Efficient Investing: Key to Financial Independence

This is the magic of compounding returns. You might want to be on one of the upper lines, wouldn't you?

This is the magic of compounding returns. You might want to be on one of the upper lines, wouldn’t you?

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.

Continue reading

Advertisements

Thinking about Money – Important but Unhealthy?

Maastricht - a beautiful little dutch city and home to the Treaty of Maastricht, leading to the unification of Europe. Good place to not think about money.

Maastricht – a beautiful little dutch city and home to the Treaty of Maastricht, leading to the unification of Europe. Good place to not think about money.

Yesterday, Woodpecker was coming back from a business trip to the beautiful country of Netherlands.

On the way back – due to bad connections – I had a very long cap-drive plus a long wait at the airport. (Including a police control of our cap on the Autobahn…did we look that much like weed smokers coming back from a happy trip to liberal dutch cities?!)

I was accompanied by a colleague working in a London office and we had a good extended chat on life, work and everything while driving and waiting.

Anyway, I observed that this lady had a really bad habit: Continue reading

Some Guidelines to successful Investing

Investments returns can help building the bridge to better downshifting. (Galata bridge, Istanbul)

Investment returns can help building the bridge to better downshifting. (Galata bridge, Istanbul)

Obviously, downshifting is much easier if you have a solid financial background and if your savings are working for you in a way as efficient as possible.

I am frequently asked what my investment strategy is, so I will put together some general ideas in this post. I will however not make specific recommendations on markets or products, as in the end everybody is responsible to make their own decisions and bear the consequences.

Disclaimer:
I am not a financial adviser. The ideas presented are my private opinion and no general recommendation. Everyone has to do his/her own research, make his/her own decision and bear the consequences.

Let me start with some first and very important advise:

1) There is no such thing as a golden bullet to become rich in an easy and risk free way by investing in a “magic” product

Sounds obvious? Well, maybe. But after investing in financial markets for over 15 years now, I learned that many people basically are still looking for this magic bullet, and most investors still think it is out there.
Whenever somebody says, “the market went so deep, it cannot go deeper” or “Real estate is a save play, there will always be demand” or “gold was important throughout human history, so buying it is a safe bet”, then actually he is advertising the magic bullet.
Do not believe talks like that. Investment is hard work if you want to beat the market.

In economics there is a saying there is no such thing as a free lunch. That means when something sounds very attractive, there WILL be a risk or hidden caveat attached to it.

A bank pays high interest on your savings? Well, maybe they are in risk of getting insolvent in which case much of your money will be lost.

A stock pays a great dividend? Well maybe they are paying it from their substance, thus neglecting growth or sustainability and despite the high dividend, valuation of that stock will go down, causing losses to you.

I will admit that actually there are a few and quite limited “free lunches” out there from time to time, but it takes a lot of time and knowledge to find those – you’ll not find them in a financial newspaper advertisements. And do not forget that other clever people are out there as well. Thus my second advise:

2) Be humble. Always assume that there is a lot of players out there that are smarter than you.

Whenever you found a great investment, be sceptical. And scrutinize if maybe this is a trap layed out for you by a really smart professional. Always diversify and never bet with too high stakes or with leverage or lended money.

3) Be very sensitive about costs

This is important! Most investors seem to neglect cost when doing their decisions. And I did as well when I started in the stock market.

However, one example shows how important costs are:

Let’s assume you invest 10.000 EUR in an ETF, and returns will be 6% per year.
Now we look at two alternatives, the first has a management cost of 2% per year, the second is a passive product with costs of 0,5% per year.

Guess what the total return is after 20 years?

  Inv. A Inv. B
Capital at Start 10.000 10.000
Return (p.a.) 6% 6%
Cost (p.a.) 2% 0,5%
Capital after 20yrs 21.911 29.177
Return (total in EUR) 11.911 19.177
Return (total in %) 119% 191%
Return (last year in EUR) 876 EUR 1604 EUR

For the first ETF, it is a surplus of 11.911 EUR. Very nice, 119% over 20 years.

But for the second ETF however, it is 19.177 EUR or 191% over 20 years!

That means, the difference in costs almost doubled your future income from that investment in the second case.

And look at the income stream that will be generated after 20 yrs from the both alternatives: The annual income of the low-cost alternative will be almost double the income of the high-cost alternative.

So, always bear costs in mind and ask yourself if high costs are necessary and justified.

4) Don’t overestimate tax-optimization

If you like it or not, you will have to pay taxes on most investment returns. Obviously, everybody would like to avoid that, but be careful: Tax-avoiding strategies often lead to ill decisions. Financial industries are happy to market products that are “tax-efficient” as many customers seem to become blind to the quality of the product as soon as they hear the word “tax saving”. This was shown in many economic studies.

5) Check the performance of your investments not too frequently

This is about happiness.

Checking too often will make you compare to others (or the market) all the time. Problem is, that comparing to others as well as thinking too much about money are both proven to have a negative effect on happiness. And it leads to hectic decisions, at least in my experience. So I tend to thoroughly choose a strategy, buy stocks, and….wait.
Especially in the first months after a purchase you might not want to look at your stocks at all. If they are flourishing you might get too overconfident, if they are diving you might be tempted to revise your strategy and sell them in an affect.

6) You might prefer real investments (“tangible assets”) over nominal investments.

A nominal investment would be a savings account, or a bond. Both entitles you to a payment by a second party (the bank or the bond issuer) whereas with a “real” investment you actually own something physical, like a part of a company, a patch of land, a piece of gold, you name it.
Real investments are more immune to inflation, less prone to haircuts or insolvency or financial repressions. See this post.

However, price still matters. Never buy an asset blindly just because you are afraid of loosing your cash in one of the many crisis.

7) Buy anti-cyclical

You think modern markets are developed, stable and rational? Far from stupid emotions and stupid behavior?
Well, they are not. I’d even say that modern markets are more prone to irrational herding behavior than 20 years ago, due to the high pace information is traveling with and action can be taken.
Thus markets frequently over- and under-shoot their fair value in highly emotional rushes.
Train yourself to sit on the other side as often as possible.
Everybody is buying real-estate/tech-stocks/old-timers?! Be careful.
Everybody says real estate/stocks/a certain country is doomed!? Consider buying. Don’t buy blindly though, but give it a thought if the market might have overreacted in that particular situation, giving you a chance for a bargain.

However, with anticyclical investments, you need patience and some stamina to withstand initial losses. Judge carefully how much downside you are willing to take (in most cases losses hurt more in reality than you might think beforehand).

8) Have fun in what you are doing

I think this is very important. You hate reading company earnings reports, plugging through balance-sheets and compare different valuation measures? Then better turn away from stock picking as the public information will simply not be sufficient to make a superior pick. I’d stay away from stock picking but rather go for passive (costs!) ETFs (fully stock backed ETFs are real values; note that certificates or options are not!).

You have no idea of different housing qualities, standards, price comparison etc. and have no fun in reading into these things? Then it might be difficult to make a bargain at the real estate market…

9) Learn about the psychology of investment

You think you have yourself fully under control and are taking you decisions in a rational way?
Well, most likely you will not. On top you might not even know where your emotions are steering your decisions.
So it’s a good start to understand common psychological investment traps as outlined e.g. in the two links below:

Presentation on Behavioral Finance

Overview of common behavioral investor mistakes

10) Money is not everything

In any case you have to accept volatility as a part of the game. It is a long and tough way to learn to really cope with e.g. 30% of your wealth being destroyed in a market crash. Be prepared that you will suffer on this way.

But always remember: Life is a game, and so is investing. It is only money!

…and as a good downshifter, you never made your happiness depend solely on money, and you know that money is a means only and never the goal.

OK, so that were general advises, but what now about Woodpeckers strategy?

Well, as said, this is my personal decision, so I do NOT say it fits everybody else’s risk appetite, financial profile etc.For the reasons stated above, Woodpecker strictly sticks to investing in “tangible assets”. I am however not good at evaluating real estate. Plus it is illiquid and difficult to diversify. Thus Woodpecker is invested almost 100% in stocks, and always was. For me it is great to own parts of companies that I belief in, plus the stock market grants decent returns in the long run, about 7% p.a. is the historical mean (Siegel’s constant). And – this is important – I find it quite some fun digging for undervalued stocks and markets.

I do stock picking and am mostly invested in German small caps (companies I know or can understand, plus often so small that they are not covered by institutional investors), a couple of stocks of southern Europe (I think there are some bargains here these days – however be careful, this is a tough and partly dangerous market) and some stocks in UK and eastern Europe. I avoid US stocks, as they are said to be slightly overpriced my many common metrics plus they add currency risk to my portfolio that I don’t like. Sometimes I do buy ETFs or certificates (careful! certificates include counter-party risk) of specific foreign markets where I see potential but have no means to pick individual stocks.

Right.

I’ll say it a third time: Don’t follow anyone blindly (including me), but find your own strategy! But equally important: Start finding your strategy now!

Investment can bring a real boost to your downshifting progress, even if it is humble and careful and passive …

Cheers,

Woodpecker

ps. Excellent Investment Blog and with very good blog-roll: http://valueandopportunity.com/