The unofficial sub-title of this site is How They Did It, with “It” being achieving financial independence.
The Escape Artist worked in finance and was fortunate to enjoy a salary higher than the UK average. This certainly helps but only as long as you don’t allow yourself to fall prey to lifestyle inflation. A higher income only helps to the extent that you save and invest more.
An important part of How I Did It is through my investment performance. When you combine good investment performance with time, frugality and a savings rate over 50%, then all things become possible. This is The Magic of Thinking Big.
The Escape Artist is unusual (I prefer the phrase “special”) in a number of ways. As a child, I was intrigued by compound interest and the thought of passive income and determined not to be poor. By working in and around the City, I got to learn about equity investing and the mindset required for FI. Most people mentally ring fence the stuff they learn & do at work from from what they learn & do at home and vice versa. This makes no sense – you need to let your mind have what James Altucher describes as “idea sex” where you combine insights from different areas of life.
My day job entailed valuing companies, businesses and different securities. So when it came to my own investing I was able to apply my valuation skills and experience to my stock-picking. Its what I know best. This is why I focus more on equity investing than real estate / buy-to let landlording which is the other traditional route to wealth building in the FI community.
In my day job, time and again I’d see growth companies over-expand, make dumb acquisitions, take on debt and then blow up spectacularly and go bust. I took note and ran my own finances accordingly.
You’d think that all people in the City would join the dots from their work to their own personal finances – collect the big salary, yes, but then live frugally, save, invest, avoid debt.
Sadly not. Although a background in finance can be helpful, you’d be surprised how many people work in the City in well paid jobs but are rubbish at investing and managing their own finances.
I have managed my own portfolio of directly held equities since I was 26. That was 18 years ago and I still remember my first share purchase (Railtrack) fondly. They say ignorance is bliss and my acquisition of Railtrack shares was pretty blissful. I bought it without fully understanding the risks, sold it a year later after it had doubled and then watched with an odd mixture of elation and unease as the stock later collapsed and went to zero. I realised I’d dodged a bullet.
After that, I raised my investing game. I read every classic book on investing. I meticulously logged every purchase, sale, dividend, rights issue and other investing cash flow. I tracked this in a spreadsheet which is now so big and detailed that the lights flicker in our house when I open it. This is not normal behaviour. I tend to avoid mentioning it in conversation in normal polite society as people then look at you like you’ve admitted to having OCD.
Most people don’t record their own performance (its sometimes uncomfortable to face the truth). This is not good enough for The Escape Artist. When it comes to investing I may have a touch of Asperger’s syndrome. I update my share prices and dividends on a weekly basis and the spreadsheet calculates an Internal Rate of Return (IRR) for my portfolio over the last 18 or so years since inception.
This is an important number. As at the date of this article, the annualised return (delivered as dividend plus capital gains) that my direct equity investing (i.e. stock-picking) has delivered over the past 18 years is 12% per year.
This may sound boring to some. I hope that you can see from the graph above that achieving 12% per year for 18 years is not boring. It turns out to be pretty fucking interesting. An illustrative starting pot of £100,000 becomes £768,997 after 18 years if compounded at 12% per year. That £768,997 then produces £92,280 next year, assuming another year of 12% total return and so on. This is worth having.
The 12% IRR is stated based on actual cash inflows and outflows and is after all trading costs (commission, bid-offer spreads, stamp duty etc.). Note that the 12% does not relate to the overall portfolio (i.e. index trackers or the fixed income elements of the portfolio). My equity asset allocation target is 75% split half and half between my direct equity holdings and Vanguard index tracker ETFs. The 12% reflects the total annualised return on all the direct equities that I’ve held over the 18 years.
The 12% is an unlevered return. It was not achieved using any debt or margin. It was also achieved, I would argue, without taking greater risks than those inherent in the equity market. I avoided over-concentration and was always reasonably diversified. As time went by I mostly stuck to higher quality, lower risk names and over time I learnt to avoid concept stocks, over-leveraged companies and frothy small caps like the Ebola virus.
Over the same period, I would guess that the FTSE All Share has delivered much less. In the chart above, I show 6% as an equity market return purely for illustration. Now, in a low interest rate, low inflation environment 6% a year is not bad. Over 18 years, the starting £100,000 becomes £285,434.
This is before expenses however and the tragedy is that many people are invested via parasitic wealth managers or financial advisers that are invisibly sucking the blood straight out of their investment veins. Those people never actually get the (gross) market return of, say, 6% per annum. They instead get the net return after fees.
The fees for investing via a wealth manager are typically close to 2.5% per annum. This 2.5% is split broadly down the middle between the fund manager and the wealth manager (aka salesman). So that 6% gross return suddenly becomes 3.5% a year. This means that our starting £100,000 becomes just £185,749. Is it just me or does anyone else think that’s thin gruel as compensation for the gut wrenching volatility that markets deliver?
Here is a rule of thumb re wealth managers / financial advisers. These people are not your friend. The more outrageous the costs, the more re-assuring and glossy the marketing material will be. If the brochures are sprinkled with classy photos of neo-classical columns, Greco-Roman statues and stone carved lions, your Escape Artist Bullshit Geiger CounterTM should be starting to crackle loudly. This stuff is the financial equivalent of Rohypnol and we know what comes after that.
Back to the 12% per year. Lets be honest, I don’t think that most people could achieve this performance themselves. Most people are terrible at equity investing because the emotions of greed and fear overwhelm them at the worst times.
Re the graph above, its important to remember that you don’t get a nice smooth growth profile in the equity market. You get stomach churning losses followed (if you are still in the game) by exhilarating profits….all interspersed with long periods of boredom. I have lived through 2 occasions when the equity market halved and I learnt a lot about myself. Having experience and control over your emotions is vital to play this game successfully.
I am not sure whether I will be able to sustain 12% annual returns going forward. However I do know that the 12% has been dragged down by some past schoolboy errors which I don’t plan on repeating. All I’d say is that each year that goes by I become a little more confident that some of the out-performance is due to my investment process. But the truth is that even after 36 or 72 years of out-performance, you could never know with 100% confidence that your out-performance was all due to skill and not luck.
There is of course no guarantee that I will achieve 12% per year going forward. If you want a guarantee, buy a toaster*. The reason the ads always say that past investment performance is not necessarily a guide to the future is because 1) the regulators make them and 2) it’s true.
In effect, I’m running a real time experiment whether it is possible to beat the equity market. 18 years in, the early evidence is encouraging but far from conclusive. There is no need to remind me that this could be due to luck.
For most people, investing via Vanguard’s tracker funds remains the simplest way to invest. But some of us can’t resist the fun of trying to beat the market. And in another 18 years, I will either have learned my lesson or be closer to proving that maybe I’m doing something right after all. Time will tell.
* Actually, on second thoughts, don’t buy a toaster
Appendix: Here comes the science bit