During a gold rush, sell shovels
People like to talk about cryptocurrencies, particularly Bitcoin, as an investment. I don't think it is one - to me it's pure speculation. If you want more details about why this is the case check out Nassim Nicholas Taleb's white paper on it.
But if your friend/colleague starts talking about it and they are not particularly statistically savvy, and you can't sneak off before being involved in the conversation, there's a stock standard response I have when they ask why I'm not into it.
"Can you pull out your Blackberry to show me the price of it?"
They will typically laugh and say who has a Blackberry, or just look at you funny as they have never heard of it. You then say that Blackberry's were the first "smartphone" and all the rage but where are they now? They got annihilated by better technology and no longer exist. There's a good chance the same thing will happen to Bitcoin and all the other coins available now.
But what if crypto does take off? Won't I miss out on the boom and be poor?
Because I own the shovels (graphics card manufacturers) that the (crypto) miners are using to search for their gold. NVIDIA is the leading manufacturer of the graphics cards which are essential for the mining, creation and utility of cryptocurrency. Long story short - without these graphics cards crypto does not exist. NVIDIA is one of the largest companies in the USA, and hence is in VGAD/VGS which I own.
In addition to that I own the warehouses where some of these mining centres are run (via DJRE), the electricity providers that generate and sell the huge amounts of energy currently use (via IJH), the semiconductor companies that provide chips for the hardware being used and on and on and on......
So if Bitcoin goes to $0 in value these companies will take a hit, but they will just switch production to something else or be replaced in my indexes by something new. Either way I will barely notice as they are but a few of the thousands of companies and properties I own. The people who are in the Bitcoin musical chairs game when the music stops are the ones who will pay the price for it.
Don't be the 3 billionth person jumping on the get rich quick bandwagon when these speculative booms happen. Own the companies that sell the shovels to them, along with everything else.
Personally I think a good financial planner is worth their weight in gold, which don't kid yourself, you'll be paying them in fees. The tricky part though is finding one. Australia has had a massive upheaval in our financial planning industry over the past few years specifically because of this, with sharks and charlatans all over the place in the industry. Here's two examples that I've seen first hand:
1. I was out on the waves with my mate when somehow it came up that he had a self managed super fund. Not to be a douchebag (don't google that Claudia) but I knew enough about his situation to know that he shouldn't have one. So I asked him some questions about it and got very concerned. He'd had a doorknocker at his house asking if he wanted to invest and make lots of money, so of course he said yes. The company then paid for him to come down to Brisbane, showed him their fancy offices, fake teeth, surgically enhanced receptionist and expensive suits and conned him into signing his superannuation over to them. They then proceeded to gouge the hell out of him with fees, and invest his small super amount into unfinished, crappy apartments in Brisbane that they could gouge further fees from. Instead of benefitting from a great bull market in shares like he should have they bled him dry. He told me he was able to get out of it, but got slugged with massive fees to do that, but I'm still not sure just how badly he was impacted or whether he managed to get any money back at all. This is not a high income earner nor a young man, and there's a good chance those scumbags have ruined his retirement years. To cap it all off when I was googling the owners of the company they are a family of shi+heads who are in the news for fighting with their neighbours because of their partying and breaching building rules. Great people....
2. My neighbour went to a "financial information session" for older women at a local pub - if the alarm bells are not going off in your head now than you need to be very careful as you are going to be easy pickings - and met a "lovely, well-spoken single mum of young kids" who was just trying to help people as a financial planner. Again - this doesn't take a rocket scientist to figure out that this could be dangerous for her. So I asked if I could see what the planner had done, and my neighbour showed me. It was ridiculous and a direct breach of fiduciary duty (i.e. putting the clients interest first). There were small things which made no sense, and then a lot of garbage which were blatant lies and misinformation. I then met the financial planner with my neighbour and told her as such. The thing that really made me shake my head was that my neighbour ran into the women at a fancy and very expensive restaurant in a different state to where they both live - how random was that! - where the financial planner was holidaying with her friends. No kids though and the planner acted weird when my neighbour asked about them. I'd love to know if they actually exist.....I thought about reporting her to the regulatory body but my neighbour didn't want the commotion. To me preying on the elderly like that is true scumminess.
The other issue is that a good financial planner can turn bad without you knowing. As a current example there is Dixon Advisory in Australia, which for years was one of our most trusted financial planning companies for retirees. Daryl Dixon was considered one of the most knowledgeable superannuation experts in Australia and a regular financial columnist in our major newspapers. People trusted him. In 2022 they have gone bankrupt due to the looming class actions for fee gouging, breach of care and providing conflicted advice. This means that the retirees who have invested their money with them may lose everything.....
This is not to say that you shouldn't get a financial planner, but you need to educate yourself regardless of whether you get one or not. This is not the sort of thing you can be hands off with as you need to know what's happening. Never sign your money or investments over to anyone else. Anyone that tells you they can pick individual shares that will do better than the average of the market (i.e. index funds) are full of shi+. Be wary of anyone who wants you to setup difficult to understand structures for your money or investments, they'll likely be taking an upfront fee to set it up and then ongoing fees each year to run it for you. That's quite the incentive for them to talk you into it!
A good financial planner will make sure that you are doing things tax efficiently, simply and most important of all will make sure you don't f$%^ it all up buy doing stupid things like selling because you're scared the market is going to fall further or "investing" in speculative garbage. They will have a boring plan that gets results which match the boring old market average. Your investments will go down very quickly and very far some times and it will hurt. The hard part is that someone like this won't seem exciting to you because you'll be comparing them to the one who is full of shi+ and telling you that they can do much better than the average and that they will protect you during downturns. You're smarter than average aren't you so why should you accept the average? This person is a charlatan to be avoided at all costs.
In an earlier post I mentioned that I split my money evenly between 4 different ETFs: IJH, VGAD, DJRE and VAS. Whenever there is a reason for me to worry about them all I need to do is have a look at what they (and therefore I) own. These examples are just a few of the TENS OF THOUSANDS of businesses and properties that I own through just these investments. Pretty cool stuff I think!
IJH: 400 of the most promising up-and-coming companies in the capitalist mecca of the USA!
IJH contains 400 of what we call "mid-caps". This consists of companies that are valued between 1.6 and 18.6 BILLION dollars as of 2022. This puts them between the massive companies that are in the "large-cap" space like Amazon, and the smaller companies that make up the "small-cap" space. I know this sound ridiculous, but I love IJH as much as a person can possibly love an exchange traded fund. It's just so damn cool to own some of the companies in it. For me its a sweet spot of some very cool businesses that are doing very interesting things. We are talking about 400 of the best companies in America that you've probably never heard of - check these random ones out:
Cognex - A company that specialises in machine vision technology and hardware to overcome assembly line errors and optimise efficiency. Their stuff looks awesome.
Builders FirstSource - A company that specialises in house framing wood, with the cool thing being that they cut to order and package before sending out. This means that there is much less wood waste on the building site as they can optimise the cuts to get the most planks of wood out of a single tree. It is estimated that this has saved nearly 500,000 trees from being cut down in just the last 3 years.
Graco - They say it best: "We pump peanut butter into your jar and the oil in your car. We glue the soles of your shoes, the glass in your windows and pump the ink onto your bills." I love owning companies like this, you don't know much about them but you can't live without them.
Wolfspeed - The world leader in Silicon Carbide technology for things like electronic vehicles and radar, I have no idea how it works but who wouldn't think that's awesome?
Are these INDIVIDUAL companies great investments? I have no idea, nor do I care, nor do I believe that anyone else knows any better given the efficiency in markets. That's why I own 400 of them. Some will do really well and leave the mid-caps to become large-caps, whereas others will perform poorly and drop down into the small-caps space. When this happens new ones will enter, as there are always 400 companies in IJH.
For us Aussies: IJH invests in USA companies, but is "wrapped" as a what we call an Australian domiciled exchange traded fund (ETF). Importantly this is not hedged to Australian currency. This means that it will go up or down in price based on both the change in value of the underlying companies on the USA stock exchange AND changes in the Australian dollar. This latter point is important to consider in your overall planning, as this can have a big impact on your outcomes. Over a long period of time (20+years) this is likely negligible, as currency changes tend to "washout" and stay within boundaries. For example, the Aussie dollar versus the USA dollar has rarely gone outside of a range between 50c and $1. However, over short timeframes this can have a large impact - which I'll explain in the VGAD section below.
VGAD or VGS: Fancy owning a slice of the biggest companies in the world? You can brag to your friends about owning Louis Vuitton!
VGAD and it's sibling VGS consist of around 1500 of the largest companies from around the world, excluding Australian ones. This makes them one of the most well diversified ETF's you can own, with a huge number of household names. This includes all the ones that come to mind when you think of big companies, such as Amazon, Alphabet (owner of Google and Youtube), Facebook, McDonalds and Tesla. Yep - it's very USA biased with around 2/3rds of the portfolio being USA companies and the remaining 1/3rd being companies like Toyota and Sony (Japan) from other countries. Some of these companies you may not have heard of, but are still huge and cool. Check these ones out:
ASML - a mammoth company (>30,000 employees) that specialises in photolithography, which is essential for the production of semiconductors. Yes, those semiconductors which are worth a fortune and as rare as hens teeth in 2021/2022.
Shopify - the largest platform for e-commerce, if you're buying or selling something on line there's a good chance they are making money from it!
There are heaps of other great companies in this ETF - by definition they have to be great companies or they wouldn't be amongst the largest in the world!
Note on currency exposure/hedging: The Australian currency is often considered a "risk-on" asset as we are tied to commodities (think iron ore exports). So when global recessions hit our dollar often (but not always) goes down relative to the USA dollar. Put simply, if your ETF is currency hedged then you can get the double impact of the Australian dollar going down (reducing the worth of your shares) AND the value of the companies going down (also reducing the worth of your shares!). To put this in perspective during the "Coronacrash" in 2020 the hedged (ie. in Australian dollars) version of the global ex-Australia index (VGAD) dropped around 30% as both the value of the companies AND the Australian dollar went down. By contrast the unhedged (i.e. not in Australian dollars) version of this index (VGS) only dropped around 20% as the drop in value of the companies was offset a bit by the increase in the US dollar versus the Australian dollar.
I own VGAD because I have a lot of other unhedged currency exposure via DJRE and IJH, so want to counter this in the event that the USA market goes down and our currency goes up. This has happened many times in the past, and I prefer caution where possible.
DJRE or REIT: Don't you know that property is the ONLY way to get rich!
The ETF's DJRE (unhedged) and REIT (hedged) provide exposure to real estate investment trusts (REITs - not to be confused with the ETF named REIT...). These are a quirky asset class in that they in many ways are similar to if you bought an investment property yourself. They often use a lot of leverage, and are mandated to pay back to you a large proportion of the income they receive after expenses. This means that they often pay a relatively high dividend yield, so expect a regular, quarterly paycheck from them. That can be good (money in my pocket!) and bad (I have to pay tax on it :(....). REITs are included in other ETFS like VGS/VGAD, IJH and VAS as they are a part of these indexes, however I choose to "overweight" them as I like the potential diversification they provide.
Equity Apartments - Next time someone excitedly tells you about their investment property in Logan that they are renting out for $350 a week you can click on this link to show them the 35 apartment towers that you own a part of in New York. You might recognise some of the names of the places they are in - Manhattan, Park Avenue, The Upper West Side, Wall Street. You can also casually state that some of the 2 bedroom ones you rent out for 10's of thousands of dollars per week, and that they might recognise some of them from shows like Succession or Billions. Or you can just sit there and drink your Vodka (Marcia), Bundy Rum straight no chaser (Claudia) or cistern moonshine (Lily - sorry Lily...) and nod your head as if you care. Or if yuppie apartments in New York are not your thing....how about a boutique, all wood small group of apartments in Saint-Mande Paris that you own as part of Gecina Sa, the France based REIT?
Aedifica - This one is cool. It specialises in environmentally sustainable residential care homes for elderly and disabled people. Check out "Villa Casimir" in the Netherlands at this link, if that doesn't make you feel good about what you own (how awesome does that place look!) and what they are doing with it there's something wrong with you. Imagine visiting your vulnerable loved ones in a place like that, that has to make you feel at least a little better and lift your spirits.
Prologis - One of my favourites, they build warehouses and distribution centres for companies like Amazon. They are the biggest REIT in the world, and their portfolio is very impressive. Fancy an automobile parts manufacturing warehouse in Slovakia? I do!
I own both DJRE and REIT, the former has slightly higher fees but the latter is hedged. Picking which one you want comes down to do you want it to be currency "controlled" (hedged - REIT) or do you want it to fluctuate with changing currency exposure (unhedged - DJRE). Personally I only buy DJRE now, it's quite a large ETF with a lot of money in it so I have no concerns that it will stop existing one day. Either one is a great investment though.
VAS: I know those companies - Aussie Aussie Aussie Oi Oi Oi!
VAS stands for Vanguard Australian Shares, which you guessed it, owns only Australian companies. This means all the ones you know of like BHP, Rio Tinto, Commonwealth Bank, Woolworths, Wesfarmers (owner of Bunnings and Kmart) and CSL. Australian shares have a number of interesting aspects to them, including:
1. In local currency terms they were the 2nd best performing country in the 121 years since 1900, behind only South Africa. BUT - in USA currency terms Australia was number 1!
2. Australian shares have the unique advantage of often providing "franking credits". Long story short this means that when you get a dividend from Australian shares you get the money in your bank AND a tax credit. This means that any tax the company paid you get a credit for. This can be very beneficial as if you take time off work / getting an income you can get reimbursed for any tax the business paid at tax time. This is not trivial, and many retirees rely on it. This is a key reason that Labor lost the 2019 federal election. When they announced that policy I thought it was a killer for them, and it turns out they realised the same thing (just too late!).
Given these advantages why shouldn't you just buy all Australian shares? Because that is putting all your eggs in one basket, which we don't do. Doing well for the last 121 years does not mean Australia will do well in the future, and even if it does there will likely be decades where it performs poorly while other countries do well. That is why I buy parts of everything from everywhere. I think it is not a bad idea at all to have a fair chunk of Australian companies, we have low corruption, good governance and "punch above our weight" with industry. But I wouldn't put all my eggs in that basket.
The great news is that it's WAY easier than buying a house. There are many ways of doing it but I'm going to describe what at the time of writing is the simplest and lowest cost in my mind.
Step 1. Sign up to a Broker: Create a STAKE account
Stake is an Australian based broker (platform for buying/selling shares) that is both low-cost (only $3 per purchase! I've been used to paying $20 with Commsec...) and IMPORTANTLY FOR ME gives you a dedicated HIN. The other low-cost brokers at the time of writing had a pooled holding whereby technically you did not have the shares in your name. This is extremely unlikely to be a problem, but then again why take the risk for no reason? I also like the Stake platform because it is so easy to use and clear. It isn't overwhelmed by graphs or colours trying to suck you in to "playing" the share market. Signing up is very easy, just go to their website and follow the guide.
Step 2. Get your Stake account details and transfer money to it
Once your account is setup login to it, make sure you are in the Australian ASX section (you will see the Australian flag in the top right corner, if it's the USA flag just click it and select Australia). Click the "money" icon that is in the top right corner of the screen, next to the magnifying glass, and select "deposit". This will bring up the details of the Account Name, BSB and Account Number for you to transfer money to. Record these in a safe place as you'll be using them every time you want to buy shares.
IMPORTANT STEP - check the price of the share you intend to purchase, as the first time you buy it you need to purchase at least $500 worth of it. Given that some shares cost hundreds and even thousands of dollars per share you may need to purchase much more than $500 worth. For example, at the time of writing VAS (the Vanguard Australian Shares index) was around $95 per share. Therefore you would want to transfer enough money to buy more than $500 worth of it at this level plus a buffer plus the $3 fee. One issue with Stake is that withdrawing the money from your account is not easy or quick, so you want to deposit as close to the amount you need as possible. Therefore I'd recommend depositing the amount that it closed at the previous day plus around 2%. This will cover any unexpected major rises in price without leaving too much leftover money sitting in the account doing nothing.
Step 3. Buy your shares in the middle of the day once things have "settled"
The start and end of the trading day is often quite variable and all over the place. I typically buy my shares at some stage in the middle of the day. All I do is a) login, b) make sure that the Australian flag is there and that my money has been deposited into the account, c) click the magnifying glass and type in the name of the share I want to purchase, d) make sure that the "BUY" option is chosen and select "Market Order" as the order type, then e) type in the number of shares I want to purchase making sure that the "Max amount including fees" is less than the value I have available. If that's all good click the "Review Buy" button then purchase the shares. That's it. Done. This should be quick and easy, but you will be VERY nervous your first time.
Step 4. Update your records
You will then get sent a PDF of the order details via email. Save this to a safe place. Have a simple Excel sheet with the purchases you have made in it, with the dates, share and price per share recorded. This is important come tax time, which is actually much easier than you'd think. Once you provide the Tax Office with your HIN it automatically fills in your tax info for you.
Step 5. Ignore all finance media and do not login to Stake again until next time you are ready to buy.
If you have bought a diversified index fund you are now the proud owner of a tiny piece of hundreds or thousands of some of the most successful companies in the world. You do not need to worry about their success, that is the job of the CEO, CFO, line managers etc. etc. that you are employing at each of these companies. If one of these companies goes bust that is fine, your index fund will replace it with another one. The current "value" of the index of these companies is completely irrelevant unless you need to sell it that day, but why would you? So don't read about it, check on it, or think about it. The only time you check on the prices is next time you are ready to purchase more shares. This is not the only way to do it, but it is the way to do it. The more you tinker the less successful you will be.
Other method of ordering I don't like: To buy shares you can also sit at your computer all day typing in "limits" on prices and waste hours or even days if they are not getting picked up (i.e. you offer less than people are willing to sell at and therefore you don't do a "deal"). Don't fall into this trap. You might save a few bucks some times but you will more likely lose money over time as the odds are the longer you muck around the more likely prices will go up. For shares liked the index funds I use the difference between the buy and sell offers are typically very small and not worth trying to arbitrage.
I love the figure on page 1 and the table on page 2. This sums up everything you need to know about shares. You have the classic "normalish" distribution of the histogram in Figure 1, which shows the most common annual return is between +10% and +20%, with almost all returns between -30% and +50%. However, there are some outliers there both negative (between -50% and -40% in 2008: ouch!) and positive (between +60% and +70% in 1983 and 1975: woohoo!). Then the table shows how the returns are all over the place, with no apparent rhyme or reason. If you think the period after the big hit of 2008 from 2009 to 2019 was great for investing have a look at 1975 to 1980, or 1931 to 1934! This shows how if you hold on after a large drop the odds are you will rocket back out of it.
These 2 pages are pretty much all the info you need. If you are stressed out during a decline and think you need to sell come back to them. If you sell, when will you buy? Can you predict the future? Selling during a decline in the share market means you have to make 2 correct decisions - the optimal time to sell AND the optimal time to buy. If you are selling out that means you think it will drop a LOT more and stay down, otherwise you will just hold on and not sell. So what if it doesn't drop any more after you sell? When will you admit you were wrong and buy back in at a higher price? Or will you lean on your confirmation bias and look for news stories supporting your view that this is just a positive blip and it will get lower soon? Then what happens if it doubles in value from when you sold? Surely that is too high so you can't buy back in then?
Trying to time the market is a suckers game, don't play it. Buy when you can, as often as you can, for as long as you can. Gradually, then suddenly you will end up with a lot of money.
When people talk about the love affair Australians and those in other countries have with investment property, and using real estate to get rich, they are really talking about the use of massive amounts of debt. This is using other peoples money to leverage your money into a much larger amount. There is nothing wrong with it if it is done wisely, in moderation, and while understanding the risks associated with it. Let's look at the typical method of buying a house for a young person:
Lily has taken a few years off of buying Faberge eggs and has been saving money towards a house deposit. She now has $100,000 to use for the purchase. She has decided against buying a "forever home" and has instead found a house she'd be happy to live in but that also makes sense as a future investment property. It is close to public transport, in a nice neighbourhood, has a decent sized block of land but is low maintenance etc. It costs $1,000,000.
Lily uses the minimum of $50,000 of her savings as a 5% deposit on the house, with the remaining $50,000 spent on stamp duty and other government fees (around $35,000 for Queensland Australia in 2021 even for 1st home buyers...), building and pest inspections and some furniture to live in the house with.
Lily now has control over a $1,000,000 asset for the measly sum of $100,000. She has leveraged her original money 9 times, adding an additional $900,000 of exposure to assets.
Looking closer at these numbers what has happened? Essentially Lily has LOST half of her original money (assuming the furniture she buys does not have much value after it is bought, which is not exactly true but close enough for this example). Her $100,000 turned into $50,000 after the fees and costs. That is money that Lily cannot get back, and if she were to sell the place she would get hit with another big batch of selling fees (real estate agent fees, inspections, advertising etc.) that would likely wipe out a large portion of the $50,000 she had left after the original buying fees. In reality Lily has "lost" close to all the money she had saved to gain exposure to the $1,000,000 asset.
Why would she do this?
This is a house that will one day turn into an investment property, so Lily assumes that long-term the house will rise in value. While Lily may have "lost" the original deposit money she has gained exposure to something that might accelerate her net worth. Forgetting maintenance costs for a minute - If the house goes up 10% in value she has regained all of her deposit money back. If it goes up 20% she has doubled her original investment. This is why we do it. To double her original $100,000 WITHOUT leverage would - on average - take around 7 years in shares with no leverage. It could be much quicker, but it could be much longer. House prices can often go up 20% in a year or two in Australia, so she might double her money in a much shorter time frame.
This is not without risk though, just ask anyone who invested in regional mining-related towns like Gladstone, Biloela, Emerald etc. in the early 2010's. A 10% drop in the house price after Lily bought it would reduce the value to $900,000, meaning that not only did she lose the $100,000 deposit but she now has a NEGATIVE net worth of -$100,000. that doesn't count the costs of maintenance, council fees etc. etc. that often make home ownership feel like financial death by a thousand cuts.
So if that sounds a bit scary - what about leveraging into shares? The traditional method is called getting a "margin loan". Now THAT is scary! Essentially you own some shares, then borrow against the value of those shares to buy more. Very similar to the home loan example above EXCEPT the buyer fee is negligible. For your $100,000 deposit you might pay <$10 now in fees to purchase another $100,000 in shares. This sounds WAY better! The catch however is in the definition of a margin loan, which means your assets are "in margin". The way these loans can offer extremely low rates, often less than home loans, is that they can IMMEDIATELY sell your shares if the proportion of the total value of the assets that is your money has dropped enough to go below a set threshold (often 50%) and you can't provide the money within a couple of days or even less to top it back up above the loan value. This is typically at a horrible time, for example during a financial meltdown where you've also just lost your job. Fancy losing all your investments savings AND your job at the same time? Not me. For an explanation of it go here, but in reality it is not worth reading as this is not something you should be touching unless you are very well versed in how shares and money work. I wouldn't touch a margin loan nor see any reason I'd ever recommend one to anyone. They are a great way to lose everything very quickly.
Another, newer method of leveraging into shares is with products like the recent NAB Equity Builder. It is similar to a margin loan in that you buy shares and then get a loan from the bank to buy more of them, however it does not have a margin call. This means that if the share market goes down you don't have to top it up or sell any of your shares. The loan rates are a little higher than traditional home loans, and there are restrictions on what shares you can buy (mostly index funds which is good!), but in my opinion this is a great option for young people looking to leverage into shares without the catastrophic risks of a margin loan. But you have to ask yourself do you really want to leverage into shares when you have so little experience with them? Statistically it makes a lot of sense to do it, but psychologically shares are hard enough WITHOUT the leverage. What I do like about this though is that you need a reasonable amount of shares to be able to get a loan, so hopefully you have had some experience with the volatility of the share market to reach this point. My concern is that someone has saved money in the bank, then thought "I want to leverage into shares" so they buy some index funds and get the loan at the same time. This is NOT a good way to enter the market, as the volatility of shares is a shock at the best of times, let alone if you are leveraged into it. If you do however have some experience with the share market, and have had the chance to go through a serious shock (no, that is not a 5% decline in a month) where all the headlines say the sky is falling and you must sell everything without losing your nerve, this could be a great opportunity for you. Remember, the loan is in todays dolllars so both the investment return and inflation are working for (or potentially against) you. Over a 10 year time frame statistically the odds are likely in your favour, but that doesn't mean they will favour you.
Wrapping up - leverage amplifies gains and losses. As of 2021 we are currently in the midst of a generational housing boom. These things happen from time to time and no one knows how or when it will end. FOMO is a huge factor now, so it is understandable that people feel like they must buy a house now, invest in shares, or speculate in dogecoin, or they never will be able to afford it and will miss "the boat". You can backtest pretty much any asset at the moment and say "if only last year I'd leveraged into XYZ I would have made 10 times what I invested and be rich now!". That is hindsight bias, the most accurate and useless type of vision. These assets have gone up that much in large part because of random, unforeseen events ties to one of the deadliest pandemics the world has ever seen. Noone knew what would happen in March 2020 when the world looked like it was on the brink of a depression. If you think shares tanked then, down around 30%, imagine if you had to sell an apartment in a major city within a day? Good luck getting half your money back on that.
While we haven't seen this exact scenario, no one in any of our lifetimes has, history echoes. We've seen situations like this before, and heard every one of the stories about "my child will never be able to buy a house" or "if you don't own this shitcoin/stock/beanie baby/tulip/spice you will be poor forever" over the past decades/centuries whenever there is a runup in prices. Funnily enough, people can still buy houses, invest in shares and blow there money on rampant speculation. Maybe the house is not exactly where you want to live your "dream" life, but there are plenty of places where houses don't cost too much and you can live comfortably on a meagre income. Maybe you do miss a tripling in share prices, or 100x gain in some random crypto coin, but there will always be more opportunities. Just don't blow your finances up in the meantime.
ADDED NOTE: If you are borrowing money to invest in something that provides an income (very important as some shares don't provide a dividend) then it is very likely that you can claim the interest as a tax deduction. If you are on a high salary in Australia, where we have a very high tax rate, this can end up being very beneficial. For example:
If you borrow $100,000 to invest in shares at an interest rate of 3.95% (the current NAB Equity Builder rate at December 2021), you would be paying $3,950 in interest. If you can claim this back on tax at the rate of 37% (which is if your salary is between $90,000 and $180,000) you will have a tax credit of $1,461.50. So essentially it is only costing you $2,488.50 per year in interest after tax to gain another $100,000 exposure to the share market. You do however have to pay tax on the dividends you receive, so you can try and balance this out to maximise your after-tax situation.
See specific tax advice on this, this is just an example.
Saving is easy - how do you spend?
The strange thing about saving money is that it is pretty straightforward - there are only so many options. You can save it in the bank (cash), or invest it into an asset that you hope will go up in value over the long term (shares, property, bonds, Lily with her Faberge eggs). You can only really save a portion of your income too.
Figuring out how to spend money to me is much harder. For a naturally penurious (read tight-arsed) person like myself it has been difficult to wrap my head around being able to spend money. One of the fascinating things about saving and investing in volatile assets like shares is that eventually (hopefully) you end up with a decent size nest egg, at which point your salary from your job and even how much money you spend (within reason) kind of becomes irrelevant. To invert the great Peter Bernstein's classic book, you're now "With the Gods". Here's how it works:
When you have no savings, your salary and ability to spend are perfectly correlated. If your salary is $500 you can spend $500. If you spend less than that you are saving money, if you spend more than that you are going into debt. The former is essential to get ahead, the latter is dangerous and can get you into serious financial problems.
If you have savings in a bank account which has interest at roughly the level of inflation, then the money you have saved already is neutral. In 10 years time it will be worth the same amount in terms of spending power. So again, if you spend less than your salary you are saving money and your assets are increasing. However, now if you spend more than your salary you are not necessarily going into debt as you have some money saved up. What you are doing though is reducing your savings as the money you have saved up is going down.
So far it has been all straightforward. Where it gets interesting is if you have that money invested into assets like diversified shares. After adjusting for inflation, the US share market has had a capitalised annual growth rate of nearly 7% from 1972 to 2021. The key part here is after inflation, as this means that any money you have invested in US shares in this period has "on average" gone up around 7% each year more than it was worth at the start of the year. So here's how you can spend more than your salary, or even spend DOUBLE your salary, but still be saving:
Marsha has $1,060,000 invested in US shares. She earns $60,000 per year after tax in salary from her job. Marsha is jealous of Lily's Faberge egg collection and decides she must get her own. Marsha has a year where she goes nuts and spends $120,000 that year, which is twice her salary, on lifestyle and trinkets. To do that she takes $60,000 out of her shares at the start of the year to fund her lavish lifestyle. Her remaining $1,000,000 shares go up the "average" amount that year. At the end of the year despite this heavy spending she has:
$1,000,000 * 1.07 = $1,070,000.
So in a year when Marsha spent WAY more than she made from her job she still managed to finish the year with more money even after accounting for inflation. Isn't that awesome!
The average real return over this period was around +7%, but the standard deviation was around 16%. This is where the "With the Gods" comment comes in. Let's look at 2 different scenarios:
The Gods DON'T like a spendthrift Marsha:
Instead of getting the average return, Marsha gets a return of -25% which is 2 standard deviations BELOW the average. While not a common occurrence it definitely can happen on rare occasions. So Marsha now has:
$1,000,000 * 0.75 = $750,000.
In a year when she decided to splurge and spend an extra $60,000 her savings have gone down by $310,000! That has to hurt.
The Gods DO like a spendthrift Marsha:
Instead of getting the average return, Marsha gets a return of +39% which is 2 standard deviations ABOVE the average. Again, while not a common occurrence it can happen on rare occasions. So Marsha now has:
$1,000,000 * 1.39 = $1,390,000.
In a year when she decided to splurge and spend an extra $60,000 her savings have gone UP by $330,000! That has got to feel great!
Understanding this has made it much easier for me to spend money in a purposeful way. In some ways this variability as helped me psychologically as I now understand that so much of it is outside my control. The somewhat "extreme" example of spending double your salary in a year, but it having a limited impact on your savings relative to the fluctuations in your investments, reinforces that once you have a reasonable net egg small or even moderate amounts of additional spending or saving mean little in the grand scheme of things. If you want to shout a fancy lunch or buy a new keyboard for your students - go for it ;)
Money Dials: analyzing your spending habits with Ramit Sethi (iwillteachyoutoberich.com)
Ramit Sethi has some good stuff about purposeful spending. Spend money freely on things that make you happier, and spend nothing on things that don't. That's why I don't have a fancy car, they make me LESS happy as I'm worried about scratching it, parking it in student car parks etc. My POS car does everything I need, and I'd happily lend it to any friend without any worries about it. It also allows me to spend money on friends, minor extravagances etc. and not even think about it - I figure I save at least $5000 per year on depreciation, servicing, interest, insurance etc. which is around $100 per week. This money can be spent on things which give me a happiness hit like buying flowers for people, building up my library of books, buying lunch for a friend etc.
How much cash do I need on hand? This is the hardest question you will have to answer. Statistically when you are very young (eg. early 20's), and if you have a consistent job that you enjoy, the "correct" answer is almost none. You could live paycheck to paycheck, investing everything that is left over each week. Any large expenses that need to be paid straight away (eg. car servicing, unplanned trips) you could put on a credit card with a long interest free period and then save for the next few weeks and pay it off. If you don't save enough you simply sell enough shares to pay whatever is left over. Same goes for any large expenses that a month of savings can't pay off - just sell your shares.
I couldn't live like that.
For a robot that would work really well, however for me that would require too much looking at money which I don't want to do. For an older (Maria edit: this should just say "very old") person with, kids(s) a house and mortgage it makes sense to have a reasonable amount in an offset account. Have as much in there as will keep you from stressing out if the market goes down or you have a big expense come up (leaky roof? rotten deck?). Money in an offset account is returning - tax free - the mortgage rate so is a pretty good investment anyway.
For a younger person without those responsibilities it makes sense to look at how much your typical expenses might come to in a month, then double that. This become your "cash on hand" threshold. You then set a threshold for savings so that once you get XX dollars above the threshold you invest everything above the threshold into diversified shares.
Lily spends $3000 per month on rent, food, car servicing, hair products and faberge eggs (her guilty pleasure!). She therefore sets her "cash on hand" threshold at $6000. She earns $4000 per month after tax, meaning she saves $1000 per month after expenses. By saving like this Lily could get to her $6000 threshold in 6 months, then set her investing threshold as $9000. Every time her bank account hits $9000 (roughly every 3 months) she invests every dollar above $6000 into diversified shares. Simple, easy, and over the long term (20+ years) likely to produce amazing results. With this method you always have between 2 an 3 months of expenses in cash, plus maybe a credit card, in case of emergencies.
You can have separate accounts, for example the "cash on hand" account and another that you use to save towards the investment. Do this if you don't trust yourself not to see the "big" numbers and splurge too much. Or you can just keep it all in your normal savings account if you want to make it easy.
Just make sure to include some fun money in your monthly expenses - you're only young once so enjoy yourself! You can also cycle through credit cards building up points for flights, hotels etc. so that you are not saving money but also building up holidays as well. Don't miss out on life just to save money. Remember that money is pointless, it just buys you time and opportunity. Investing early and hard means you can career change, raise a family, take a year off etc. much more comfortably in your later years. But investing too much means you miss out on life.
One of my favourite blog posts - which lead to one of my favourite books - about what money is
The Psychology of Money · Collaborative Fund
This is a good one about how no one wishes they worked more or had more money when they are on their deathbed
The Nothingness of Money (moretothat.com)
I remember hating the book when I read it, as I felt like there was a lot of fluff with some good tips for things around the edges but the real meat of it was horribly wrong. Maria mentioned it so I thought I would read it again as maybe I was too harsh. I still hate it.
Here's things I like about it:
1. Going for date nights to chat about finances is a great idea.
2. Having the bucket for "mojo" money is really important. You need that for peace of mind. However it was very simplistic. If you have a safe job you love you don't need anywhere near as much as someone whose job is not as secure. I understand this is a "cookie cutter" book aimed at the masses but this is a big issue.
Here's things I hate about it:
1. A balanced index super account makes no sense for a young person. Statistically the odds of this being better than a globally diversified all shares account over a 30+ year time horizon are miniscule. I cannot understand why this is recommended other than that it is the safe option for older people and therefore he wants to minimise the risk of criticism. When you are young the odds indicate that you should go HARD at investing, particularly if the money is locked away for 30+ years.
2. Paying off your house quickly has many major ramifications. On first principles it seems logical - this is a huge debt so we should pay it off quickly - but the 2nd order logic rules it out.
a) Why are you buying the house instead of renting it? You could argue security is a factor, but really the only reason to buy is under the assumption that it will be worth a lot more in 10,20,30+ years time than it is now in either real (after inflation) or nominal (not accounting for inflation) terms. If that is the case, and the payment you made for it is fixed to the amount you paid for it, then why would you want to pay the loan off? Inflation will gradually chip away at the mortgage for you anyway, as will the standard payments. You are likely to be far better off investing the leftover money into something that spreads your risk away from this single asset. If instead of paying extra on the mortgage you invest that into globally diversified shares - particularly if you debt recycle and therefore can claim the interest on the loan used for the shares as a tax deduction - you spread your risk away from the house. Then in 10, 20, 30+ years you have the house AND a share portfolio.
b) if you ever intend on renting the house out any extra payments you made will reduce your tax deductions. This is MASSIVE and could cost you 10's of thousands a year in lost tax benefits. A mortgage offset account achieves the same as paying extra but does not have this impact. Seek specific tax advice on this, it's worth paying for.
c) he gives out random stats with no backup - for example "houses often costs up to 5% of the purchase price each year to maintain". Cheap or expensive house, a roof is a roof. Many of the houses which young people can afford are large and in the outer suburbs, so may cost more to fix than a smaller, more expensive house in the inner suburbs. $20k of repair to a $400K house renting for $300 a week wipes out more than a whole year of rental income, whereas for a $2 million house renting for $1500 a week it is only a few months.
d) I don't understand the 20% deposit recommendation. Again, the main reason to buy is assuming prices will go up over time. Lenders mortgage insurance (LMI) is not a huge amount, so why wouldn't you buy with a smaller deposit so that you lock in the current price? If you have to save another 3 or 5 years to get to 20% versus 5% why would you do that? If the price goes up by 6% over that time, which is not a large or uncommon amount, than you have to save more to get to the 20% AND you have a much higher loan to pay anyway.
A quick example of this:
Let's say you were buying a basic apartment/townhouse in a reasonably low-cost area of Brisbane, Australia. The house costs $500K. LMI for a 95% loan (i.e. borrowing $475K, you have "only" a $25K deposit) costs around $15K. Adding that LMI is the equivalent of paying $515K for it. That is a 3% increase on the price of it. Inverting this, that means by waiting to save the 20% deposit to not have LMI you would need to be able to save the remaining 15% of the purchase price (i.e. another $75K) in around 6 months JUST TO BREAK EVEN if the house prices rise 6% in a year (i.e. 3% in 6 months). If you can save $75K in less than 6 months to make this work - the equivalent of more than $150K of savings in a year - you don't need to worry about these miniscule amounts!
If you recommend buying a house why put that caveat on it? Recommending saving longer to get a 20% deposit over a 5% deposit with LMI right now is the equivalent of saying that house prices will not go up in the time it takes to save the extra 15%. To me this is completely illogical, as why would you buy an asset that you do not expect to go up in value? Unless you are good at market timing and are confident that over the next couple of years it won't go up, but then magically you will buy at the right time and it will shoot up from there?
3. Credit cards are one of the best financial investments you can make if you use them correctly. Frequent flyer sign up bonuses are spectacular investments. I cycle through credit cards regularly to get them, you're crazy if you don't. It is not uncommon to pay a fee of around $200 to sign up for a card, but then if you spend enough in the first X months you get 100k+ frequent flyer miles. These miles are often worth around 2 cents per mile in travel credit, which makes your $200 investment worth $2000 of flights. On top of that you get free travel insurance AND access to their business lounges. This is insanely good value for a 10 minute sign up process. Again - only if you never pay interest and pay them off on time. Once the period is over that you need to hold it to get your points, usually a few months, you cancel the card and move onto the next one. For aussies a good site is pointhacks.com.au to see what offers are out there.
4. His recommendations about shares annoy me. He says to buy AFIC and snub active stock pickers, which is a very good diversified listed investment company and a sound choice, but that is just Australian companies. Where is the global diversification? He then later brags about the real estate investment trust BWP he recommended people buy, and says people should subscribe to his newsletter to pick stocks with him. So should you buy an index fund or pay him more money to pick stocks with him. This really annoyed me.....
You can probably tell I'm not much of a fan.....
This is a quick rundown of how we are set up financially. This is not necessarily how you should set it up or think about it, this is just my thoughts.
Our assets, in order of gross value, are:
1. Our principle place of residence (PPOR)
I'm not a big fan of individual houses as "investments"; however I do appreciate the emotional aspects that come with them. When we moved to the Sunshine Coast we did not know how long we would be here for, but we had a 1yr old daughter and thought it could be a nice place for her to grow up. At the time (2016) the Sunshine Coast was still recovering from the large drawdowns in housing value after the combination of the GFC, reduction in coal mining and 2011-2012 floods. While prices had started to go back up they were showing no signs of FOMO. I inspected 30+ houses in person and hundreds more online, and after going over the numbers of all of them we managed to buy a place that we believed was selling for land value yet had a house that had "good bones". To put it in perspective - and show why houses scare me as an asset - we paid $115,000 LESS than the prior owners paid for it 9 years before, and they had spent hundreds of thousands on it during that time period. It was the definition of a money pit for them. While at the time of writing it has gone up in value quite a lot since then anything could happen. You just have to look a few hours up the road to Gladstone to see how carnage can play out in the housing market - house prices there went down around 60% from 2012 to 2018. A house in West Gladstone went from $429K to $170K in that time period. Had you bought in 2012 you would likely have taken on a large amount of debt that you have been trapped with, paying off a large mortgage on an asset dropping in value that you have struggled to rent out and had to pay for maintenance etc. This ruins lives and is my nightmare. Having so much of our financial security trapped in the one asset is always concerning to me, hence why we have the shares inside and outside of super.
2. Our superannuation
I did a lot of dumb stuff when I was young, but thankfully I put way more than I needed to into superannuation from a young age. It is in 100% internationally diversified shares, or as close as I can get to it. We have enough here that once we turn 60 we should have enough to live a very comfortable retirement and look after any health issues that will inevitably arise. We make sure to take advantage of a number of key benefits of super:
a) Spousal splits. Each year I transfer money out of my account into my partners. That makes sure our balances are relatively even. There are a number of thresholds that it is good to stay under, for example the $500K threshold for the 'carry-forward' concessional super contributions. Staying under this threshold means that if I take a couple of years off work or part-time and contribute little to super I can catch up when I come back. Simply, whatever part of the concessional cap you don't spend each year adds up over 3 years. So if I only contribute a small amount and have a large part of the cap I don't use, let's say $20k per year for 3 years, on the third year if I return to work and will have a large tax bill I can put that $60k into super at the concessional rate of 15% tax. That would save more than $13k in tax that year.
b) Spousal contribution. If I put $3k into her super from my after tax money I get a $500 tax rebate.
c) Government co-contribution for low income earners. If my partner puts in $500 of after tax money the government matches it.
Superannuation is brilliant, it has so many tax advantages but also asset protection benefits that people don't think of. The only reason to not take advantage of it is if you are expecting a large inheritance from parents who are likely to pass on when you are around that age. When choosing a superannuation provider go with one that is reasonably low fees, has been around for a long time, and offers the ability to be heavily invested in diversified global shares. We are with Unisuper and are invested in a split between the "High Growth" and "Global Companies in Asia" options that brings the International Shares component to around 50% and the Australian Shares component to around 40%, with the remaining in property and income. We leave it like this, and every year I check to see if the fees are changed. If not then I leave it as is.
3. Shares outside of superannuation. We have much less of this compared to shares in superannuation, purely because of the tax advantages. Obviously we can use a discretionary trust outside super to gain tax benefits, but for our situation it doesn't make that much sense given how we plan to live our lives over the next couple of decades. If we both become low incomes earners, which we probably will as I transition from full-time work, the benefits of a trust become small and the costs outweigh it other than asset protection. However with much of our assets in super there is not much need for it (hopefully - trying not to jinx myself!). Our shares outside of super are setup very simply. I know it is not tax efficient, which I can live with, or as "optimal" as it could be based on back-testing, factor investing or efficient frontiers (I am being sarcastic here - I have serious issues with these methods). What it is though is bloody difficult to guess if its gone up or down based on news headlines. Here is the strategy I use which consists of four index funds:
25% VGAD (An index containing the largest companies in the world, with the value in Australian dollars)
- This is a core part of my portfolio, and is the Australian dollar equivalent of VGS. This means that in addition to the value of the companies in the index, if the Australian dollar goes up it also goes up in value, but if the Australian dollar drops it goes down.
25% VAS (An index containing the largest companies in Australia)
- A simple index containing the largest companies in Australia such as our miners, banks and industrial companies.
25% DJRE (International Real Estate Investment Trusts).
- This is where I differ from many people, in that I am a fan of Real Estate Investment Trusts (REITs). You already own some of them when you have other index funds, as REITs are included in many indexes, however I overweight REITs in my portfolio as they offer some diversification and potential for wild swings (both positive and negative). Global REITs are pretty cool in my opinion, as they encompass everything from beautiful, classic apartment buildings on Wall Street in Manhattan through to industrial workshops in Slovakia (literally, I've checked). I just love the idea of owning not just businesses but thousands of bits of land and buildings around the world. When prices go down I can just bring up a picture of my apartment tower and remember that I'm happy to own a small sliver of it along with thousands of other buildings around the world.
25% IJH (USA midcap index containing 400 middle size USA companies)
- USA midcaps have a long history of doing very well, similar to large cap companies such as Amazon etc. that are in VGAD but offering a little bit of diversity. It's a cheap index that I'm very confident in, so why not?
I buy shares quarterly, the first Friday of March, June, September and December. I debt recycle money out of a split in our home loan and invest it into whichever of these 4 has the lowest value in our portfolio on that day. I then don't check the value until the next investment day. I invest the same amount each quarter, which is based on the plan I wrote. We keep about 3 years of "cash" in offset against our mortgage for peace of mind, the rest goes into shares. I chose 3 years as that means I could leave work that long without selling anything, or could use a big chunk of it to pay for a course and then still have at least 2 years of money to live on while doing the course. It's that simple.
The only debt we have is our house mortgage, which is equivalent to about 1/3rd of our assets outside of super. We could gear up more and take on more debt, and will do that if/when our assets go up enough that our ratio is down to 1/4, but why add on the risk if you don't need to?
"Three things ruin people: drugs, liquor and leverage." Charlie Munger
For Maria, Claudia and eventually Lily