Institutionalise how you save and track finances in order to get ahead

This week Frugal Investors are encouraged to focus on institutionalising the way that they save and invest their money, on a monthly basis. Habit is everything!

I actually do a lot less trading than I did previously, and the performance of my equity portfolio is better as a result.

Instead I focus on what Me Incorporated is doing and how it is performing. For that I follow “The Routine,” which consists of three monthly activities:

• Depositing 55% of mine/my wife’s after tax income into our SIPP/ISA’s after pay day
• Recording the transactions on an excel sheet
• Updating my Net Worth spreadsheet to plot our performance

Remember that the Net Worth spreadsheet template is freely available here. By focusing on getting the money into my accounts tax-efficiently, I make sure that I am making money right off of the starting blocks in the form of tax breaks from the government (described in detail here).

Performance So Far

I was pleasantly surprised to see our household net worth move up between October 2019 and January 2020.

Here’s where we were in October when we launched Frugal Investors:

As of the 24^th of January 2020 that figures stands at £1,274,936. That’s a net improvement of 19.83% and compares favourably to the FTSE All-Share total return index (4.11%) and the S&P 500 total return index (10.56%)

Contributors to performance

The obvious question would be how it is that the net improvement in total wealth is so much higher than the total returns of stocks over that period.

The answers should surprise you and help to emphasize why Total Financial Management beats focusing-too-much-on-the-stock-market every time. If you institutionalise how you save money on a monthly basis, and then focus on getting free money from the government in the form of tax relief on pension contributions, you’ll be pulling ahead of the crowd right away and moving yourself closer to financial independence.

Here’s the explanation behind this out-performance:

1. Movement in the capital value of stocks since October 2019

Stocks have been on a tear. Yes, the FTSE All-Share hasn’t moved much, but meanwhile the US market has more than doubled the return of the UK and emerging markets stocks and gold have done well too. The point is to be diversified and have a balanced portfolio that benefits.

2. UK Government SIPP contributions

For every £1 that I put in my private pension, I get as much as £0.4 put into my SIPP account on top of that or given back to me through my tax-code. This year I will have hit the £40,000 annual contribution limit for my pension. What that means is around £56,000 actually has gone into my pension account (through direct deposits by HMRC or through tax code). A lot of the c. £16k government contributions hit my account during this period.

Free money!

3. Dividends paid out during this period

I am in part reminded of a conversation I had with a famous portfolio manager when I pushed him to answer why a certain stock hadn’t made any money and was still showing as a -0.56% loss. This was when I was about twenty and still had a lot to learn about investing. I just couldn’t understand why he was saying ‘I had made money’ when the paper report suggested the position had lost -0.56%.

The answer is this: if you buy dividend shares, with stable dividends, that pay out high income streams (dividend yields above 5%) then you shouldn’t be focusing as much on the capital value of the shares. Let’s say I own 1000 shares of British American tobacco and it cost me £34.18 per share (£34,180 total). Funny enough, the price of BAT today is £34.18, so on paper I have made 0% capital return on the investment. However, the business has been paying a 5.94% dividend yield for five years during that time and distributing the income into my account. As a result I have actually made a 29.7% return on the position or 5.94% per year!

4. Annual interest coming in from fixed savings

The best fixed interest savings rates that you can get tend to come with interest payments at the date of maturity. I had two of these investments mature and the interest has been recorded during the period! Ace.

I have a strong preference in this market for rolling 1-year fixed rate savings accounts at the best available rates. In Canada not too long ago there were fixed rate GIC’s with CIBC that offered a competitive bonus rate 2.5% fixed return for 1 year. That compares extremely favourably with the Government of Canada 10 year bond yield which is 1.41% (24^th January 2020).

In the United Kingdom places like Atom Bank were offering 2.1% fixed savings accounts and I intend to do a more comprehensive review of these products soon.

Remember just because you own a ‘super sexy’ portfolio of stocks that is riding a wave of good fortune now, it doesn’t mean this side of the equation, that is far less risky, is any less important. Warren Buffett himself has his £128bn war chest of cash invested in short term treasuries and bonds. You’d be wise to follow his moves.

5. Workplace pension contributions

Let’s not forget that when it comes to building wealth, it doesn’t start with buying shares. You need to figure out what the maximum employer contribution is for your pension, and max out on this. I have a very comfortable 5% employee/6% employer defined contribution scheme and I ensure that I make the maximum contributions on a regular basis and monitor the balance. Each month this then gets updated on my Net Worth tracker so I can understand how I am doing.

It goes without saying that the capital value of the stock and bond portfolio has appreciated quite a bit, as the market has had a pretty much relentless rise from October 2019 through to present.

If you have seen my recent update, I personally think that this market is due for a correction – a correction that, following the coronavirus, may very well be happening already. Does that mean I have sold all of my stocks and moved into cash? No. At the same time it’s a good opportunity to sell some equities and lower your weighting, because the risk is tilted in favour of a small correction, which will give you an opportunity to pick up a few bargains.

Overall Message

Focus on your savings routine and get excited about the un-exciting parts of your personal finances!

I really enjoy trying to find the best deals on fixed interest savings, and when we finally get to the end and I have more than I started out with, it’s rewarding to finally add it to my little spreadsheets and know that I am another step closer to financial independence.

In the past I used to celebrate my success because I could see my “stocks had gone up”. But the key thing is this: how are your total finances doing? Have your net worth gone up, and are you closer to achieving your financial goals as a result of it?

Now that I can answer that question with an assured answer, based on fact, I feel much better for it.