Passive Investing: Everyone can be an investor today. You should as well.
IS INVESTING HARD?
Let’s be honest, investing can be tough. Not because it’s difficult, in fact it has never been easier, but because it requires a reasonable amount of time and self-discipline to become successful.
Malcom Gladwell, in his book “Outliers: The Story of Success” examines the factors that contribute to high levels of success, and claims that one of the key elements to mastery is practice. Gladwell affirmed that by practicing 10.000 hours there is a high chance that you could become a guru in any discipline. So imagine you spend 8 hours a day improving a technique or skill, it will take you at least 3,5 years to become proficient, and that is practicing every day, including weekends.
But don’t worry, you can still be a successful investor without the pain of having to train yourself to become a financial commander. Investing is nothing more and nothing less than allocating money (capital) into an asset hoping that it will generate a (positive) return in the future. In plain words, it’s ‘putting your money to work’.
WHY SHOULD YOU INVEST?
One of the worst enemies of wealth preservation is inflation. Investing is one of the tools, probably the most powerful, to beat this intruder. It is essential if you don’t want to see the money you have saved in your bank losing its value at the rate of inflation, which for the US is expected to be at 2,8% for 2021. You can check the inflation rates so you can do the calculation for your case in particular.
This means that if you had $10.000 in your savings account, assuming your bank offers a 0,5% interest (if you're lucky), the value of your money by the end of the year would be $9.770:(10.000 x (1-(2,8%-0,5%)). That's right, you would have lost $230 of buying power in 12 months, close to $20 every month! That doesn't sound like a very efficient savings strategy.A way to overcome this is by investing your money, instead of “saving” it. Let’s say you decide to invest 6.000 USD in the stock market (and keep 4.000 USD as an emergency fund). You decide to buy stocks of a company you heard of that is selling at 60 USD per share, so you go ahead and buy 100 shares. If you know nothing else about the company apart from the fact that you like it, there is not much difference as to betting 6.000 USD in the casino roulette hoping that the ivory ball lands on the number or color you bet it would. To make a difference between investing and gambling you should be able to answer some questions about the company: What does it do? Are they expanding? Are they profitable? Do they hold too much debt? Will they be able to pay off interests? Who are their competitors? What is the industry they operate in? Are they leaders or disruptors? And many other before you have a reasonable picture of how your investment could evolve in the future, enough for you to feel sufficiently confident to invest your hard-earned money. Not to talk about the psychological aspects of investing, which are as important as the financial, and arguably more difficult to master.
Addressing all these points requires hours of research, specialisation and mental discipline, let alone getting the answer right (which is in most cases not even possible). But there is a solution, a sort of ‘short-cut’ to all of this, and it’s called PASSIVE INVESTING.
PASSIVE INVESTING is a buy-and-hold strategy for long-term investment horizons, with minimal trading in the market, reducing transaction fees dramatically.
ANYONE CAN (AND SHOULD) INVEST TODAY
If you had invested those same $6.000 in a basket of stocks from the S&P500 at the beginning of the new millennium and reinvested profits, considering the average annualised market return of this index has been 9,2%, you would have today close to $35.000. That’s a $29.000 profit (483%!) excluding inflation. Okay, so you invest some money, let it sit 20 years and come back to collect your profits? That’s right. But if you’re going to do it, why not fine-tune your strategy and increase the probabilities of being successful? We know by now that investing in the right companies and at the right time can boost your likelihood of success. So how do we accomplish this?
The first part, choosing the right company, is hard. There are plenty of books, online tools, courses, blogs, etc. from where to cultivate your investing education before you make sound investing decisions but not everyone is that enthusiastic in allocating their time to develop the skills required to select the ‘winners’, so today I want to focus on those that don’t care that much about the process (and the benefits) but still want to take advantage of investing. There is an additional strategy to mitigate bad-timing effects which is called ‘diversification’ which I will talk about in future posts.
The second part, when to buy, is even harder. Timing the market is virtually an impossible endeavour, even for the most sophisticated and successful investors. The chances of buying at the exact bottom and selling at the exact top are close to zero, but there is a way to mitigate the risks of missing the ‘goldilocks’ moment to enter the market: dollar-cost averaging — which I will also talk about in future posts.
EXCHANGE TRADED FUNDS (ETFs): A profitable instrument for ‘laid-back’ investors
Investment Funds are collections of stocks, picked by a Fund Manager, who decides, according to his or her criteria, which individual companies will compose the fund. The money invested is accumulated from different individual investors.
There are many different types of Funds in which you can invest in, but for retail investors it can boil down to two: Mutual Funds and Exchange Traded Funds (ETFs). Mutual Funds appeared earlier than ETFs, in the 1920s in the United States, and these were reserved for institutional and professional investors with large amounts of money, from which to obtain the most succulent fees. It wasn’t until the 1970s when their popularity increased after Wells Fargo and the Vanguard Group formed the first Index Funds (a Mutual Fund that tracks an index, like the S&P500) and made them available for the general public (the first ‘retail investors’). These type of funds require very low spending on management, as their objective is to replicate the performance of the underlying index (the ‘benchmark’). By purchasing all the holdings that belong to the index, these funds are able to perform as good as the benchmark they track.
Mutual Funds are still a decent option for investors today, however you must take into account that the fees paid to bolster all the work done by bankers, analysts, and so on, will take a bite to potential profits. Management fees could go as high as 5%, depending on the bank you contract the service with, how specialised the fund is, the liquidity it has, and many others.
LESS ACTIVE MANAGEMENT, LESS FEES: A SHARPENED SOLUTION
A modern and cheaper ‘version’ of Mutual Funds are Exchange Traded Funds, which appeared in the 1990s’ and gained popularity thereafter. One of the differences with standard Mutual Funds are that management fees are significantly lower (as low as 0,03% for the Vanguard S&P500 ETF today) but the main characteristic that made it explode and increase retail investor adoption is that it trades like a stock, meaning you can buy it and sell it anytime during market open-hours, whereas Mutual Funds normally charge penalties for early withdrawals (and some even for extraordinary contributions!). ETFs therefore are a more ‘liquid’ alternative for investors than Mutual Funds. These, together with other characteristics, make ETFs a great option for retail investors that want to benefit from investing in the stock market, spreading the risk (increased diversification), having immediate access to their invested cash and paying as low as 0,03% in fees!
An exchange traded fund (ETF) is a basket of securities that trade on an exchange, just like a stock, and offer low expense ratios and fewer broker commissions than buying the stocks individually.
Nowadays anyone with access to the internet and a bank account or credit card can invest in stocks and investment funds through an online broker. Opening an online broker account is as easy as ordering a pizza online and the amount of alternatives for different brokers is increasing by the day. There are more sophisticated and specialised (for professional traders and prominent investors) and others more straight-forward, user-friendly and a better option for retail investors. You can search for the one that works best for you on pages like brokerchooser or stockbrokers.
Final Thoughts
Saving money is key to preserve wealth for the future, to buy a house, pay for your education or your children’s, start a business, save for retirement, etc. but investing it is even better. Inflation is a whimsical force that occurs in growing economies, but it can, and does, become mighty when manipulated. We leave today in an era of relative economic deceleration, ‘established’ industries being disrupted and central banks ‘printing’ fiat currency to fill the gaps that COVID-19 left in our economies due to a deceleration in productivity.
With the advance of technology, it is possible today to invest in stocks, funds, commodities, currencies, any many other form of financial instruments that will (if done well) generate an income (through dividend distributions) or profit in the form of capital gains (stock price increases).
As probably everything in life, the better you understand something the better you can manage it (and profit from it). Investing isn’t any different, the more time you dedicate to it, the better you will get at it as you will learn how to manage the risks involved. However not everyone wants or requires to become the next Warren Buffet or Elon musk in order to be financially successful, so Exchange Traded Funds are a great option for the vast majority of retail investors to get initiated in the stock market. If you don’t take control over your present and future financial situation, no one else will. It’s an extremely empowering and a life-changing experience for those who dare, and it’s never been easier.
