The fifty year wealth strategy in two decades

How does one go about creating the footprint to achieve financial independence within two decades?

Financial independence is, to an extent, a state of mind. I recently talked on the telephone with a friend of some thirty years. In fact he was my first boss after I left university, and though we did not get along too well in that relationship, we met after a decade apart, when I was much more mature, and forged a strong, if distant relationship. My friend had retired at the ripe old age of 54 and went world cruising on a 58 foot Oyster ocean-going sailing boat. He has recently become a land lubber after travelling around the world since the start of the Millenium, where I missed the trans-atlantic crossing to Bermuda for the celebrations. When I explained to my friend that I needed income generating assets of £4M before I was sixty, he retorted “you don’t need anything like that Jerry”. With all my detailed financial planning, I had neglected to account for a few facts like: no kids in private education, no mortgage repayments on the private residence, etc, etc. He was right. I had been calculating net income requirements based on our current personal outgoings, adjusted for inflation over the years, and not realizing that almost fifty percent of our outgoings would disappear within ten years. Stupid really.

I want to fast forward for a moment to exit strategy – how to assure that you have sufficient income in retirement to live within your means, yet preserve the real value of that income stream for the full duration of your retirement. I saw on the news that Harry Patch, the last remaining World War I hero, had died at the age of 111. It reminded me that we have hardly lived half of our lives, and it also reminded me that our plans for perpetual income generation would need to last for between thirty and fifty years. At least one of our presumptions for the last twenty years was correct, and that is that you can’t rely on spending capital as a substitute for income.

That’s applicable to very young investors these days, especially those who found the key to cash back investment in the heady days of big property loans, and what seemed for almost a decade to be unlimited borrowing. That has come to a short, sharp shock ending for most of us property investors who thought we could borrow our way out of an ever increasing debt pile whilst the property price inflation would take care of it all some time in the future. But when?

2009 has become the year of sober thoughts and sober financial planning. For those who remortgaged to fund lifestyle in excess of their net income, it’s become a sober reminder that you can’t always ride the wave of asset price inflation to surpass erosion of capital as a substitute for income. I refer; of course, to using cash back from borrowing more than 100% of the purchase price of property, or remortgaging property assets to more than 100% of original purchase price and spending the proceeds on non-investment activities.

The behaviour of any asset class is, by nature, unpredictable in the short term. But it is a reasonable assumption that, over time, the real value of property will not decrease. Like stock, the total return on investment of a property is the sum of the capital gain (or loss) and the rental income (net of all costs). So a sustainable investment strategy involving real property really has to treat the capital value as a component that keeps up with inflation, and the net income after costs as a component that is short term income and can be spent perpetually. Just how much of that income can be spent without eroding the real value of the asset investment is a subject that requires detailed analysis. Whilst it’s true that great leverage can be applied to residential property investment, the leverage comes at a price. The price is that if medium term cost of letting exceeds income from letting, the property portfolio becomes a liability, not an asset. And as some investors will no doubt experience over the next few years, an uncontrolled and rapid increase in ownership of highly leveraged residential property will result in bankruptcy.

Balancing leverage with ability to cope with short term market fluctuations (from all sources of income) is a subject worthy of further analysis.