine when you’re young, but you get a taste for slightly finer living as time goes on 🙂
As far as a side income goes, my aim is to not need this. I don’t from a basic living POV in that my company pension would pay for the needs and a certain amount of wants, and my ISA will give me an income for wants. Although I did run a company on the side, after a lifetime of working for The Man I’m not particularly entrepreneurial, particulary in the hustling for sales end of things. OTOH I have turned down the occasional bit of design and product work, because I’m not paying 40% tax on what I do in my free time 😉 So the jury’s out on that, I’m being conservative and discounting it to 0 at the moment.
> than mucking about growing cucumbers in barrels
hehehe, I _personally_ don’t grow anything. DGF is the expert on that. I build stuff, as in carpentry, and mess with electronics to automate and eventually for telemetry. All that weeding lark is way beyond the pale for a guy born in the city, but everybody else seems to get something out of it, so good luck to ’em 🙂 I think Jacob has a better chance with containers where he is because he has heat and light, try that game in Blighty and the results aren’t all that good. Or was it my lack of skill – I used grow bags for tomatoes in my conservatory and they ended up sharp little devils compared to what we get from the polytunnel.
There is some conflation of aims here, well I like to call it synergy. I have a more downbeat viewpoint of some future macro hazards so some of this is to gain more resilience. I’m not sure I expect a collapse of society, more a greying towards the 1960s of my childhood, where there was much more community but much less stuff, and some everyday things like heating was hard.
Gaining control of some of those needs is a deliberate attempt to diversify methods of addressing them. These non-financial investments give options, and some of those options reduce running costs, and sometimes improve quality.
Thanks for all the comments guys, it’s much appreciated, as I’m still refining thinking on this whoe area 🙂
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