The downshifting equation and your way to financial freedom is as follows:
Passive returns + Income from Job = Spending + Savings
Thus your way to increasing independence from the grind in the job-tread-mill has two main components:
- Efficient Spending
- and efficient investing.
Spending control in the form of frugal living decreases your actual need for money (right side of the equation) and gives you more room for high savings in the beginning of your downshifting journey.
Later on, passive returns will increase steadily and the need for savings will reduce once you have a meaningful stash accumulated. As frugal living will obviously continue, poof!, the need for income from a job will reduce accordingly!
And this is what we want.
As an advocate of the middle way, Woodpecker works on all variables at once, thus I started reducing need for work early on when passive income was already nice but way from enough for complete retirement. But how you play the variables is up to you. The important thing is to build a stash and to control spending.
The post today is about investing
Disclaimer: I am not a financial advisor. This post displays only Woodpecker’s opinion. Please do your own research prior to investing.
The magic of investing lies in compounding returns.
Small gains in the beginning pile up to huge returns over long time thanks to compounding.
However, the magic of compounding very much depends on the interest you can earn on your capital.
1.000 EUR invested 50 years ag would yield 12.000 EUR today at 5% return p.a.
But it would yield 19.000 EUR today at 6% p.a. and 31.500 EUR today at 7% p.a.
A general rule of thumb is the 70-rule: Divide 70 by the annual percentage return, and you will get how many years it takes to double your investment. E.g. with 7% it takes 70/7=10 years to doubly your investment etc.
Achieving a high return p.a. is absolutely mandatory and will make the difference between getting rich, or just get along well. Every percentage point is important!
Your aim should be a yield of at least 4-5% p.a. after taxes, the more the better. Thus, investments like “save” government bonds, saving plans from your bank, most life insurance products drop out immediately in todays low-interest-rate environment.
In the long run, the best bet probably is the stock market.
Let me summarize the advantages of stocks over other investments:
- Siegel’s constant, stating that stock markets in the long run yield about 7% gain p.a. after inflation. No one knows if this holds true in the future, but it shows the outstanding robustness of stocks in the past. Why should that change?
- Stocks are assets, tangible values. No counterparty risk, no default risk involved. You own part of a company, a factory, arable land, a tanker, whatever. This things will be there even after an inflation, a budget crises etc. A huge benefit over all debt investment (as bonds).
- Low transaction costs. Thanks to online trading and passive funds, you can invest cheaply, transaction costs can easily stay way below 1% for a buy/sell-roundtrip. Buying real estate in contrast, at least in Germany will cost ou about 5%-10% a round-trip.
- Diversification. You have a whole universe of investments at hand, you can spread out your capital in different countries, industries etc. Again very difficult with the (in Germany currently) so-en-vogue real estate.
- Dividends. Stocks generate dividends. Up to 4-5% only from dividends (plus price increase) are easy to be found. This makes stocks much more attractive than e.g. gold. See above example what magic this few percentages of dividends alone can do to your stash.
- You can learn, as you will do multiple transactions. Unlike real estate, if you are into managing your stocks yourself, you will learn and improve by the dozens of practical transactions you will do over the long run.
Consequently, Woodpecker is invested 85% in stocks and was for almost all the past. There has been many stressful years in the last decade as a stock investor, but 2013 was great, and overall return of the last ten years was around 7% p.a. in Woodpecker’s portfolio, including dividends and after tax and costs.
The few other things about stock investments and it’s challenges:
- Volatility can be stressful. After a few swings you will get cooler, but the first and second crash in your portfolio is likely to make you uneasy and giving you some bad nights. As the famous investor Kostolany said: “Stock profits are pain and suffering money. First comes the pain, then comes the money.” But remember, we are here for the long run, the marathon. The long-term return is what counts, and typically this is great in stock markets.
- Stock markets are quite high these days. I can really not make any recommendations here. Only that I would bet everything, that in 20 years from now, markets will definitely mark even much higher. What happens in between is not seriously to be predicted (see bullet one). Forget about all the experts. Fact is, no one knows. Stocks could crash next year, but they might continue to rally as well.
- Stock picking is a difficult art that takes a lot of time. If you want to do it yourself, there is no way around value assessment, digging numbers, reading reports, reading books on investment, on history, on mass psychology and on anti-cyclical behaviour. You will not outperform the market without putting a lot of work into it, even if you are smart. Remember, there is a lot of other smart guy out there in the market and some of them work like hell. If you don’t have fun digging numbers and reading reports, you’d better go for a passive investment in the form of an ETF (exchange traded funds).
- If going for an ETF, this is already much better than normal funds, as typically managing fees are much lower. They should be below 0,5% or so, as our example above shows how much a lower yield due to fees will eat into your long-term returns. The ETF should fully backed by stocks to avoid counterparty risk. At it should be diversified, e.g. on the EUROSTOXX or some other broad index. And dividends should go to you or get reinvested.
- Get a cheap depot and always check on unnecessary costs. Keep the number of transactions low to reduce costs. Always remember you are in a marathon. What happens during a week, a month, a year, is none of your concern.
- Read here a former post about some behavioral guidelines on investments.
I will not go into more detailed investment strategies in this blog, nor will I disclose any individual stocks I prefer and the like. There is plenty to find in the internet. However, when reading around always ask yourself how independent that particular source is or if they serve other interests by their recommendations.
And never, ever, trust 100% in any recommendation! See them merely as inspirations and always put some own thoughts in any investment decision!
Cheers and happy investments in 2014,