Little FU#1 – Step 3 Devise an Investment Strategy

Recap – This is step 3 in the process to set up a plan for my son, FU#1, to buy a property and reach FI before he is 40 years old.

In step 2 of the plan, we set up an initial budget for him to implement. The main part of this budget was to automate his savings to enable him to achieve a 50% savings rate.

Now we come to step 3, which is to devise an investment strategy to attain the goal of the plan.

I based this plan and strategy on the assumption that FU#1 will be earning £25k net from year 4 onwards, and that he will have a savings rate of 50%. He will save until he is 40 at which point he can reach FI.

I modelled various scenarios (based on the same investment contributions) in a spreadsheet, using a mix of LISAs, ISAs, and Pension savings to try to identify the most optimal strategy.  The results were quite surprising and not what I expected.  The chosen plan turned out to be relatively simple.

I am aware that the plan may need adjustment/refinement as circumstances change, and, as I’ve said previously, this plan won’t be perfect but the most important thing is to start. As GETRICHSLOWLY points out in his post, the perfect is the enemy of the good.

Summary of the Chosen Strategy

I will give an outline of the chosen strategy here, with further explanation on the detail below.

Assumptions – All investments will be invested in low-cost index funds with 100% equity. Growth assumed to be 7%. Savings rate = 50%. Any state pension has been ignored.

Pension savings will consist only of the minimum contributions made to his auto-enrolment pension, which is automatically taken out of his pre-tax earnings by his employer.

Years 1-7 – Invest £4000 per year in a LISA, with the remaining savings into S&S ISA. This will give FU#1 a £43k deposit to be put towards buying a property.

Years 8-21 – Invest all savings into S&S ISA. The value of the ISA at year 21 (age 40) will be £365k.

Years 21 onwards – no more contributions required.

Utilising a 4% withdrawal rate, this will provide £18k per year tax-free income.

At this rate of withdrawal the ISA will last beyond when he will be able to draw his personal pension at 57.

In my spreadsheet I took a 25% tax free lump sum out of the pension at age 60 and put it into the ISA spread over 4 years.

The final figures came out as detailed below.

AGE          ISA VALUE          PENSION VALUE          TOTAL VALUE

40                 £365K                          £80K                                  £445K

50                 £425K                          £157K                                 £582K

60                 £471K                          £232K                                 £703K

70                 £535K                          £456K                                 £991K

80                 £398K                         £898K                                 £1.29M

The Detail

How did I formulate this strategy, in the context of the available investment options in the UK?

We needed to look at the investments available to help purchase a property, and to provide an income from the age of 40.

Youngfiguy, in this post, identifies four key factors in saving and investing – Risk tolerance, Time-Horizon, Access, and affordability.

From a risk and time point of view, the period of investing will be between 5-15 years, so, being quite risk tolerant,  I am happy to invest in 100% equities, with ongoing monitoring of the LISA which has the shortest investment period of 7 years.

With regard to access, when looking at different scenarios for FU#1 on a spreadsheet, it became apparent that pension saving alone wasn’t going help him achieve his goals, as he needed income from when he plans to become FI at 40, to when he would be able to draw a private pension (at 57?) So he would need investments that could be accessed as required.

Affordability has been addressed in his budget with an ongoing assumption of 50% savings rate.

For FU#1 we have identified that tax-advantaged investment accounts will be the best way to achieve his goals. Those available in the UK include LISAs, ISAs, and Pensions. (I am not going to explore the pro and cons of each in this post as it would take too long and make the post unreadable).

As FU#1 is enrolled in his company auto-enrolment pension scheme, I used the minimum contributions and found this made sufficient provision for the pension element of the plan. This may need further investigation if his earnings go into the higher rate bracket.

The main decision to make was the investment split made between the LISA and the ISA. On looking at different scenarios in the spreadsheet, using the LISA only for a house deposit, and then investing the remainder and ongoing investments in an ISA provided the most flexibility, albeit with slightly lower figures overall, than continuing to split investment between ISA and LISA. The LISA can be kept live by leaving a small amount of money in it after using it for a house deposit. This will keep future investment options open if circumstances change.

So you might be asking why not invest in the LISA and ISA if it returns more money?  Because the ISA route provided enough, with the difference being the cost of flexibility for immediate access to the money if required. The Escape Artist explains it better in HOW MUCH IS ENOUGH.

I will post the spreadsheet on to this post when I have worked out how to put it on!!

In my next post on FU#1 I will detail the accounts and investments set up for him.

Do you have any thought or comments on the plan?

What investments are you relying on? Pensions, ISAs, or a mix?