I spent a week following Andew Hallam, author of Millionaire Expat, around Singapore whilst he gave several public talks about how people should manage their investments. Here is what I learned.
Some Good Advice For You
In today’s climate of bargain-basement fund pricing and automated investment management tools, you may wonder whether you still need a living, breathing financial advisor.
You do. But with a twist. Are you thinking about advice that’s focused on how to make a killing on hot buy/sell recommendations? If so, you are correct – you don’t need that. You never did.
Instead, you need good advice.
Good advice is timeless … and timely. At its essence, good financial advice never goes out of style. Its principles are permanent: It should be brave and true, and meant for you. At the same time, good advice must remain relevant in an ever-changing world. Your advisor should be able to help you embrace promising new opportunities and insights, while avoiding the false leads and frightening challenges that are as formidable as ever in today’s markets.
Good advice looks at the parts … and the whole. Good financial advice helps you manage your investment portfolio for preserving or increasing your wealth according to your goals. It also helps you plan, implement, and manage your myriad related interests: taxes, insurance, estate plans, philanthropic pursuits, business interests, real estate holdings, and more. Beyond that, what are your goals? How can we relate your total wealth to your relationships, resources, and realities? Good financial advice should bring a unifying whole to your multifaceted parts.
Good advice is personalised … and persistent. Good financial advice is essential for making good decisions – not just in general, but for you: your money, your interests, your life. It’s about being in a relationship with an advisor who is there for you, not only during the promising planning stages when everything makes sense, but when your resolve is being sorely tested in turbulent markets. Or when your own life’s events have knocked you off-course. Good advice helps you find your way when you’ve been sideswiped by the unexpected.
Good advice is wise … and compassionate. Good financial advice is grounded in enduring academic evidence, structured process, and informed experience. But for all that, financial advice is nothing if it fails to contribute to that which brings joy to your life, protects the ones you love, and reassures you in times of trouble. For this, a good advisor must not only advise you; he or she must listen to you. This brings us to our most important point.
Good advice is in your highest financial interests, period. Above all, good advice should always and only be in your highest financial interest, even when it means the advisor must take a hit to deliver it. Around the world, various advocates are pressing for legislation to govern best-interest advice in a fiduciary relationship. Such efforts are often met with resistance from those who would prefer to continue prioritising their own best interests. As a result, the financial advice you choose to use will probably always call for a “buyer beware” perspective. As the late Vanguard Group founder John Bogle has wryly observed, “There are few regulations that smart, motivated targets cannot evade.”
We wish it weren’t so. That which best serves investors ultimately best serves all of us, so I would welcome a world where good advice reigns supreme. Until then, I hope you’ll now know what good advice looks like when you see it. It’s the kind that sees you through turbulent times, onward to your relevant financial and life goals. If this sounds dramatically different from the stock tips or market-timing tactics you’re used to hearing, that’s because it is.
May I offer you additional advice about good advice? I hope you’ll be in touch.
4 Things You Should Know About Risk And Investing
One of the main things I talk to my clients about is their attitude to risk, after all it's an inherent part of investing.
There is no such thing as risk-free investing. There is no 'sure-thing', regardless of what anyone tells you.
I always make sure that my clients are fully aware of the risks associated with investing as part of my 'Investing Masterclass' session. Aside from the obvious market corrections that mean substantial losses, clients are often surprised to see how time out of the market, usually generated by fear, can also have an adverse affect on overall investment returns.
Everyone wants to protect their assets as much as possible so an understanding of how we process risk can help us determine why we make certain financial decisions.
Here's 4 ways that risk can impact your wealth.
#1 WE UNDERESTIMATE RISK
It’s one thing when we imagine risk and its potential impact on our lives and our investments. It’s quite another when it really happens.
In investing, underestimating risk can trick you into believing that you can tolerate far more of it than you actually can.
As financial columnist Chuck Jaffe has wryly observed: “[A] common mindset is ‘I can accept risks; I just don’t want to lose any money.’”
Unfortunately, we can’t have it both ways.
When the risk comes home to roost, if you panic and sell, it’s usually at a substantial loss.
If you manage to hold firm despite your doubts, you may be okay in the end, but it might inflict far more emotional distress than is necessary for achieving your financial goals. Who needs that?
#2 WE OVERESTIMATE RISK
On the flip side, we also see investors overestimate risk and its sibling, uncertainty.
We humans tend to be loss-averse (as first described by Nobel Laureate Daniel Kahneman and his colleague Amos Tversky), which means we’ll exaggerate and go well out of our way to avoid financial risk – even when it means sacrificing a greater likelihood for potential reward.
Whenever we hear about the latest global news be it Trump declaring war via Twitter, stalled Brexit talks or acts of terrorism, it's natural for us to think about what impact this could have on our investments. The truth is it doesn't really matter what is happening in the world.
We don’t mean to downplay the real influence world events can have on your personal and financial well-being. But the markets tend to price in the ebbs and flows of unfolding news far more quickly than you can trade on them with consistent profitability.
So it’s a problem if you overestimate the lasting impact that this form of risk is expected to have on your individual investments.
#3 WE MISUNDERSTAND RISK
Especially when coloured by our risk-averse, fight-or-flight instincts, it may seem important to react to current financial challenges by taking some sort of action – and fast.
Instead, once you’ve built a globally diversified, carefully allocated portfolio that reflects your personal goals and risk tolerances, you’re usually best off disregarding both the good and bad news that is unfolding in real time.
This makes more sense when you understand the role that investment risks play in helping or hindering your overall investment experience.
There are two, broadly different kinds of risks that investors face.
Avoidable Concentrated Risks: Concentrated risks are the kind we’ve been describing so far – the ones that wreak targeted havoc on particular stocks, bonds or sectors. In the science of investing, concentrated risks are considered avoidable. They still happen, but you can dramatically minimise their impact on your investments by diversifying your holdings widely and globally. That way, if some of your holdings are affected by a concentrated risk, you are much better positioned to offset the damage done with other, unaffected holdings.
Unavoidable Market Risks: At their highest level, market risks are those you face by investing in capital markets in any way, shape or form. If you stuff your cash in a safety deposit box, it will still be there the next time you visit it. (Its spending power may be eroded due to inflation, but that’s yet another kind of risk, for discussion on a different day). Invest in the market and, presto, you’re exposed to market-wide risk that cannot be “diversified away.”
#4 WE MISTREAT RISK
It’s a delicate balance – neither overestimating the impact of avoidable, concentrated risks nor underestimating the far-reaching market risks involved.
Either miscalculation can cause you to panic and sell out or sit out of the market, thus missing out on its long-term growth.
In contrast, those who stay invested when market risks are on the rise are better positioned to be compensated for their loyalty with higher expected returns.
In many ways, managing your investments is about managing the risks involved.
Properly employed, investment risk can be a powerful ally in your quest to build personal wealth. Position it as a foe, and it can become an equally powerful force against you.
Respect and manage return-generating market risks. Avoid responding to toxic, concentrated risks. These are the steps toward a healthy relationship with financial risks and rewards.
Achieving this healthy relationship with risk is not a one-time thing - you will be in the market for the long-term after all. So it's something that you'll need to address every time there is movement in the market.
Having a financial advisor and ally who you can call on in times of concern can really help you maintain a balanced view of risk and prevent you making emotionally charged decisions.
6 Steps to Finding a Good Financial Advisor in Singapore
Finding a great Financial Advisor can help you significantly with planning for life events, and building your retirement pot. However finding the wrong one can be like getting married to the wrong person in haste and we know that divorces are costly, complicated and messy!
Here are 6 tips to finding your perfect finance partner.
1. ASK FRIENDS FOR REFERRALS
Personal recommendations from friends are a good place to start a short list for research. However, you should take caution with these referrals because:
If they are a relatively new client, it's likely that they will have a confirmation bias - it makes them feel better about their own decisions if they recommend their IFA to you. They may be well-meaning but they have not yet had time to see how it’s working with the adviser themselves.
They might not have done much due diligence of their own and therefore might not be the best choice for you, or even for them.
It’s a good starting point though and will help you start your adviser 'shopping list'.
2. ASK THE ADVISOR IF THE FEE YOU PAY IS THE ONLY COMPENSATION THEY RECEIVE?
Financial Advisors can be compensated in 2 main ways: either via commission paid to them from the products they sell you, or by charging you an annual fee (typically a percentage of the amount they are managing for you).
You need to find a fee-based advisor rather than one paid by commissions. There is a greater risk of a conflict of interest when your Financial Advisor gets paid commissions as it is likely that different products pay different amounts of commission. And with the best will in the world, you’ll end up with the products that pay the most commission, rather than the most suitable for you.
3. WHAT PRODUCTS IS MY MONEY INVESTED IN? CAN YOU CUSTOMISE THE PORTFOLIO TO ONLY USE LOW-COST INDEX FUNDS OR ETFS?
If the advisor does not or is not willing to use low-cost trackers, and tells you that they use actively managed funds selected by the firm's “Chief Investment Officer” then move on to the next advisor on your list. Here’s why:
Cost: A portfolio made up of low-cost trackers will cost you less than 0.5% per year, a simple fund can cost as little as 0.1%. Actively managed funds tend to charge 1%-4% per year. At best you are paying twice as much, at worst you are paying 40 times more.
Returns: Active funds have been proved to underperform index trackers 95% of the time. New data suggests it could be 99% of the time!!
4. ASK YOURSELF - DO I UNDERSTAND THE INVESTMENT STRATEGY?
Don’t trust any investment strategy you don’t understand. Don’t trust any advisor who won’t or can’t take the time to explain exactly why and how they operate.
Most of your portfolio’s return will come from the asset allocation, diversification and rebalancing - not picking the individual funds. Therefore get the advisor to walk you through their asset allocation - and if they can’t explain it then chances are they don’t understand it either! This is a good overview of asset allocation that you can read beforehand.
5. ASK THE ADVISOR WHAT HAPPENS IF I CHANGE MY MIND - CAN I SELL MY INVESTMENTS IF I WANT TO?
“If the firm says no, run. This is non-negotiable.” is the advice of Andrew Hallam, author of The Global Expatriate's Guide to Investing. Life never happens in line with your 20-30 financial plan - so you need flexibility in accessing your investments and should be free to move them to other platforms if required.
Ask who the product provider is - if it’s on this list then beware of long lock-in periods and high fees: Friends Provident, Zurich International, Royal London 360, Generali Worldwide, Hansard International, Alexander Beard and Old Mutual (Royal Skandia).
6. FINALLY, ASK THEM WHY THEY BECAME A FINANCIAL ADVISOR
If they can't give you an answer beyond 'I like helping people' then the truthful answer may be that they enjoy the high commissions they receive. Their answer should help you understand what motivates them as an advisor and whether this is a person you want to start a long-term financial relationship with. Selecting a financial advisor will be one of the biggest financial decisions you will make so try to find someone who you enjoy working with, that you can talk to easily and you feel as if you they have genuine and believable reason for becoming a Financial Advisor.
Take your time and shop around – there are lots of good financial advisors out there so go out there and meet with them. You just need to find the right one for you and your family.
What is Asset Allocation?
Asset allocation. It’s so ingrained in how we manage our clients’ investment portfolios, we talk about it all the time. But what is it? What are assets, and what happens when you allocate them?
Asset Allocation: A Classy Subject
Big picture, an asset is anything beneficial you have or have coming to you. For our purposes, it’s anything of value in your investment portfolio. After bundling your investable assets into asset classes, we allocate, or assign, each asset class a particular role in your portfolio.
To offer an analogy, allocating your portfolio into different asset classes is similar to storing your clothes according to their roles (pants, shirts, shoes, etc.), instead of just leaving them in a big pile in your closet. You may also further sort your wardrobe by style, so you can create ideal ensembles for your various purposes. Likewise, asset allocation helps us tailor your portfolio to best suit you – efficiently tilting your investments toward or away from various levels of market risks and expected returns. Your precise allocations are guided by your particular financial goals.
That’s it, really. If you stop reading here, you’ve already got the basics of asset allocation. Of course, given how much academic brainpower you’ll find behind these basics, there is a lot more we could cover. For now, let’s take a closer look at those asset classes.
Asset Classes, Defined
At the broadest level, asset classes typically include domestic, developed international, and emerging market versions of the following:
· Equity/stocks (an ownership stake in a business)
· Bonds/fixed income (a loan to a business or government)
· Hard Assets (a stake in a tangible object such as commodities or real estate)
· Cash or cash equivalents
Just as you can further sort your wardrobe by style, each broad asset class (except for cash) can be further subdivided based on a set of factors, or expected sources of return. For example:
· Stocks can be classified by company size (small-, mid-, or large-cap), business metrics (value or growth), and a handful of other factors more recently identified.
· Bonds can be classified by type (government, municipal or corporate), credit quality (high or low ratings), and term (short-, intermediate-, or long-term due dates).
We can then mix and match these various factors into a rich, but manageable collection of asset classes – such as international small-cap stocks, intermediate government bonds, and so on.
Generally speaking, the riskier the asset class, the higher return you can expect to earn by investing in it over the long haul.
Asset Allocation, Implemented
To convert plans into action, we turn to select fund managers with low-costs fund families that track our targeted asset classes as accurately as possible. Sometimes a fund tracks a popular index that tracks the asset class; other times, asset classes are tracked more directly. Either way, the approach lets us turn a collection of risk/reward “building blocks” into a tightly constructed portfolio, with asset allocations optimized to reflect your investment plans.
The Origin of Asset Allocation
Who decides which asset classes to use, based on which market factors? To be honest, there is no universal consensus on THE correct answer to this complex and ever-evolving equation. As evidence-based practitioners, we turn to ongoing academic inquiry, professional collaboration, and our own analyses. Our goal is to identify allocations that seem to best explain how to achieve different outcomes with different portfolios. As such, we look for robust results that have:
· Been replicated across global markets
· Been repeated across multiple, peer-reviewed academic studies
· Lasted through various market conditions
· Actually worked, not just in theory, but as investable solutions, where real-life trading costs and other frictions apply
Asset Allocation in Action
As we learn more, sometimes we can improve on past assumptions, even as the underlying tenets of asset allocation remain our dependable guide. Bottom line, by employing sensible, evidence-based asset allocation to reflect your unique financial goals (including your timelines and risk tolerances), you should be much better positioned to achieve those goals over time.
Asset allocation also offers a disciplined approach for staying on course toward your own goals through ever-volatile markets. This is more important than most people realise. As Dimensional Fund Advisor’s David Booth has observed, “Where people get killed is getting in and out of investments. They get halfway into something, lose confidence, and then try something else. It’s important to have a philosophy.”
So, now that you’re more familiar with asset allocation, we hope you’ll agree: Properly tailored, it’s a fitting strategy for any investor seeking to earn long-term market returns. Please let us know if we can tell you more.
The Magic of Compound Interest
The number one excuse I hear for not saving money is that everyone wants to wait until they have more. Well, with compound interest on your side, it is not a good enough reason.
Compound interest sounds incredibly boring but you don't really need to understand the dull formulas behind it. You just need to know it can have a magical effect on your long-term savings and you don't need to do anything to benefit from it. However, my Personal Finance Quiz demonstrated that it's not well understood.
THE HUGE IMPACT IS UNDER-ESTIMATED
In my quiz, I asked:
Only 33% of people who answered got this right - it's actually $327,670.74. You would have made $262,520.74 in interest from depositing just $63,150. This was, by far, the question with the highest number of incorrect answers.
SO HOW DOES COMPOUND INTEREST ACTUALLY WORK?
Just think of it as interest on interest.
Investopedia defines it as:
“Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods of a deposit.”
It's easier to understand visually so let's walk through some pretty charts.
UNDERSTANDING THE AMAZING EFFECTS ON YOUR MONEY
1. Get started early and benefit for longer
The earlier you get started, the more you earn even if you stop regularly adding to an investment. It’s much harder to catch up later. We can see this from the example below - Mark got off to an exemplary start in his savings life and put away $250 per month for 10 years from the age of 25 and then stopped. His total savings at 65 are worth almost $37k more than Gary who put away the same amount from the age of 35 for 30 years. Howard was well-behaved all his life and diligently put away $250 amount for all his working career from the age of 25 and his savings leave the other two for dust - he has more than $300k more than either of them.
Don’t wait until you earn more to start ‘seriously’ saving - this is just as true for 40-year-olds as it is for 22-year-olds. Put whatever you can away now.
2. It can turn you into a millionaire if you get going early enough
It's the chart you see all the time but it's worth repeating. To have a million at 65, you don't need to save as much per month when you are younger as you do when you are older. Right now, you probably wish you had started saving smaller amounts but it's not too late. Yes, you might not be able to save £1000 per month to catch up but be serious about what you can save and start putting that away. As the old saying goes, you will never be as young as you are today.
Monthly savings required to have $1m at 65
3. Small percentage changes in interest rates have enormous effect.
Let's say you come into some money at 35 - $25k to be exact. You could have been lucky enough to have got a big bonus that year or it could be an inheritance from a long-lost aunt. You sensibly decide to put this away for 30 years. Take a look at the following pie charts - they show the impact of interest rates on your original $25k windfall.
Rather than leaving it floundering in a high-street savings account earning next to nothing, instead you decided to put it into a low-cost index tracker earning you 7% interest per year. You made a wise choice - thanks to compound interest, your account balance is now $203k and the interest is responsible for 88% of that.
4. Your money starts doubling quicker and quicker over time
In this example, we look at $10,000 over a 30 year period earning 7% annual interest. By year ten, it has very nearly doubled, then it only takes another six years to be worth three times what you originally invested. You can see the numbers of years it takes for your money to multiply gets shorter and shorter as time goes on. The lesson here is just put your money away and leave it alone.
WANT TO KNOW HOW WORK IT OUT?
If you want to get technical then this if the formula for how to work out annual compound interest:
A = P (1 + r/n) (nt)
Useful, eh? No, it's not as you will never use this to work out compound interest. There are plenty of compound interest calculators online to do all the work for you.
If you like to impress people at dinner parties with your maths skills or do a lot of pub quizzes then you might be interested to know about 'The rule of 72'.
The rule of 72 calculates the approximate time over which an investment will double at a particular interest rate. You can do this by dividing 72 by the interest rate.
For example, an investment that has a 7% annual rate of return will double in 10 years (as we saw in the chart above).
3 RULES OF COMPOUND INTEREST
1. Start as early as you can: the more you can save in your 20s the better, as we have seen from the example above. Even if you are in your 30s or your 40s don't leave it any longer- save what you can as soon as you can.
2. Keep investments for a long period: resist the urge to withdraw any money if you don’t have to. Make sure you have your rainy day savings that are easily accessible for emergencies.
3. Keep adding to your original investment: the more you put in, the more interest you will earn. Whenever you have a pay-rise, a work bonus or a mini-windfall, commit to putting part of it away in your long-term saving pot.
What is Liquidity?
Are your investments liquid or illiquid? When a holding is liquid, it simply means you can sell it anytime the market in which it trades is open for business, without losing your proverbial shirt in the exchange. If it’s illiquid, you cannot sell it, at least not for anything near what it’s worth.
Degrees of Liquidity
Cash and cash equivalents (such as checking or savings accounts) are the most liquid assets of all. All day, every day, you can almost always find somebody who will gladly give you something relatively worthwhile in exchange for your cash.
At the other end of the spectrum, some investments are highly illiquid, which means your ability to trade in and out of them whenever you please is strictly limited.
For example, many hedge funds and similar closely held vehicles may routinely impose lockup periods, during which you are prohibited from selling your investment. You may be prohibited from withdrawing any of your money until you’ve owned the holding for at least a year, plus your ability to withdraw funds after that may be limited to specific windows of opportunity such as once per quarter or twice per year.
Also, normally liquid investments can become illiquid under duress. As Ben Carlson observed on his Wealth of Common Sense blog, the following adage applies so well, it’s become a bit cliché: “Liquidity is like oxygen. You don’t notice that you need it until it’s not there.”
To cite an extreme example, during the September 11th 2001 attacks, the New York Stock Exchange and NASDAQ markets did not open for business that Tuesday; they remained closed until the following Monday. During that time, investors could not trade on either exchange, effectively rendering most of their investment portfolio illiquid for those four days.
Individual securities or sectors can also shift dramatically from liquid to illiquid, especially if investor panic sets in. An example is when the bottom dropped out on the Collateralized Debt Obligation (CDO) market in 2007, contributing to the subsequent global financial crisis.
Finding Middle Ground
Between these extremes of highly liquid/illiquid holdings, you’ll find most of the investments that are most familiar to you. Mutual funds; exchange-traded funds (ETFs); stocks and bonds; and similar publicly held, exchange-traded securities are typically relatively liquid. They don’t flow in and out of your accounts as freely as cash, but even in turbulent markets you can usually sell them in a same-day transaction. (Mutual funds trade once daily at the end of the trading day. Individual securities and ETFs trade at prices that fluctuate throughout the day.)
It’s also worth noting, some investments can be more or less liquid or illiquid, depending on how you hold them. Real estate is a prime example.
· If you own a piece of property directly, it’s relatively illiquid. Even in a stable market, it can take days, weeks, or months to sell your property once you’re ready to do so.
· A non-traded Real Estate Investment Trust (REIT) may be at least as challenging to unload whenever you please. Typically, the non-traded REIT’s board – not you – will decide when and how trading is permitted.
· A publicly traded REIT mutual fund or ETF is usually as liquid as any other mutual fund or ETF. Even though the fund’s underlying holdings may be relatively illiquid, you can usually sell your shares in that fund whenever public markets are open for business.
Liquidity: A Part of the Plan
Bottom line, cash (and cash equivalents) is the closest you come to having a completely liquid asset. This means it’s important to have plenty of it on hand to cover near-term spending needs. We recommend budgeting for expected expenses as well as the inevitable surprises.
That said, cash will only take you so far. It’s highly likely to lose rather than gain worth over time, as inflation eats away its spending power.
As such, a degree of illiquidity – or the inability to convert an investment back into cash whenever you please – is essential to building wealth. It’s the stuff from which investment returns are made.
We suggest managing liquidity as one consideration among many, achieving a balance that’s right for you. Maintain enough liquidity to ensure you’re never forced to sell a less-liquid investment just to get at the cash. Accept a degree of illiquidity in your soundly structured portfolio, to judiciously seek premium market returns over the long-term. Understand when illiquidity is essential to pursuing higher returns, versus when you’re just taking on extra risk, without much else to show for it.
Could you use some assistance on making these determinations? We’re here to help!
5 Financial Best Practices To Follow Now
We are already half way through 2019 - are you ready for the rest of the year? Here are five financial best practices for the rest of the year. Pick a few of them or take on the entire list. Either way, you’ll be that much further ahead by the time 2020 rolls around.
1. Do nothing. Seriously. If you have a well-built investment portfolio in place, guided by a relevant investment plan, your best move in hyperactive markets is to let that plan be your guide. That often means doing nothing new with your holdings. We list investment inaction as a top priority, because “nothing” can be one of the hardest things to (not) do when the rest of the market is in perpetual motion!
2. Double down on your planning. That said, a “do nothing” approach to turbulent markets hinges on having that relevant plan in place, guiding your appropriately structured portfolio. A fresh new year can be a great time to tend to your investment plan – or create one, if you’ve not yet done so. Have any of your personal goals changed, or will they soon? How might this impact your investment mix? Have market conditions put your portfolio ahead of or behind schedule? Are you unsure where you stand to begin with? It’s time well-spent to periodically ensure your plan remains relevant to you and your personal circumstances.
3. Prepare for the unknown with a rainy-day fund. Time will tell whether 2019 markets are friendly, foul, or (if it’s a typical year) an unsettling mix of both. Having enough liquid, rainy-day reserves to tide you through any rough patches is a best practice no matter what lies ahead. Knowing your near-term spending needs are covered should help with both the practical and emotional challenges involved in leaving the rest of your portfolio fully invested as planned, even if the markets take a turn for the worse.
4. Redirect your energy to contributing financial factors. While you’re busy staying the course with your investments, you can redirect your attention to any number of related financial and advanced planning activities. While you don’t necessarily need to act on everything at once, it’s worth reviewing your financial landscape approximately annually, and identifying areas in need of attention. Maybe you’ve got a buy-to-let property you need to review, or an estate plan that’s no longer relevant. Perhaps it’s been too long since you’ve reviewed your insurance line-up, or you’d like to revisit your philanthropic goals. Refreshing any or all of these items is likely to contribute more to your financial success than will fussing over the stock market’s daily gyrations.
5. Have “that money talk” with your kids, your parents, or both. Speaking of your kids, when is the last time you’ve held any conversations about your family wealth? It’s never too soon to begin preparing your minor children for a financially literate adulthood. As they mature, their financial independence rarely happens by accident, with additional in-depth conversations in order. Then, as you and your parents age, you and your kids must prepare to step in and assist if dementia, disability or death take their tolls. There also can be ongoing conversations related to any legacy you’d like to leave as a family. For all these considerations and more, an annual “money talk” can be critical to successful outcomes.
So, there you have it: Five creative ways to bolster your financial well-being while the stock market does whatever it will in the year ahead. While this list is by no means exhaustive, we hope you’ll find it an approachable number to take on … with two critical caveats.
First, we’ve got a bonus “financial best practice” to add to the list:
Above all else, remember what your money is for.
Money is meant to fund your moments of meaning.
So, be it resolved for the rest of the year ahead: Next time you find your stomach tightening at the latest frightening or exciting financial news, tune it out. Walk away. Go do something you love, with those whose company you cherish. Circling back to our first call to inaction, not only will this feel better, it’s likely to be better for your financial well-being.
Second, we recognise that each of these “easy” best practices aren’t always so easy to implement. We could readily write pages and pages on how to tackle each one.
But instead of writing about them, I’d love to help you do them. Get in touch if you want to convert your dreams into plans and your plans into achievements.
Investing in your 40s
This is probably your power saving decade where you can really start to save some large sums of money.
By now, you should have developed good savings habits, you should understand how your investments work and how they are performing.
By now you should know what your retirement ‘number’ is and how you are going to get there. Make sure this documented and you check your progress on an annual basis.
You will probably have some very serious responsibilities by now - home owner, partner (or maybe an ex-partner or 2), children, pets, etc. Make sure you have a sufficient Plan B pot for emergencies.
Have you got a good savings plan for your children? It’s possible to build them a £1m legacy if you start putting away a small amount for them on an annual basis over a long period of time. Not only will it help them as they grow older but also means you won’t have to dip into your retirement pot as much when they need help from the Bank of Mom and Dad.
Think carefully before re-mortgaging your house to do extensive work to add that extension - it might mean your revised mortgage repayments now go beyond your dream retirement age.
Top tip for your 40s:
Get a will sorted out if you haven’t already.
Make sure you are strictly saving whatever is required to hit your retirement goal, as there is still time to tap into the power of compounding, and have an investment portfolio with a relatively higher risk.
Investing in your 50s
Early retirement now becomes a phrase you like the sound of - you might only have 10 years or so left in the job market so make sure you are saving everything you can.
You are now getting closer to your retirement age so it’s important that your investment portfolio is balanced appropriately for this stage in your life. You can’t tolerate as much risk as you could 15-20 years ago so make sure your asset allocation is sensible.
Resist the urge to help your children with house deposits, further education etc if you are not 100% sure you have an adequate pension. Your children can always wait a bit longer to save for a house or they could access student loans - you do not have any extra time to make up for shortfalls in your retirement fund at this stage. If you have been saving for them since they were newborns then you might not need to worry about this anyway!
Top tip for your 50s: Be certain that you are comfortable that you can live on 3-4% of your total pension pot - this might be your last chance to really accelerate your savings. And make sure you are crystal clear around your retirement numbers - what you need, what you have, what you need to put away to hit your goal.
Investing in your 60s and beyond
Your Sixties
You are probably going to retire during this decade but retirement planning doesn’t stop. You will remain an investor in the stock market throughout this decade and beyond.
You need to protect what you have in your pension pot so do not undertake any unnecessary risk. Your asset allocation might need to be adjusted towards cash and bonds at this stage.
Make sure understand what you will spending your money on in retirement so there will be no surprises. Have you got adequate health care coverage for example? Will you be downsizing your house and therefore have house purchase costs to consider?
Top tip for your 60s: Consider a part-time job or a side business if you still want to generate some additional money for yourself.
Your Seventies (and beyond)
Keep an eye on your money. You still need to be fully engaged with your finances. If your living costs start to drop and you have surplus cash that you will never need, then start considering how to pass your wealth on to the next generation.
If there anything you wish you had done at a specific time in your life that you didn't? What advice would you like to share with people just started to build long-term savings?
Do You Have An Old Money Mindset?
I recently asked a new client why she decided to work with me.
She told me that the section in my Personal Finance Bootcamp course about how retirement really works these days resonated with her.
She told me that she did have an 'old money mindset' and wanted to change before it was too late.
Maybe you are the same?
This is how most people used to retire.
You pay into a pension during your lifetime of earning a salary. The pension amount is taken straight out of your pay so you don’t notice it and your company adds a certain amount too. This could end up total being 10%-20% of your annual salary going into a pension scheme. You might even have been lucky enough to get a final salary pension scheme.
With your pension taken care of, you buy a family home when you are young, stay in that one house and pay the mortgage off over the full term – usually 25 years.
You work for 45 years and retire at 65 – by which time your pension is a generous amount which more than covers your living costs. You’ve paid your mortgage off so now your living costs are low too.
You now have more time and money on your hands than you ever did – so you start going on holiday more, booking cruises and generally enjoying your free time. Life is good.
What’s more common now?
Most people's retirement will look nothing like the 'old' way - despite many people thinking it will.
You change jobs 5 to 6 times throughout your working life - maybe even 10. In the US, it’s predicted the youngest in the workforce will switch jobs up to 15 times during their working life.
Each time you switch jobs you set-up a new pension scheme and end up with lots of small pots scattered around.
You might even take a career break or go self-employed and pay nothing into a pension.
You rarely check the performance of your pension except for a cursory glance at your annual statement before filing it away. Maybe sometimes it crosses your mind that you should review what it’s worth but there is always something else that gets in the way of you doing this.
Corporates are under pressure to ensure pension schemes can cover those in or coming up to retirement, so current company contributions are lower than previous generations too.
You like the idea of buying a house so you decide not to increase your pension or savings contribution to build up a decent deposit. Seems like a sensible thing to do as your parents did it and they seem to be having a very enjoyable retirement free from money worries!
The difference is that you keep upgrading your house as your salary increases, so you never pay the mortgage off, you just keep trading up and getting a bigger mortgage.
Throughout your career, you spend almost everything you earn, but you have some amazing experiences along the way. You believe you have your pension already covered with your work scheme so there is no need to worry about it.
You get to 65 and it’s time to access your pensions. You need to find those all those account details from 5-10 (or more!) company pension schemes. You find that some schemes were put into maintenance mode when you left the employer, which by now could be a mix of 10-35 years ago. You have lots of gaps whilst you waited to become eligible for a company scheme. This means the investment returns have not kept up with inflation and not performed as well as they could have.
The result – your retirement income is much less than you are used to living on.
You have the current house that you purchased but, since you weren’t able to get on the property ladder until your mid-30s, it’s possible that you are still paying your mortgage of until your early 60s. Your parents had paid theirs of by aged 51 so were able to increase their savings as they were no longer paying a monthly mortgage. You are not able to do this.
The state pension has either been discontinued or is much lower than it is at this current time. You had an amazing career, earned a good salary but now you are having to lower your living standards.
Where did it all go wrong? You had a company pension, saved a bit extra each month and invested in a house. You followed your parents model of retirement but the outcome is quite different.
What can you do?
It all sounds like doom and gloom - but it’s not IF YOU TAKE ACTION.
You just need to wake up and realise that what worked one or two generations ago, won’t work for you. It’s just a case of being more pro-active with your money and not burying your head in the sand.
Some simple steps you can take now - work out roughly what kind of pot you need for retirement, then deduct all of your assets – pensions, cash, investments, property, and see if you have a gap.
If you do have a gap, then you start working out how much you should be saving on a monthly basis to reach your savings goal.
Why I (And Warren) Think You Should Use Tracker Funds
In a recent webinar, I covered the merits of using Tracker Funds in your portfolio. They are gaining massive momentum and anyone looking for long-term returns MUST understand them. In the webinar I mentioned Warren Buffett’s views on traders.
Buffett – regarded by many as the world’s top investor – famously made a $1m bet in 2008 that a simple index fund would outperform five actively-managed funds over a period of time. Funnily enough, only one Fund Manager stepped up to the challenge.
The result? Over the course of the bet the S&P 500 index fund returned 7.1% compounded annually, significantly more than the basket of funds selected by the fund manager. That basket only returned an average of 2.2%.
Buffet’s biggest problem with actively-managed funds is that their performance doesn’t justify the high fees. But more on that later.
What is an Index Tracker?
Let’s first look at what an index is and how an index fund replicates the performance of a particular index.
An index here refers to a list of publicly traded companies within a specific market. For example, the FTSE 100 is an index composed of the 100 largest companies (by market capitalisation) listed on the London Stock Exchange.
The aim of an index fund is to track and replicate the performance of the specific index, by investing in the companies quoted on it.
Say you invested in an index fund tracking the FTSE100, if the FTSE goes up by 3% as a whole, your investment will go up accordingly. It’s a very straightforward investment option - your only decision is which indexes to track.
I keep hearing about ETFs - are they they same thing?
Index funds should not be confused with ETFs – Exchange Traded Funds. Although both aim to replicate the performance of an underlying index, there are two key differences: flexibility and pricing.
Index funds are priced once a day, after the markets close. ETFs, on the other hand, can be traded throughout the day like stocks and the pricing is determined by supply and demand for the securities.
FYI - most of my personal portfolio uses ETF trackers.
So why should I use Index Trackers and/or ETFs?
As touched upon before, the biggest benefit of investing in an index fund or an ETF, as supposed to individual stock picking and actively managed funds, is cost-savings.
Index funds are passively managed so there’s no fund manager’s fee to pay. As a result, they are much cheaper to invest in, with some funds in the UK starting as low as 0.06% p.a. In comparison, actively-managed funds start at 1% and above, often coming with hidden charges to boot.
In most instances, these high fees are not justified. It is estimated that more than 80% of managed funds failed in beating the market over the past 20 years. Your chances are therefore very low at choosing an actively-managed fund that will do better than a market-related index fund.
The diverse investment nature of tracker funds also means that the assumed risk is reduced and it’s less susceptible to political movements like Brexit. For example, on the day of the Brexit results, UK index funds fell by 6%, while actively managed funds dropped by 8%.
Another benefit is that they can be easily managed and therefore you don’t need to become an investment geek to use them. For this reason, I think they are well worth considering for most people looking to supplement their pensions and get decent returns over a long period. This is especially true if you don't want to put time and effort into other investment options such as property, individual stock picking or starting a business.
Whatever your reason for choosing to invest in an index tracker, you’re in good company, from Warren Buffet to Richard Branson, all acknowledging the benefits of adding this investment option to their portfolio.
Even Superstar Fund Managers Struggle with Personal Investing
I recently came across an article in the FT which told the story of Victor Haghani, who was a very successful fund manager in the 1990s. He managed billions of dollars for huge hedge funds, worked with Nobel-prize winning economists, and legendary Wall Street names at Salomon Brothers and then Long Term Capital Management (which famously went bump in 1998).
But when it came to investing his own money, he didn't know where to start.
This really resonated with me as on my most recent trip to Singapore, I spoke with a few front-office ex-colleagues who all said similar things to me. They may well manage millions of dollars on a daily basis but due to mix of restrictions on trading, lack of awareness and a small dollop of apathy, they have the vast majority of their wealth simply sitting in cash accounts.
Haghani was in a very similar situation. He hadn't a clue how to invest his own personal wealth and a journey of discovery led him straight towards low-cost trackers funds.
“I don’t know if it is embarrassing or amazing, but I knew nothing about how to invest for my family. As I started... discussing it with friends and former colleagues, I realised a lot of people were in a similar position. People say investing is simple, and it is, but if you have been really close to the markets for a long time you have to unclutter your mind.”
He now uses index-tracking funds to invest across the largest asset classes and get broad exposure to global economic growth at the lowest possible cost. ETFs are perfect for this and very simple and cheap to buy.
Mr Haghani now passionately espouses the value of long-term, low-turnover investment at the lowest possible cost. “I don’t know what is going to happen next year or the year after,” he says. “But now, knowing how I want to invest over a very long horizon is actually the easier part.”
“The desire to be active manifests itself in a number of big problems. Repeated studies show that investor returns are worse than fund returns, because people chase returns and try and time the market. This means they end up doing worse than they would have with a simple static allocation to the market,” he says.
Passive is preferably to active as it also keeps costs exceptionally low. “Active management means you have to pay higher fees, which is a drag on performance. Another drag is tax inefficiency. Very active strategies don’t realise that we tend to pay taxes when we realise gains. That means deferring gains is a good thing.”
Since leaving his Wall Street days behind him, Haghani has since set up a new company to manage his family and friends wealth and the aim is "to stop investors hurting themselves by following their irresistible urge to be active with their investing.”
If such a high-powered trader surrounded by experienced colleagues and clever bits of kit didn't know where start then why should you? There's no shame in getting help.
Can you live off £1m in retirement?
It’s a key question when it comes to planning your retirement or setting a financial goal, and you will find it hard to get a straight answer.
You need to take into account your current and desired lifestyle, current age, risk tolerance, investment options, life expectancy and post-retirement bucket list. Working through these element is a cornerstone of my approach with planning clients.
Many people still think of £1m (or your local currency equivalent) as a big pot of money or a benchmark number to hit, perhaps thinking this would be more than enough to last them throughout their golden years. But can you really live off £1m in retirement?
How much would you get in interest?
Your first thought might be that you could live off the interest by putting your £1m into a straightforward savings account at a a bank or building society. The best rates available for this size of cash are currently around 2%, which will generate £20,000 before tax. Many rates are 1% so you'll get an even more depressing £10k interest per year.
Given interest rates have started to move up in the UK you might be hoping that it won't be long before bank rates are more attractive - think again. The latest forecasts predict only another 0.5% increase between now and 2020. So basing your retirement on living off the interest is a very risky option without any guarantees of what your pension income will be each year.
Additionally, if you take out the interest every year you can’t take advantage of compound interest and your £1m will never grow. Inflation (currently at c.3% in the UK) will eat away at your measly fixed interest of £10k-20k, reducing your spending power every year which eventually might not even cover your living costs.
Time to get stuck into the capital
So if living off the interest isn't going to work, it's time to start spending the capital. But how much can you safely spend and not run out of money?
Many financial industry experts recommend the 4% rule. That means, in order for your £1m pension fund to stand a chance of carrying you through your retirement, you should not withdraw more than 4% per annum. Ideally you would also invest the pot of money to try and grow at least at the rate of inflation, giving you a chance of maintaining your living standard going forward.
So the 4% rule would give you £40,000 to start with, and depending on how you invested the pot you would get a diminishing amount per year (it's 4% of the annual pot, not 4% of the initial pot).
Some finance gurus are now advocating reducing the 4% to 3% to reflect expected lower stock market investment returns going forward. So your £40k just reduced to £30k.
Although £30-40k is now beginning to resemble more of a decent sized retirement income, you still have to consider how it compares to your current lifestyle and whether its enough to realistically live your retirement free from financial worries.
This is a hot topic at the moment as individuals with a defined contribution plan no longer have to buy an annuity following the pension reforms. Many people are opting to take the whole amount as a lump sum and have the flexibility of taking as much money as needed. But this could be a risky game without professional advice, as ideally you should keep as much invested as possible, and you need to monitor the 'drawdown' amount very careful.
Normally I'm a big advocate of 'Do-It-Yourself' investing. But when it comes to quitting work (at any age) and living off your financial assets I think it's wise to get some expert advice.
Will an annuity get me more?
The traditional pension route was to save up as big a pot of money during your working life and then buy an annuity with it once you retire. The benefit is a guaranteed regular income for the rest of your life, sometimes also linked to inflation, however rate's vary significantly from provider to provider.
So how much can you expect from £1m?
If you buy an annuity offering an inflation-linked, lifetime guaranteed income that will provide around two-thirds of the value to your spouse or partner after your death, you can expect an annual income of around £21k.
If you are used to earning £75k plus per annum, this will be a significant cut to your earnings upon retirement.
Is it enough?
So pure bank interest will possibly give c£10-20k, sensible spending of the capital gives you c£30-40k, and an annuity gives c£21k.
If you are a higher income earner and used to a certain standard of living, and want to maintain that lifestyle in retirement, a £1m retirement fund isn't going to get you there.
What are your options for a better retirement?
The best thing you can do right now is follow the process I take my clients through:
1. Start working out what kind of lifestyle you want in retirement: if this is 25 years away if can be quite vague, if it's 5 years away it needs to be very detailed
2. Do an inventory of what you have now: cash and savings, pension pots, equity in property, investment accounts
3. Forecast the future: estimate the future value of assets in step 2 based on your savings rate, and estimated investment returns.
4. Assess your retirement gap and work out how much you need to put away per month to close it.
Of course there are lots of strategies and tactics you can use in step 4, but I think most people overthink this element, get bogged down in the detail, and forget to do steps 1-3.
Start working on your lifestyle finance plan as early as possible (HINT: if you don't have one then start TODAY) to give yourself the best chance of achieving the kind of financial independence you crave during your working life.
How to Make Your Child A Millionaire on $1 Per Day?
Paul Merriman, the financial educator and advisor, believes that you can invest just $3,000 on behalf of your child, and turn it into $50m. If he’s right, this could be the most important article you ever read. If you have children – implement these steps. If you don’t have children, you might want to implement these steps on behalf of your nieces, nephews and god-children.
So, let’s see how you turn $3k into $50m! For ease, let's assume your bundle of joy is called Jimmy.
Option 1: $3k lump sum
First, you invest $3k at the birth of the child. You will put this in a tax efficient wrapper in your country. For the UK, you could put it into a Junior stocks and shares ISA (2016/2017 limit is £4,080).
Next you invest it in something that will return 12% - I’ll discuss if this is possible.
By the time Jimmy is 65, your $3k investment has grown to $4.7m!
It gets better. Your child now withdraws 5% of the pot each year for the next 30 years - which is an average of $671k a year! Sadly Jimmy dies at 95, but he had an amazing retirement. Your little Jimmy spent $20m in retirement, and still leaves a pot of $30m for the next generation (hence the $50m).
Option 2: $1 per day for 18 years
An alternative is to put $1 aside everyday for your child's first 18 years. So the same process applies – put $365 a year in a tax efficient wrapper, invest at 12%, and leave until 65.
Jimmy would have $5.3m at 65, can withdraw an average of $745k per year, and still leave $34m behind at 95!
Option 3: $1 per day for 65 years
An even better option is that you pay $365 per year for the first 18 years, and then you somehow convince your child to continue putting in $365 every year until they are 65. It's a financial education lesson they will be forever grateful for.
Jimmy would have $6m at 65, can withdraw an average of $843k per year during his retirement years, and still leave $38m behind at 95!
Is 12% annual return possible?
The first hurdle is to find a long-term 12% return. Paul’s advice is to invest in small companies, and find ones that are value orientated – often referred to as ‘small-cap value’. In the US, this class of companies have returned 12% over a very long period, so it is not too much of a leap to assume the same for the future (listen to Paul's podcast).
One stumbling block is that the US is more advanced than the rest of the world in terms of creating low-cost tracker funds that segregates the market to identify ‘small-cap value’. Therefore, those in the UK need to turn to actively managed funds. Normally, I prefer passive investments, but I’ve found one that is low-cost and fits Paul’s mandate.
Its called Aberforth Smaller Companies Trust Plc (ASL) and its annual return over 26 years has been 13%, (annual fee is 0.79%).
What if I get a lower return? Is it still worth doing?
A more conservative route would be to buy a straight forward low-cost tracker fund.
The 2016 Equity Gilt study from Barclays indicates that the long term average stock market return (since 1961) has been 7.7%, and the real return after taking account of inflation of 2.5% is 5.2%.
You could buy the Vanguard FTSE UK All Share Index Trust to capture this return.
Here’s how the numbers change:
· Option 1: $3k lump sum: has turned into $1.5m at 7.7%
· Option 2: $1 per day for 18 years ($6,570): has turned into $2.1m at 7.7%
· Option 3: $1 per day for 65 years ($23,725): turns into $2.8m
If you take inflation into account, the equivalent amounts todays would be $200k, $319k and $497 respectively.
Summary
So can you turn $3k into $50m? It is possible, and even with a more conservative approach of 7.7% return, you could still end up providing your child $1.5m-$2.8m. Even after inflation, that’s still $200k-$497k which is pretty amazing!
And the reason it works is through the power of compounding – investing small amounts over a long period of time.
Will your child live to 95? Will the stock market return 8% or 12%? No-one can tell you that, but you can focus on what you can control. The message here is clear - the earlier you start saving for your children, the more your money will earn.
Work through your budget and see how much you can spare to put away monthly or annually and start doing it today!
Why is Planning for the Future So Hard?
I was chatting with a new client this week and they mentioned that they just weren’t bothered about saving for the future. They said that they wanted to live in the here and now and that they would worry about the future when it actually happened. It's an interesting perspective and it got me thinking about WHY it is so difficult to concern ourselves about the future.
We all know if we started saving at 25 that we’d have a lot more money when we retire, than if we start saving at 35. If you are not sure why, then read my recent blog about it here. However, I know that this motivates very few of us to start saving at a young age, including myself. I didn’t get really serious about my savings and investments until I was almost 30.
Things are stacked against us
We all want immediate gratification. We want things now. There is no instant reward in putting aside £200 a month for 60-year old you, especially if you have just got going in your career and really want to upgrade your car. Keeping up with the Jones is alive and well - more so than ever in our social media age. And don’t think it’s just the young millennials that are over-sharing new purchases and flash holidays on Instagram and Facebook - 61% of Facebook users in the UK are over 30.
Plus YOLO - you only live once. Surely it’s better to make the most of what you have now as you can’t be sure you will be around in future. What’s the point in saving for a future that you cannot guarantee will happen? All of these are valid and understandable points but we should plan optimisically for living a long and healthy life!
Making friends with Future You
It’s hard to identify with our future selves if we haven’t really thought about the kind of person we will be and the lifestyle we will have in 10, 20, 30+ years time. It’s very hard to imagine yourself as an older person after all. In his eye-opening TEDTalk about the battle between our current and future selves, psychologist Dan Gilbert describes this as “the ease of remembering vs the difficulty of imagining”. The talk is definitely worth watching to understand how much can change in decade of your life and how little you think you are going to change.
Your present and future selves are strangers to each other unless you can construct a very vivid vision of your future. If you feel disconnected to your future self then saving for your retirement might make you feel like you are simply handing out £100 a month to a random stranger in the street.
In 2009 psychologist Hal Ersner-Hershfield conducted a study which looked at how connected people felt to their future. American Scientific summarised the results as:
Among the people in the study those who most identified with their future selves planned their life with longer-term payoffs in mind: they saved more money and as a consequence had amassed more wealth than others.
So it’s worth putting the time in now to build a vivid vision of your future - one that motivates and inspires you to work hard and put money away now - even though the payoff is not immediate. Once you feel more connected with Future You, only then you will want to work hard to support your new best friend. After all, if you want Future You to be able to quit the rat race at 45 and buy a vineyard in the South of France, then Current You needs to lay the groundwork now.
So how do you go about getting to know Future You?
As we have seen, it’s easier to make good financial decisions when you feel connected to your future self and a good way to do this is to vividly visualise the future. Here are some ideas to get you going:
1. Use a photo app to ‘age’ a current photo for you and your family. What do you all look like at 50 and 60 and 70? This can help you imagine what you all might be doing in the future.
2. Build a mood-board of whatever you are saving for - a sabbatical, retirement, finishing work 5 years earlier. Find images of the exact dream house you would like to live in, the kind of holidays you would take, the car you would drive. Even if you just want to maintain what you have then you will need to update your car from time to time and repair and refresh your home. Pinterest can help you do this.
3. Get Future You to email you to check on your progress and remind you of your goals. Futureme.org allows you to send yourself emails from the future.
The power of visualisation
We now know your future vision has to be in 3D 4K quality to trick your brain into caring. One of the most important steps I take my clients through is ‘Vision Building’ - this is usually the point where my clients start to get excited about finances. A rarity, I know! I get my clients to ask themselves some pretty big questions about:
· Where you want to live
· What kind of lifestyle you want
· What standard of travel you want to enjoy
· What holidays you will take
· What kind of home you want to live in
Why don't you document your dream future today based on the question above today? Send it to me - I'm always interested to see what people dream of doing in the future!
Your Home is Not an Asset
An Australian friend visited me over the weekend and he mentioned he was planning on buying a property in Melbourne to live in. He thought it was a smart investment for his cash and he was surprised to learn I thought otherwise. I also have been asked about homes as investments on recent webinars that I have done too so I thought I would address it more fully here.
Why Your House Is Not An Asset
“Your house is not an asset.” When Robert Kiyosaki said this in his book, ‘Rich Dad Poor Dad’ (1997), he caused quite a stir amongst financial experts.
Two decades later, some parts of the world are still recovering from the global recession caused by a crash in the housing market, and people are beginning to realise that there might be some merit to this statement.
“House” here refers to your primary residence, not an investment property that is being rented out.
However, many people still believe that their house is an investment. Your home is many things, a shelter for your family, place of security, but it’s not an asset.
So why is your house not an asset?
It doesn’t generate cash flows
If we look at an asset as a resource that generates cash flow and a liability as something that is a drain on cash flows, then it becomes clear why your house should not be thought of as an asset.
Even if you are mortgage-free and own your home, you still have to pay for upkeep, taxes and utility bills. This means your house is not making money but taking money out of your pocket. It’s a drain on your funds and, in actual fact, a liability.
If you do have a mortgage, then your house is the bank’s asset. In this circumstance, your house is working for the mortgage provider and is not earning you a single penny.
You might think that you can get cash out by borrowing against your home, i.e. re-mortgaging to release some equity. However, this is a false perception of security as all you are doing is creating more debt. At some point, this borrowed money will have to be paid back.
Value appreciation doesn’t make it an investment either
Many people believe that because they sold their house for more than the initial purchase price, they automatically made a good investment. Let’s look at a simple example.
Say you bought your house 10 years ago for £180,000 and you decide to sell it now for £210,000. You might think, great, I made £30,000 on my 'investment' - £3,000 p/a return, not bad, right?
But if it costs you £1,000 per month for your mortgage, home insurance and life insurance plus another £200 per month for services and utilities, that’s £144,000 over the course of 10 years to walk away with £30,000.
This is assuming house prices have increased steadily over the period and not taking into account any routine or major repairs. That’s not a good investment.
Is your intention to sell?
Very few people buy their primary residence with the intention to sell it again in the near future. And even if you do sell it at a reasonable profit, that money will most likely go towards buying a new home. Not necessarily to fund your lifestyle, pay for your children’s education or to go on a luxury holiday. It is trapped equity and therefore can’t be considered as an investment.
There are many good reasons to buy a home - I love my home and the sense of security it gives me and my wife - but I do not consider it to be a reliable asset and I don't think of it as a savvy investment. For that, I look to other investment options such as low-cost tracker funds.
The moral of the story is, as Robert Kiyosaki would say, “Invest for cash flow, not appreciation.”
I RECOMMEND READING...
I think 'Rich Dad, Poor Dad' by Robert Kiyosaki will change your perspective on your personal finances. It certainly had a big impact on me and I regularly go back to it.
You can buy the book by clicking on the link below:
Rich Dad Poor Dad: What the Rich Teach Their Kids about Money That the Poor and Middle Class Do Not!
8 Ways To Cope During a Financial Crisis
”Surely we are due a crash soon?” asks just about everyone I meet with.
That's a question that is impossible for me – or anyone - to answer.
After all, it’s the 10 year anniversary of the Global Financial Crisis but since then, apart from some minor corrections, the market has continued to recover and is now at its highest peak ever.
The markets have been so stable for so long now, that anyone who started investing in the last 10 years has yet to weather a perfect market storm.
Even if you have, you may have forgotten how panic-inducing those times can be.
This worries me.
Experience and evidence alike show us how severely bear markets test investor resolve, sabotage otherwise solid plans, and just plain hurt.
We’ve also seen how damaging it can be to act on rash fear rather than rational resolve during market downturns.
The market is going to tank again at some stage. We just don't know when.
All we do know that when it does happen - and it will - the only thing we can control is our response.
So let’s pretend, shall we?
Just as we prepare for other emergencies, here are 8 practical steps you can take when financial markets are tanking … and, to be honest, even when they’re not.
1. Don’t panic (or pretend not to)
It’s easy to believe you’re immune from panic when the financial sun is shining, but it’s hard to avoid indulging in it during a crisis. If you’re entertaining seemingly logical excuses to bail out during a steep or sustained market downturn, remember: It’s highly likely your behavioural biases are doing the talking. Even if you only pretend to be calm, that’s fine, as long as it prevents you from acting on your fears.
2. Remember the evidence.
One way to ignore your self-doubts during market crises is to heed what decades of practical and academic evidence have taught us about investing: Capital markets’ long-term trajectories have been upward. Thus, if you sell when markets are down, you’re far more likely to lock in permanent losses than come out ahead.
3. Manage your exposure to breaking news.
There’s a difference between following current events versus fixating on them. In today’s non-stop media world, it’s easier than ever to be inundated by news. When you become mired in the minutiae, it’s hard to retain your long-term perspective. Step away from the screens.
4. Revisit your carefully crafted investment plans (or make some).
Even if you yearn to go by gut feel during a financial crisis, remember: You promised yourself you wouldn’t do that. When did you promise? When you planned your personalised investment portfolio, carefully allocated to various sources of expected returns, globally diversified to dampen the risks involved, and sensibly executed with low-cost funds managed in an evidence-based manner. What if you’ve not yet made these sorts of plans or established this kind of portfolio? Then these are actions we encourage you to take now if you haven’t already done so.
“The key to successful investing is to get the plan right and then stick to it. This means acting just like the lowly postage stamp that does one thing but does it well. It sticks to its letter until it reaches its destination. The investors’ job is to stick to their well thought out plan (if they have one) until they reach their destination. And if they don’t have a plan, write one immediately." Larry Swedroe, financial author
5. Reconsider your risk tolerance (but don’t act on it just yet).
When you craft a personalised investment portfolio, you also commit to accepting a measure of market risk in exchange for those expected market returns and your advisor should have talked you through this. Unfortunately, during quiet times, it’s easy to overestimate how much risk you can stomach.
If you discover you’re miserable to the point of breaking during even modest market declines, you may need to re-think your investment plans. Start planning for prudent portfolio adjustments, preferably working with an objective advisor to help you implement them judiciously over time.
Re-read my article on how we process risk.
6. Double down on your risk exposure – if you’re able.
Warning: This is not for the timid!
If you have nerves of steel, market downturns can be opportunities to buy more of the depressed (low-price) funds that fit into your long-range investment plan. You can do this with new money, or by rebalancing what you’ve got. But if you’re able to do this and hold tight, you’re especially well-positioned to make the most of the expected recovery.
7. Revisit this article.
There is no better time to re-read this article than when today’s “safety drill” is no longer an exercise but a real event. Maybe it will take your mind off the barrage of breaking news!
8. Talk to me
We don’t know when. We don’t know how severe it will be, or how long it will last. But sooner or later, we expect the markets will tank again for a while, just as we also expect they’ll eventually recover and continue upward. The mantra is: We believe in the markets.
Rather than working through this financial crisis alone, you might benefit from working with a financial advisor to help you through these dark days and stop you from making any emotionally charged decisions. They can help protect you from your worst enemy during this time - yourself!
Active vs Passive vs Evidence-Based Investing
In Investing, You Get What You Don’t Pay For
— John C. Bogle Founder and Former Chairman, The Vanguard Group
Even if you have only just started on your investing journey, you will probably have come across the terms active and passive investing. But do you know what they mean?
Maybe you already have some investments - do you know if they are actively or passively managed?
There's also another investing strategy that you might not have heard so much about - evidence-based investing.
Here's a brief outline of each type of investment.
ACTIVE INVESTING
Active investing means that a fund manager will create a portfolio of funds for you with the objective of BEATING the market.
They will strategically build this portfolio based on research and will make case by case decisions on whether to buy, sell or hold in the belief that these companies or sectors are going to grow at a faster rate than the rest of the market.
Active fund managers will frequently buy and sell stocks and every time they make a trade, this incurs fees and charges which is taken out of your investment.
In addition to the frequent trading, your fees will also need to cover a team of people who are inputting into the portfolio selection which could include any combination of company analysts, industry analysts, market analysts, financial analysts, data scientists, commodities and foreign exchange experts and economists.
The overall aim is that the above benchmark returns will justify the higher fees.
But paying higher fees do not guarantee good returns.
Actively managed fund performance has struggled over the last 10 year period.
For the last 5 years ending December 2017, almost 85% of U.S. large-cap funds helmed by managers did worse than the S&P 500, according to S&P Dow Indices data.
If only 15% of fund managers are able to create portfolios that outperform the benchmark index, then it is very difficult for investors to find a good active fund manager in the first place.
Jeffrey Ptak, from Morningstar gives this advice when people ask him what's the one thing someone should look for to identify an active fund that will succeed in the future:
"The short answer is that there isn't any one thing, and that's why, to be blunt, most investors should probably index, not hunt for active funds."
Effectively investors are paying more for worse results than if they had invested their money in index funds.
So what is a simple way to keep your costs low and statistically, beat the returns that a fund manager could get you?
PASSIVE INVESTING
Passive investments are trying to MATCH the market by tracking market indexes such as the UK FTSE or the S&P 500 in the US. Rather than buying individual stocks you are buying all the stocks in that index.
Your fund will mirror the performance of that specific index so when the market goes up so does your investments but when it goes down, your investments will go down too.
As no-one is actively managing the portfolio - there's no need to select individual stocks so you don't pay large management fees, and there is no frequent trading therefore fees can be kept low.
Lower fees means you keep more of the returns.
The increase in index funds has been dominated by Vanguard and iShares and shows little signs of slowing down.
The over-arching philosophy behind passive investing and index funds is that capitalism works, the markets are efficient and therefore buying the whole market will perform better than trying to pick individual shares over a long period of time.
The ease of buying trackers also makes this appealing to every day investors – there are lots of online brokerage services that mean the process is relatively easy and low-cost.
Even Warren Buffett is a fan of passive investing: "Consistently buy an S&P 500 low-cost index fund. I think it's the thing that makes the most sense practically all of the time."
The downside to index funds is that you will NEVER do better than the market.
EVIDENCE-BASED INVESTING
So we have seen that fund managers do one of 2 things: They focus on picking individual securities, or they attempt to mimic the performance of index benchmarks.
Evidence-based investors share some similarities of passive investing - the believe in staying in the market for the long-term and keep costs low but they are fundamentally different in how the portfolios are constructed.
The funds are managed in a rules-based manner and are not reliant on an individual person or management team’s beliefs about the overall market or individual stocks.
They design strategies based on academic research rather than speculation or the need to track commercial indices and build portfolios along the dimensions that drive expected returns.
The building of a portfolio of evidence-based funds expands upon the benefits of index investing while minimising some of its potential negatives.
If you want to know more about evidence-based investing, then schedule a call with me.