It’s hard to watch The Big Short, and not come away thinking that the odds are stacked against you as a would-be individual investor. It’s a great film that makes some very valid points, but leaves you thinking.
Surely if there are all these hedge funds that mismanage their clients’ money, and getting a seat at the big-boy’s table requires vast amounts of capital, there’s a gap in the market for cooperatively run mutual funds that actually act in their clients’ interests?
It turns out that there are already companies in this space, but the chances are you wouldn’t hear about them from a financial advisor.
It would be fair to say my approach to personal finance has been haphazard at best.
I’m lucky in that I grew up with parents that instilled in me a strong sense of saving for what I want (delayed gratification), and living within my means. I understood from a young age what compound interest was, and have avoided debt when possible for this reason. The only reason I got a credit card was for purchasing goods more safely online, and to date the only interest I’ve paid is on that first credit card – I forgot to pay it one month during my student days!
With this approach I was never at risk of financial disaster, but it’s also fair to say that I haven’t done much right either. With saving instilled in me as a child, I’d characterise my effort up until this year as practically 0%. If I didn’t have the upbringing that I did, this level of effort could have resulted in a mountain of debt.
I still have a lot of learning to do
When it comes to my work, I’m a big believer in the 80/20 rule (also known as the Pareto Principle), which states that 80% of the effects come from 20% of the causes. So, in order to have the greatest impact, you should do 20% of the possible work in a given pursuit.
Only once all the “20%” work has been done, should you work on optimisations, as doing more would mean the opportunity cost would likely be greater than the reward.
This of course assumes that 20% is a viable product; sometimes it isn’t. But this is a post about personal finance, not about how I spend my time at work
Today, I think I’ve just about reached that 20% level when it comes to personal finance. And it may be a viable product.
Here are the things I wish I’d known 10 years ago.
1. Saving alone is not enough
“Saving” is simply spending less than you earn. This is essential for healthy finances, but the default of leaving all your assets in a savings account (or cash ISA in the UK) is a trade-off that an educated investor wouldn’t make.
As a child, I remember looking at my savings account statement and calculating how much money I would have in a years time. Interest rates on savings in the 1990s New Zealand were regularly above 5-6%, which is a pretty decent return on any investment these days.
I did some basic math and was extremely excited, until Mum brought me back down to earth by pointing out that I had compounded the interest monthly at the annual rate. Sadly, my dream of turning $200 into $360 in one year was not realistic!
2. Most people don’t save enough, and I don’t either
I held this mistaken belief that because I had no debt and was a relatively careful spender, that I’d be just fine. I thought that because I earned more than most people, and didn’t spend all of it, I would naturally be better off in retirement.
If you can get past the stunning arrogance of this belief, there’s an important lesson in there. You probably don’t save enough either.
3. Trading is not how you invest in the stock market
Trading for short-term gains is gambling.
You don’t have to know about individual stocks to invest in the stock market, and actually, your money is probably safer if you don’t.
Yes, really. The best-performing investors in stocks are dead. The second-best forgot about their accounts.
4. It’s not difficult to invest “properly”
Financial advisors are not required, in fact choosing an advisor is probably harder than choosing the investments in the first place. But with regulations tightening around the world, the situation is improving.
After you’ve paid off debts and built an emergency cash account (equal to 6-12 months living expenses or whatever you feel comfortable with), you’re ready to invest.
Your investments should be growth-oriented with high exposure while you’re young and earning (so long as you have the stomach for it), with a gradual re-balance towards more conservative investments as you near retirement.
If that sounds too hard, just invest in Vanguard Target Retirement funds and have it done for you.
5. You don’t need a lot of money to invest
I used to think that to buy shares in Apple or Google I’d need lots of money. Actually this couldn’t be further from the truth. While the price for a single share can be high for many, broker platforms will happily sell you part-shares.
Having learned about index investing though, I don’t know why I ever would. Picking individual stocks is a fool’s errand.
6. There are financial services firms that operate in their customer’s interest
The reason is that it keeps its fees low, and is structured as a mutually-owned not-for-profit. It’s effectively owned by its clients; so if you invest with it, your interests are aligned. This is rare amongst investment firms.
Recently I was pleased to hear about Simplicity.kiwi, a New Zealand-based not-for-profit which, strangely enough, uses Vanguard as one of its major fund suppliers. This is where my New Zealand savings will be going in future, and I’m excited to see how this firm develops.
7. You don’t have to buy a house to be financially secure
Buying a house is what I’ve been saving for the past 10 years, and actually I’m starting to wonder why. It is the reason I held cash, and the opportunity cost of that decision has been enormous.
As young adults, our generation saw our parents make huge gains on their houses (if they were lucky enough to own them), which in some cases outpaced the stock market. <future prediction warning> It’s unlikely that these gains will be repeated </future prediction warning>, but I think many of my generation will see property as a much safer bet for retirement than it actually is.
If I really wanted to speculate on real estate? There’s no need for a mortgage – I could just buy VNQ and be done with it… (I am not advocating this position!)
8. You don’t need lots of different investments to diversify
Holding a few Index Funds is probably enough.
9. You shouldn’t invest in anything you don’t understand
As jlcollinsnh says in his manifesto:
Sound investing is not complicated. Complicated investments make money only for those selling them.
10. Retiring early is a thing
It’s trendy right now, but Financial Independence has become a movement.
What determines your retirement date is actually a really simple equation, and there’s only one number that matters – your savings rate as a percentage of your after-tax income. There’s an online calculator for the numbers here.
If you saved 50% of your income, and never increased your expenditure, it’s possible you could retire 17 years from a standing start if you wanted to. Of course, there are some assumptions baked in here, which are conservative for the most part, but there’s always the risk that you’ll retire in a recession which erodes your capital.
Also, most people probably aspire to increase expenditure at some point, but it’s important to know what the trade-off is. Do you want to work an extra 10 years for an extra $10k/year in retirement?
For more detail, and an estimate of success, there’s firecalc, although that has its own problems in that it uses the last 100-odd years of US stock-market data, a period the USA has dominated economically. Thus it could be somewhat skewed, or less-relevant for international investors that invest currencies other than USD.
But whatever your plan for retirement is, increasing your savings rate is guaranteed to allow you to retire earlier. It may even move the date to some time before your death!
Investment decisions are highly personal, and I think this is why people shy away from talking about them. It’s a shame, as many people of the same age will have similar goals, and we’d all do much better if we talked more openly about what we do with our savings.
Some of us like to keep up with the Joneses, but maybe your friend with the latest iPhone XS (or £2,000 computer…) wouldn’t have bought it if they understood the opportunity cost that £1,149 of VTWSX represents (or knew that you did). Some downward pressure on conspicuous consumption probably wouldn’t be a bad thing, unless you hold only AAPL.
If you do nothing else
If you know nothing about investing, and don’t really want to, but want your money to work for you, open an account with Vanguard, and setup a direct debit with them to buy the target retirement fund that is closest to when you expect to retire (plus 5-10 years, because we’re all going to retire later than we think).
I wish I had done this 10 years ago.
- jlcollinsnh.com, particularly the stock series and manifesto
- mrmoneymustache.com is probably the most famous “FIRE” (Financial Independence, Retire Early) blogger, but his approach to frugality can be a bit extreme for some
- The UKPersonalFinance wiki on Reddit is a great resource
- /r/PersonalFinanceNZ is good for NZ-centric discussion
- monevator.com has some excellent articles