March 12, 2018
Whenever I feel the urge to read (or re-read) blogs and books on financial independence, I’m often struck by how much of a hodgepodge our passive income assets really are! Often the authors suggest very simple investment strategies, while ours has turned into a many-headed monster of a thing. Have we cocked this up, I wonder, and what should we do with it in the coming years?
Our Current Cash-Flowing Assets
As at the time of writing, aged 45 we’ve these assets between us which currently generate cash flow:
- A two bed bungalow with a 40% mortgage, which we let out. We used to live here.
- A paid-off three bed detached house which we let out. We used to live here.
- A paid-off three bed semi-detached house which we live in. We rent rooms out in this house.
- The semi-detached house also has a small shop embedded in the front, which isn’t accessible from the house and which we let out separately.
- ISAs holding a range of share funds, invested in companies around the world (Vanguard passive-index physically-backed ETFs). These generate dividends, and should appreciate in value over the long term. These funds are spread across thousands of large, medium and small-sized companies, across various industries and geographies.
- Two of the houses have solar arrays on the roof which generate free electricity for the tenants, and will earn a feed in tariff from the UK government for the electricity they generate for the next 17 or so years.
- We have a travel blog and books which generate some income for us through advertising and sales.
Sleep At Night Assets
We also hold the following assets which, in real terms, generate less income than the value they lose to inflation. We keep them to enable us to sleep at night! They’re liquid (easy to convert to cash), so can be got at quickly in the event of an emergency. They’re also pretty much secure, so there’s not much chance of us losing them. We’d also use these to fund large one-off purchases as and when we need to make them, topping them up with excess income from the above assets over time.
- We hold premium bonds to fund emergency repairs with the rental properties (enough to cater for multiple large issues at the same time – two boilers needing replacing at the same time as another major repair, for example).
- And finally we have a cash emergency fund in Cash ISAs and the bank, enough to cover about 6 month’s ‘normal’ expenses in the unlikely event all of our income streams dry up.
Future Earner Assets
Plus we have these assets which will generate a cash flow in future:
- We have a number of private pensions from previous jobs, which we track and have had a pension expert look over (he suggested we leave them as they are – although this was a few years ago).
- And we’ve contributed enough years of NI to earn at least partial state pensions (assuming they’re not means-tested by the time we can access them). We may end up contributing enough years for full pensions, although we’re yet to decide.
Why Have We Got this Lot?
Probably because we don’t really know what we’re doing! If we’d planned this from the start we’d most likely have aimed for a small house for us, a cash emergency fund, and put the rest into share funds and bonds as suggested by JL Collins (tax sheltered in ISAs as much as possible). That said, we’d probably still have private pensions, as even when we’d no focus on financial independence (and I didn’t even understand the tax break I was getting on pension contributions), the offer of matched investments from employers sounded too good to pass up!
What’s Wrong with this Diversification?
I’m not sure there’s anything ‘wrong’ with it as such (or is there?), but we find ourselves chatting about these aspects from time to time:
- Property maintenance issues. If you rent out a house or commercial property, you’ll have to repair and improve it from time to time. This is perfectly natural of course, but it requires us to hold a much larger amount of money in low-yield bonds than we might otherwise, and has a mental overhead as we ponder what needs doing.
- Issues with tenants. Again, this is pretty natural. From time to time we get issues with tenants, but we’ve (almost) always used local property letting experts to manage the process of finding and vetting tenants and collecting rent. In over a decade we’ve had few issues, nothing major. The 10% hit we take on income has been well worthwhile. When we’re away travelling the agents also take care of any repairs for us. They are very responsive so issues get handled quickly which in turn keeps tenants happy, and they usually stay with us for a number of years.
- Leverage may be too low? We’ve a relatively small mortgage amount on the houses, having worked hard to pay them off over the years. In a rising market and (for now), low interest rates, we might be financially better off releasing some equity and buying more property to let out.
- Not tax efficient. Almost all of our income is taxable. Shifting more money into tax-sheltered investments could make more sense, especially when we get our private pensions and more of our income becomes taxable.
- House sharing. We share the house we live in with tenants while we’re here in the UK. This hasn’t really caused us any major issues (we spend most of our time in a large bedroom/living room/ensuite which is physically separate to the house), but it obviously requires some flexibility on both sides, and we might be more comfortable if we had our own place.
- Limited lifespan. Our travel blog needs feeding! While we’re not travelling the readership stays surprisingly high, but the income does gradually drop off while we’re not adding new material. We can’t count on this income stream over the long term.
- Access to pensions. Two of our largest pensions are defined benefits, which we cannot access until our 60s, unless we move the money into our own pension arrangements.
Overall it is a pretty complex bunch of stuff, which requires Ju to track and record closely so we can complete personal tax returns accurately, and so we know how each asset is doing. It doesn’t take a huge amount of time, but she probably spends a couple of hours a month entering meter readings, recording costs against properties, keeping records of income and so on. On top of that she spends:
- maybe a day a year completing tax returns,
- maybe a day researching buy to let mortgages when it comes to the end of the deal,
- and I spend a few days here and there researching Vanguard funds and so on.
What Feels Right with this Diversification?
At the moment we’re not planning to make any changes to the way these ‘passive income’ streams are working. This is why not:
- It ain’t broke! At the moment this series of assets is generating more income than we’re spending. We can’t see any major issues with it, and have become comfortable with it over a period of years, so don’t feel the urge to mess about with it too much.
- We’re always learning. Stock market investing is something which, until a few years ago, neither of us had much experience of. The shares we have are ticking along at the moment, and we’ve gradually ramped up our investment in them as we grow more confident.
- Reduces importance of any single asset. Neither of us are investing experts, and having our income streams fairly widely spread feels like it helps reduce the impact of things outside of our control. If a tenant leaves and we’re left with an empty property, we can keep going as we are until we can find someone new. If there’s a world-wide stock market crash, it should have minimal affect on us (we don’t actually spend the dividends at the moment – they’re re-invested each year).
What Might We do in Future?
It seems likely we’ll alter these assets in future – who knows what will happen to us, to the world around us or to the assets themselves? Quite what we’ll do remains to be seen, but some of the changes we might make are as follows:
- Shift the defined benefit pensions into SIPPs. As we’re only 45, we’re some years off deciding whether we want to do this, and we’re using our experience of owning shares to help inform the decision. We need to take into account the fund values, what happens if one of us dies, the costs of self-investing, the difficulty of getting access to the funds (we’d have to use professional advice – which may be no bad thing), the risks of self-investing and so on.
- Simplify by moving into shares. Many FI bloggers have a simple portfolio of a single Vanguard share fund, and take 2% to 4% of the fund value a year as income (look up ‘safe withdrawal rate’). Some have a Vanguard share fund plus a percentage in a Vanguard bond fund. We could, perhaps, eventually end up in a similar position by selling whatever we own other than the house we’re living in.
- Felice PazzoMarch 19, 2018 at 2:54 pmPermalinkHi Jason. I’m guessing that the lion’s share of your assets are tied-up in uk residential property (maybe a little commercial diversification with the shop). If you have complete confidence in UK property* (and, implicitly the UK economy), what’s to worry! However, if you want to (as far as practicable) immunise yourself against any “black swans”, you should be looking to diversify. You’ll find a good starter on monevator.com, &/or pick up a copy of Investing Demystified (Lars Kroijer). I realise that to question the inexorable rise of uk property (including the caveat “over the long term”) is tantamount to heresy amongst the majority of the UK public; hence the caveat, if you don’t believe it’s possible to go wrong with UK property, why change. [* I’ve generalised by referring to UK property; having all your property geographically close (same county/ town) is another instances of ‘eggs in the same basket’, e.g. what happens if a large local employer re-locates elsewhere.]. P.S. I’m as guilty as the next of not having as much diversification in my investment as I know I should have – in my case, too much home bias to exposure to UK plc (FTSE tracker) … but I’m trying / learning. Cheer