If you’ve been following along with my articles over the past months one thing will be readily apparent to you. Savings accounts are terrible places to keep your money for the long-term. You are losing money here. And you are placing your retirement in jeopardy – if you are relying on savings accounts for your retirement. But fear of investing is a real challenge for people. Here’s how to get over it.
Clear achievable goals are vital!
Now not everyone relies on savings accounts for their retirement. But they will make other mistakes. Like not having a clear, definable and achievable goal. Without a clear goal, people will not invest rationally. They may find themselves bouncing from one investment to another. Basically, moving money around to make money.
Sometimes they will make money, sometimes they will lose money. But they never really know for sure.
Others will sink their money into one specific investment. Like a real estate project for example. Now there is nothing wrong with this per se. I personally love real estate as an investment. But it is highly specialized work. You really need to know what you are doing here. There are a lot of pitfalls.
Fear is not an investment strategy
Finally, some people will avoid certain investments out of fear. They will stay out of the stock market for years, thinking “now it will tank”. Needless to say they lose a ton of potential profits. After since the previous crash the S&P 500 is up nearly 240%! If you invested $100,000 in August 2008 you would have $236,000 now. On the other hand, if you put this money in a savings account you would have $87,000.
Not great.
Knowledge is power
So it might seem that it is fear that is the number 1 thing that stops people from succeeding in investing. But it actual fact it is the lack of knowledge. It is this lack of knowledge that I have addressed in this series of articles. So that you can invest with confidence.
But more on that later.
What is investment?
In my second article in this series I introduced myself to you. At school I learned what investing actually is. Investment is the process by which you finance the projects of someone else. It is important to keep this in mind. This imbues investing with a tangible quality. This quality can be lost when we just think of stocks and bonds.
But when you think of these stocks as actually being investments in someone else’s business it no longer seems abstract. When you invest in a company you are making a difference in someone else’s life. You are giving someone a job. You are creating a useful product. And someone else is investing in the company that you work for.
You are an investor
Investors are not all faceless, rich fat cats. Most of them are people like you.
But it took me many years of study and mistakes to truly understand investment. A university degree in finance helped but didn’t teach me everything. The trouble was that it did not give me a rational framework for investing.
Later, at work I dealt with various types of investments. Mostly different types of bonds and derivatives, like options. I invested in the stock market through pension schemes. I also had stock options from my various employers. But I never really took full advantage of these options until I earned the CFA® Charter.
The CFA® Charter
The CFA® Charter enabled me to put investing into perspective. It provided a framework for understanding investment. It taught me how to make the right decisions. And the knowledge was the cure for fear.
…the knowledge was the cure for fear.
Overconfidence kills!
In my third article I explored whether fear was stopping people from succeeding in investing. Indeed, it does but there are other problems. One problem that I identified was overconfidence. I talked about the Lehman Brother’s bankers who thought that they really knew what they were doing. And yet they engineered the most high-profile banking failure of all time. Many of them were also financially ruined by the collapse. These bankers thought that they understood their own bank better than anyone else. But they invested their personal fortunes in the bank and lost it all.
They were so over-confident that they ignored the most basic of investment principles: diversification. And they paid the price.
Fear is paralysing
But most people are stopped from succeeding by fear. Fear of losing their money in an economic collapse. But what do people fear the most? The unknown. People fear the unknown. And most people don’t know where to invest.
But fear can actually cause the losses that you are afraid of. Take a look at this graphic:
This graph shows what would have happened if you invested $100,000 right before the crash in 2008. This would be an investment in either the stock market (S&P 500) or a savings account. The blue line is for the stock market and the orange line is for the savings account.
…it is fear itself that we must fear
If you were scared away from the stock market in 2008 you would have lost $148,000 over the next 10 years. As they say, it is fear itself that we must fear. Not investing.
And as I said previously, knowledge is the cure for fear.
How can you eliminate your fear?
And this is what I addressed in my fourth article. I explained how you can eliminate your fear of investing with the right framework. That framework was:
- Define your goals and calculate the cost.
- Figure out what return you need.
- Determine your risk tolerance.
- Consider your constraints (time horizon, liquidity needs, taxes, legal and regulatory, unique circumstances).
- Decide what assets you want to invest in.
- Calculate how much you want to or can contribute.
- And review annually!
This in essence, is the Investment Framework.
What tools do you need to succeed?
In my fifth article I gave you the basic tools that you need to succeed in investing. For example, I explained:
- How you can begin investing today no matter how much money you have
- That you can find untapped sources of money from your employer (pensions)
- You may need a mindset shift to adopt the Goals-Driven Mindset
- About the concept of return on your investment
- And how to calculate your required return
You just need a few dollars…
Many people think that they thousands of dollars to begin investing. But there are many options available to you. Some of them for just a few dollars. If you have a job then you can invest. What really surprises me is how little attention pay to their workplace pensions. In my view these investments represent the single best option available to most people. This is mostly because of the tax benefit.
A word of caution however. Always check the fees attached to these pensions. They can be quite high relative to the normal cost of the investment. But this cost is usually outweighed by the tax benefit.
Use the online tools
When it comes to calculating your required return, I told you about the online finance calculator. This is such a brilliant and free online resource. But it’s a bit tricky to use so I explained how to use it. But once you know your required return, you know how realistic your goals are and what it will take to reach them.
How can you avoid losing money?
In my sixth article I explained how to avoid losing money in your investments. There are two broad ways that you can do this. One is the margin of safety approach. This is the approach that Warren Buffet uses. Basically, Buffet calculates the intrinsic value of a stock (say $50). He will only buy the stock when the market price is half this (say $25). This means that market price is more likely to rise to $50 (a 100% return) rather than fall.
Now this is a gross simplification of Buffet’s overall approach. But it is a method of significantly reducing the risk of loss. You can use the same approach with other investments such as real estate. But this approach requires some understanding of investment.
What if you lack investment skills?
If you lack investment analysis skills you can use the other approach: diversification. In this case you invest in huge portfolios of stocks, bonds and real estate, etc. You invest across industries. And across different countries. You can accomplish this easily by investing in mutual funds and/or index funds. There are many options and talked about them in the afore mentioned article.
To summarise again:
- We have the following main risk management options:
- Margin of safety
- This makes sense if you want to make a few big investments
- It requires some investment expertise
- You also need time to watch your investment
- It will require more management than diversification
- You will have more control over the investment
- Diversification
- This is ideal if you don’t have any investment
- You benefit from the expertise of fund managers, professional investors, etc.
- You can review once a year or if there are significant changes in your circumstances
- It won’t take you a lot of time to set it up or manage it
- And you can try a combination of the two if you want.
- Margin of safety
What about the kids?
In my seventh article, I discussed how to invest for the kids and ensure that your family has a secure financial future. While you do this, it’s important that you maintain your lifestyle. This is where Goals-Based Investing comes. As a father, you have multiple goals. But how do you prioritise them?
I usually follow the below approach:
Ashvin b. Chhabra talks about the aspirational portfolio in his book The Aspirational Investor. In short, the aspirational portfolio is your hopes and dreams. It is true wealth. You can develop this portfolio by finding that dream, high-paying job or by successfully developing your own business.
Start at the bottom and make your way up
If you follow the priority laid out in this pyramid, you are moving in the right direction. You start at the bottom and make your way up. This is how you secure your kids’ future. You secure their future by first securing your own:
- Develop an emergency fund
- Build your retirement portfolio
- Prioritize your goals into your aspirational portfolio:
- Kids
- Wealth generation
- Charity
- Wealth generation can be used to build your kids’ portfolio and/or charity
- As with any goal:
- Calculate how much you need
- Determine your time horizon
- Determine your initial contribution
- Figure out how much you can contribute
- Calculate the required return.
Are savings accounts “safe”?
In my eighth article I covered the reason why investment funds are much safer than savings accounts. This is primarily because banks are so financially fragile. We learned this during the Great Financial Crisis of 2008. In order to keep the financial system going central banks around the world had to bail out the world’s biggest banks. This cost trillions of dollars.
The impact is still being felt today. Both in the fact that there are still billions of unrecovered bad debts and in the extremely low interest rates on savings. So why would we want to keep this system going? Certainly, if you ware keeping your money in bank accounts then you are contributing. But at the same time, you are being robbed. I revealed in my eighth article how this is happening.
How can you achieve success in investing?
In my ninth article I provided you with a case study of how one of my clients achieved success by applying my system. I told you about Mark. Mark is an exceptionally disciplined man who had saved a tremendous amount of money. He did this by not wasting his money. He bought a house while still young. Mark paid off the house by the time he was 40.
Mark’s issue was that his money was earning negative interest in the bank. But at the same time he did not know where to invest. He tried speaking to bank advisors. But he found he did not trust them. So he came to me.
I guided Mark through the system. Together we determined realistic goals for him. And we designed a plan that would work for him. This plan outlined the kinds of investments that would help him reach his goal: retirement at 50. This goal would also involve minimal risk.
You can develop the discipline!
Now you may think you lack Mark’s discipline. What you will find in my next article is that you too can achieve this same discipline. It all comes down to changing your mindset. And you can do this with practice.
If however, you cannot wait for the next article, reach out to me now. I’m only too glad to help.
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