Throughout this series of articles, I have given you a tremendous amount of information about how you can invest. I have taught you where to invest. Now you need to put it into action. However, you must make sure that fast thinking doesn’t sabotage your investments. Read on for details!
Take action now!
Why do you need to do this? Why do you need to take action now? Because sooner or later you will have other priorities. Kids, house, car or your job. Things will happen. So, don’t put investing off until later. You may bargain with yourself that you’ll eventually take care of it. However, later you have lost part of your most critical resource. That resource is “time”.
Time is the one resource we cannot get more of.
Time is the one resource we cannot get more of. And as I have explained. It is the most powerful generator of your long-term investment returns. $1000 invested for 10 years at 10% returns you $26,000 for instance. Over 20 years it gives you $67,000. More than 2 and half times as much for the same investment. Time is very powerful.
So, don’t waste time. Start now.
Don’t let fear paralyze you…
However, I do understand that there may be things holding you back. I have already addressed how fear of losses paralyses a lot of people. But I will go over how you can get over this. I also understand that pressure from relatives may be a factor. Maybe your wife doesn’t understand why you are investing your savings. It’s worked up until now hasn’t it?
Well actually it hasn’t and I will demonstrate why.
Finally, I will go over one action that you can take now and get an instant result.
Fear affects your investing mindset negatively
In previous articles I have spoken about how to overcome your fear of investing. Fear affects your investing mindset in many ways. It can be paralyzing, stopping you from taking important and urgent action. Or worse, it can cause you to make decisions that really, really hurt you!
I mentioned that time is your most important resource. Not making an investment decision can mean not making investment gains. And over time these losses are magnified. Or if you put your investment in a loss-making asset (like a savings account), the loss is further magnified.
Trust is difficult…
Closely related to fear is the inability to trust advisors. You are putting your financial future and the kids’ future in their hands. If they make a mistake the cost to your family could be catastrophic. So again, not being able to trust advisors can be paralyzing.
There are good investments
However, you can find ways to deal with these issues. There are good investments for you. And there are investment advisors that you can trust. Despite that, it is likely that in the short-term you won’t need an advisor. But as your wealth increases, it is likely that you will. Nonetheless, there is no need to run out to an advisor just yet.
The key developing an investment mindset is understanding why your mind works the way it does. You can then couple that with the Investment Framework. Then you will be ready to begin making good investment decisions.
Fast and slow thinking
Daniel Kahneman, a renowned psychologist, talks about the two types of thinking. In his book, Thinking, Fast and Slow, he describes System 1 and System 2 thinking. System 1 thinking is “fast” thinking and System 2 is “slow” thinking.
Fast thinking is when we react quickly to something. Like swerving to avoid hitting a squirrel in the road. Slow thinking is when we are deciding between two alternatives. Like which car to buy, based on its horsepower, miles per gallon, etc.
We don’t use these systems correctly
The trouble is, with investing we use these two systems incorrectly. We tend to overreact to bad information. Many people today make the “quick” decision to not invest in the stock market. This might be because of the stock market crash of 2008. Or maybe we know of someone who lost a fortune speculating on stocks. So, we decide that stocks are too risky. That there will be another crash. We don’t want to be there when it happens.
Unfortunately, this “fast thinking” system is the wrong system to use when evaluating investment decisions. Investment is a highly complex activity. Because of this, there is a strong motivation to simply avoid it altogether. We all know that to learn to invest “like the experts” an awful lot of work is involved. An awful lot of “slow thinking”.
Slow thinking takes effort
The slow thinking system is laborious. It requires effort. It can be exhausting. After a long day at work many of us are too tired to spend hours learning investment. And maybe we have kids too. We’d rather spend our time with them than figuring out how to read a stock prospectus.
Slow thinking, system 2 thinking is hard work. Fast thinking, system 1 thinking is almost effortless. Therefore, it is very seductive. For this reason, we fall back on fast thinking, even if it gives us totally the wrong answers.
Fast thinking is an evolutionary trait
Fast thinking doesn’t always serve us badly. This system evolved to protect us from predators and other dangers. If you were walking through the woods and came across an angry bear you wouldn’t stand there pondering its mood. You would instantly react – and run!
This type of thinking serves us well when we need to make quick decisions. These decisions may save our lives. But fast thinking hurts us when we need to make investment decisions. It is compounded by our lack of knowledge. It is exacerbated by the warnings of economical doom and gloom we receive frequently in the media. This makes us nervous and afraid. Just like when we saw that bear in the woods. As such we fall back on fast thinking. We decide to choose the status quo. This usually means keeping your money in a savings account where it is earning negative interest.
This is compounded by the fact that we don’t know who to ask or who to trust. We don’t know where to get the right information. Everyone seems to be an expert. So, we couldn’t use our slow thinking system even if we wanted to.
What is the solution?
So, what’s the solution? The solution is to follow a rational framework. I have spoken about the Investment Framework. I learned about this framework when I studied the CFA® Program. This program provides “… a strong understanding of advanced investment analysis and real-world portfolio management skills.”
This framework is followed by investment professionals to assist investors all around the world to evaluate investments. This includes top pension companies, banks, insurance companies and individuals like you. Ethics and trust are key aspects of becoming a CFA® Charterholder.
You don’t need to hire an advisor
Not only that, if you understand the framework, you don’t need to hire an investment advisor in most cases. But if you do, you will better understand what they are telling you. Using this framework, you can invest with confidence. You can easily apply System 2 “slow” thinking. You will be as certain as possible you’ve made a good choice.
So, if you’ve read all of the articles in this series you now know the framework. You are ready to take that next step. It is time to do something and get a result. But you may still be nervous about it. So, start small. Take one step that is so small you cannot possibly fail.
How much money do you need to retire?
I recommend simply calculating how much money you need in retirement. You can then compare that to how much you are already putting aside. Is it enough? The answer does not matter today. What matters is that you have the knowledge. You know where you are today and where you need to get to.
There is a simple way to figure this out. First just look at what your living expenses are today. Total up your mortgage or rent payments, plus what you pay for bills (electricity, water, cell phone, food, etc.). Maybe a add a bit on top for enjoying yourself. You do want to enjoy your retirement, don’t you?
Let’s say that this comes to $65,000 a year. This is what you need after you pay any taxes. Let’s say that your tax rate is 35%. This covers any and all income related taxes that you’ll have to pay. So, you will need a pre-tax income of $100,000.
Don’t forget inflation!
Now this is based on today dollars (2018 at the time of writing). Average long-term inflation in the United States is 3.22%. Let’s say that you are 40 today and intend to retire at 60 years old. Based on an inflation rate of 3.22% you will need an income of around $188,000 from your retirement portfolio.
How do you calculate that? Use the online finance calculator. In the picture below, I’ve already
filled out the cells for you:
Fill the cells in just as I have here and hit “Calculate”. The key result that you are looking for is the “Future Value” (or “FV”):
You can pretty much ignore the rest. $188,495 is what you need to be earning from your retirement portfolio to be comfortable in retirement. But actually, if you pay off your mortgage before retirement you may not need this much. But to be prudent let’s assume that you do.
How big does your portfolio need to be?
So, if you need to be earning $188,495 from your portfolio, what size portfolio do you need? Conservatively speaking, you should be able to earn a return of around 4 to 5%. Let’s be prudent and say 4%.
So, $188,495 is 4% of $4.7m. How do we know? Just divide the income of $188,495 by 4% and you get $4.7m (I have rounded down slightly).
How much do you need to save?
So how much do you need to put away each month to accumulate a portfolio of $4.7m? It is reasonable to assume that you can earn a return of around 7 – 8% per year. This would be from a diversified portfolio. Lets goes with 7.5%. This would be from a portfolio including an even mix of stock and bond index funds.
Let’s say that at age 40 you already have put aside $1m. We fill in the calculator like so:
And this will give us results like this:
And quite helpfully, the calculator tells you exactly how much you need to contribute in order to reach your required portfolio. You need to put aside $10,441.10 per year.
What if you can’t afford this?
But what if you can’t afford $10,000 per year? Or if your current savings are significantly less than $1m? Then you may need to consider retiring later. Maybe at 65. Or maybe you accept a lower income in retirement. Or maybe you find ways of reducing your expenses now so that you can put more aside.
But do you see how this analysis alone changes your mindset? You are now asking the right questions. If there is a problem you are now proceeding towards a solution. You will not be surprised by your retirement portfolio. You will know exactly where you are heading. And you can make changes now to get back on course.
This is an example of slow thinking.
Going back to what I said earlier about fast and slow thinking: this whole process is an example of slow thinking. You are not reacting to extreme events occurring in the market. You are doing real analysis and considering the results. And you are making decisions based on clear reasoning.
Don’t fall victim to the “Bloomberg Effect”!
By following this framework, you will be immune to what I call the “Bloomberg Effect”. The Bloomberg Effect is this habit of reacting to changes on a daily, hourly or second by second approach. On Bloomberg they report the market like it’s a sports match.
Investing is not a sport!
Well investing is not a sport. An experienced investor does not make changes in his investments based on what is happening in the news. Instead, he monitors his investment over months or even years. He considers far more than P/E ratios or whether the stock is up or down on a particular day. Neither does he react to headline profit or loss numbers.
This is because he conducted reasoned analysis into the company before investing in it. He considered the quality of the management team. The experienced investor looked at the overall state of the market and economy. In addition, he considered the product that the company sells. He looked into their history. And he has in place a tried and tested framework that he does not deviate from.
The experienced investor also invests for the long-term. He does not buy in the morning to sell in the afternoon.
And neither do you.
Invest for the long-term
You also are investing for the long-term. If the market is down today, tomorrow or for the entirety of this year it doesn’t matter. In the long-term you know that it will go up. You know this because you have done your research (by reading my articles). You are also following a tried and tested framework.
Your framework differs from the experienced investor only in that you are not a professional investor. You are a man just trying to meet his personal goals. These goals include retirement and leaving something for the kids. Above all, you now have the right mindset to achieve those goals.
Reinforce this new mindset!
But make sure you have sealed this new mindset into your consciousness. Go ahead and make these calculations. It will take you five minutes and you will have an instant result. You will have suddenly made your goal clear and achievable (even if you have to make some changes now to achieve it). I have indicated the steps to follow in the following illustration:
As the graphic shows, you need to take the following steps now:
- Figure out your current living expenses
- Add a bit for leisure
- Adjust this amount for taxes
- Decide when you are going to retire
- Use the online calculator to adjust this for inflation (in the future)
- Divide your future required income by your expected future return (4%)
- Use the calculator to calculate your annual contributions
- Decide if this will work or if you need to make changes.
In my next article I will talk a little more about what I can do to help. But if you cannot wait for the next article, reach out to me now. I’m only too glad to help.
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