Today you are joining me at the beginning of my second series of articles. In my first series I covered everything you need to know to begin investing. You can find a summary of these articles here. If you read my articles you now know the basics of how to invest. You will be feeling significantly more confident about investing. You will no longer feel concerned that you will lose your investment in the next economic collapse. And you will not be blowing your money away in savings accounts. You must make good investments if you are to reach your goals.
What will this series cover?
This next series will cover some of the same ground but much more in-depth. Any unanswered questions you had will now be answered. If you haven’t read the first series don’t worry. As I write I assume no prior knowledge. And I will refer back to prior articles where relevant.
So why do you need to invest? What’s the value of learning how to solve this problem? Well it could be the difference of millions of dollars to you over the course of your life. I have one client whose number one goal is to save sufficient money to retire. He calculated that he would need to have a retirement portfolio of $4m to retire comfortably. Based on what he was doing (keeping his money in savings accounts at the bank) I found that he had no chance of reaching his goal!
Savings accounts are a guaranteed loss!
The trouble was that once you adjust the bank savings rate for inflation you will find that you are losing money! Yes that’s right. Keeping your money in the bank is a guaranteed loss. Most of us understand that inflation causes the prices of goods to rise. We see this in the price of our monthly food bill from month to month.
We have become accustomed to the prices of things going up. However, what few of us do, is consider what this means for the money we are saving for retirement. When inflation is high enough, we can actually get poorer! This is even if we contribute more money every month to our savings accounts.
…protect yourself from inflation…
So this is one reason why you need to know how to invest. To protect yourself from inflation.
The other thing that I discovered was that he was literally giving away money. For example, an alternative to the savings account was a diversified fund. This fund would be partially based on an index (like the S&P 500) and partly invested into government bonds. The long-term average annual return on the S&P 500 is about 10%.
Current top deposit rates at US banks are around 2.75%. Average US annual inflation is 3.22% To calculate your real rate of return from an investment you must subtract inflation. So your real rate of return (assuming the interest rate at US banks persists) is negative 0.47%! You are losing money in bank savings accounts!
You could lose millions of dollars in savings accounts!
Leaving aside inflation for the moment you can immediately see that if you invested everything into the S&P 500 you would earn perhaps 7.25% extra per year. Over the years this can translate into millions of dollars! I found that by keeping his money in savings accounts instead of investing it into the stock market, by retirement he would have lost $12 million!
My Background
So who am I? What do I know about investing? In my next article I will fully introduce myself. I obtained both a Bachelors and Masters degree in Finance. I am also a CFA Charterholder. Besides the academics, I have worked for more than 20 years in various investment fields.
Even so, I had my struggles. It wasn’t easy for me and I will explain why. I had a number of roadblocks that I needed to overcome to learn how to invest. I’ll explain how I solved this problem and how you can too later in the series. I will also introduce you to the framework for investing that you can use yourself.
How to avoid losing money
Now this is all very well but isn’t the stock market really risky? If there is a crash won’t you lose everything? The answer is no. In the upcoming articles I will explain how and why. I will show you the historical evidence that proves why. There are various principles that you can implement that will greatly reduce your risk of loss.
Bankers call this “risk management”. In any commercial bank you will find large risk management departments. All these guys do all day long is (try) to protect the bank from risk. How do I know? Because I used to do it.
One way bankers prevent losses…
One of the methods that risk analysts use is to determine what the worst case scenario would be from a given investment. They then decide if this is something that the bank can tolerate. For example, lets say that the bank wants to make a real estate loan. The borrower wants to borrow $65m against a property that is valued at $100m. The loan is 65% of the value of the property. This provides a margin of safety for the lender. As long as there isn’t more than a 35% fall in the value of the property, the bank isn’t going to make a loss on its loan. For the borrower it’s a different matter. The borrower would lose all of his investment in this case. But then he must practice risk management of his own.
What about stock market investors?
One key way that an equity investor can protect himself (that is the borrower in the above example) is through diversification. Don’t keep all of your eggs in one basket. If you invest in every stock in the S&P 500 you will be well diversified. Some stocks will go up in value and some will go down. But as I said above, on average the S&P 500 will go up by 10% per year.
Now there are of course times when the market crashes. But frankly this overstates things. While the market will go down significantly during a crash (the S&P 500 went down 39% in 2008) it recovers. The S&P 500 went up 156% in the next ten years more than making up for the loss.
How does Warren Buffet do it?
Warren Buffet has a method of risk management which is similar to the banks methods. He buys the stock of companies that he judges to be priced at 50% of their value. This provides a margin of safety in that his estimate of value would have to be off more than 50% for him to risk losing money. In Warren Buffet’s view this is very unlikely. I’ll get more into Warren Buffet’s investment strategy later in the series.
Index Investing
Later in the series I will talk in-depth about how you can quite easily invest in diversified funds. Primarily this is done through index funds. I will explain how these work and the difference between mutual funds and exchange-traded funds (ETFs). I will explain about the difference between passive and active investment funds. In my view, for most investors, a passive index fund is the way to go. This especially true if you simply don’t have time to monitor investments.
Investing for the kids
Perhaps you have a family so you are feeling that you need to ensure they have a secure financial future. Perhaps anything you do for the kids will be more a safeguard guaranteed investment where you are very risk adverse. But equally, it is important to you that you can maintain your lifestyle – also that your children and your wife can live comfortably.
In this series you will learn how you can accomplish both goals. You will discover how to protect your kids’ future while maintaining your lifestyle. Typically, men might be looking to retire early. This is a huge goal.
One of my clients, in addition to retiring comfortably, wanted to ensure that his daughter’s education was paid for. While he was doing very well financially, some of his current investments were very risky while not actually providing a particularly high return. The majority of his wealth was in bank accounts. Bank accounts are the worst place to keep your money. Later in the series I will discuss what measures you can take to protect your children.
How to improve on the rates from the bank
A key source of frustration for people is the terrible rate of savings that you receive from the bank. This is particularly galling when you recall that the banks were responsible for the greatest financial crisis that we have known. As a reward for nearly destroying the world economy, banks were bailed out by Western governments. The Fed essentially printed money to pay for the bail-out. This resulted in inflation which destroys the value of your savings.
What this means is that responsible people like you financed the bail-out of irresponsible bankers. I’m sure that you would like to put your money somewhere else besides banks. A huge challenge for people is not knowing where to invest your money for the best return possible. Well trust me, the bank is not the place!
What you need to know is: where can you put small sums of savings that will grow (faster than inflation)? Essentially, I have answered this question already. If you put your money in a diversified stock portfolio you will earn an extra 7.25% per year on average.
I will talk in detail about the problems of banks in later articles. Specifically I’ll talk about the severe problems they cause society as well as the problems that they cause for you personally.
Can I access my money when I need it?
One issue that comes up frequently when I talk to clients it the question of access. Access to your money when you need it. In investment parlance, we refer to this issue as liquidity. Different investments have different levels of liquidity. This is your ability to quickly liquidate the investment and get your money back.
Different types of investments have different levels of liquidity and therefore different levels of access. So, for example, if you put your money in a savings account you can usually access it anytime you want. But if you put your money in a pension you may have to wait decades. Usually until you retire. Sometimes you can get your money back early if you pay a significant penalty.
Access issues with pensions are common…
Many of my clients have issues with this. Private pensions can be frustrating. Suppose you are out of work and all of your investments are tied up in private pensions? Well you can’t get any money back until you retire. Not much good if you need to eat now.
Others have issues when they move countries. I have clients who have moved from Britain to the US. Or from Britain to Australia. One of my clients is frustrated that he can’t move the funds from his British pension into a 401K. I have myself have a Roth IRA. I moved from the US to the UK. But when I tried to make contributions to my IRA I was charged a penalty!
This is a real problem. The answer here is to have other investments besides your pension. I’ll talk more about your options later in the series.
Conclusion
So to conclude, I’m going to have a lot of good stuff for you in this series. Besides covering the above I am going to cover the following:
- The number one problem that stops people from succeeding in investing
- An in-depth description of how my system works: the Investment Framework
- I’ll show you what you need to know before you can implement this framework
- I’ll teach you the actual steps that you need to follow and how you can apply them to your personal situation. For example:
- How to avoid losing money
- Protect your kids’s future
- How to improve on the rates from the bank
- Being able to access your money when you need it.
- Real life examples of how people successfully applied my system.
- How to change your mindset so that you can meet your investment goals
So there it is. By beginning this journey, by reading this series of articles, you are taking a giant leap forward towards your goals. By the end of this series you will have a strong alternative for the banks’ pathetic savings accounts. I’m excited for you.
And of course, if you can’t wait for the articles you can always talk to me now. Just tell me a little about yourself and I’ll see what I can do to help.
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