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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
I give money to every beggar and homeless person I see. The reality is they will enjoy the booze and drugs my money can buy more than I will at my age.
Not that I gave a penny to a bloke on London’s Golden Jubilee Bridge last week. His sign could be read a hundred metres away. “Hungry — need food.” I could also see that he was a danger to the structural integrity of the pylons.
A big lad — and badly advised in his choice of words, I feared. Good luck to him, though. I feel less sympathy, however, with those who complain about “the cost of living crisis” when they clearly spend like mad.
It’s the same with investing. And, frankly, I’m one of the worst culprits. You shouldn’t feel sorry for my meagre pension pot after three decades of employment, as I have a bad habit of living beyond my means.
My lifestyle wasn’t excessive when I was a managing director of a global bank. But why did I buy a yacht post-divorce (and, worse, keep it when I lost my job)? What explains the holidays to Australia? The top-shelf tequila? The second wing-foiling board?
If you think expenses don’t affect our long-run balance sheets, think again. There is nothing you can do — apart from avoiding tax — that shifts your savings profile as much. Stock picking or asset allocation are irrelevant by comparison.
Take that £30,000 boat of mine. In 2020 I had to earn £50,000 pre-tax in order to buy it. That could have topped up my pension instead, growing at least 6 per cent per year since. A £71,000 white elephant, in other words.
There are the costs in perpetuity too, such as eight grand annually in marina fees. These you have to capitalise and tax, as you do when valuing merger synergies, for example. Assuming a 15 times multiple (a 1/15 or 6.7 per cent return) and a personal tax rate of 40 per cent, Jammy Dodger was equivalent to £72,000 in savings.
Seen this way, summer holidays are the number one enemy of retirement. A ten grand all-inclusive with the family to Greece? More like £90,000 wiped off the family books. Even a thousand pounds spent in Butlin’s each August is worth £15,000 to a saver paying no tax at all.
But this column has never been about saddling you with problems and guilt. So let me explain how you can use the above to your advantage.
British parents could warn their kids that a fortnight’s worth of ice cream on the beach — at ten euros a day for them and that random new friend they can’t shake — is a €2,100 claim on the future value of their Junior Isa. Your call, darlings.
Or how about the £500 a year your partner blows on streaming services to watch their favourite shows? Tell them it’s the same as giving up ownership of a £4,500 fund invested in US equities — which also has a long-run return equivalent to a multiple of about 15 times. Cancel them and we’ll split the difference.
And this approach can be used on any recurring expenses you’d like to cut back on — personal trainers, Soho House memberships, the lot.
Trouble is, most humans aren’t in the habit of comparing immediate costs with capitalised values. Whoever thinks of the annual lunch with the girls — a hundred bucks a head — as a claim on $450 of lifetime wealth?
It’s not hard, though. Even including tax in your decision-making process is a useful start. I worked with a guy once who would always put down the phone after securing, say, a $10 discount off his water bill and say, “I just made twenty bucks!”
By which he meant he would have had to earn twice that amount before tax to save the equivalent sum. And then from there it’s easy to calculate the assets he added to his family’s pot. It’s just $10 times 15 (assuming a 6.7 per cent perpetuity return).
So next time you’re pondering a subscription to an app or wine club, just take the annual cost and multiply it by the inverse of whatever investment return you’re used to and again by one minus your personal tax rate.
If you have your savings in a bank, for example, maybe you earn 4 per cent annually. And perhaps your tax rate is 30 per cent. Those sunglasses you buy at the airport each July for £200, therefore, will lower your wealth by 200 times 25 (1/0.04) times 0.7.
Three and a half grand! A pair of sunnies! You’ve got half a dozen others sitting in a drawer beside your bed. Resist! And for those who are more risk-loving, with most of your money in stocks, say, you’re still forgoing £2,100 of investment capital.
I should acknowledge here that some readers will find this confusing. It seems backwards that capitalised values for a given expenditure are smaller for those earning a higher return on their money.
But it’s mathematically correct, because in the case of the Ray-Bans, we’re asking: “How much capital would I need to produce £200 a year?” If your money earns less, you need more of it. We are deriving present values, not future values.
The latter is all about “what would this expense become if I invested it?” That’s very different from telling your wife: “You’re consuming the equivalent of a small endowment.”
Indeed, that’s how universities, foundations and the like manage their capital. Not as something to be spent, but as an asset that generates a perpetual stream of income. We should all be thinking this way. If it weren’t so boring.
The author is a former portfolio manager. Email: [email protected]
