The onset of Christmas brings with it for many a sense of refuge. The promise of a few days when our everyday worries are neutralised by a haze of twinkly lights, booze, food, and family bonding. As long as we can just get there…

I felt I recognised a touch of that pre-Chrimbo fatigue in a comment from Monevator reader, Sarah, requesting a motivational piece on Financial Independence (FI) in the face of evaporating savings rates and warnings of muted equity returns ahead.

Actually, reading that comment from Sarah gave me some cheer. Not because I’m a git that revels in the misery of others, but because it helps to remember that I’m not the only one who finds the FI going hard sometimes.

It can be a tough old plod, and I think this is partly because even the followers of FI generally think of saving the way the rest of society does – as a sacrifice.

Yes, we’re deferring consumption today to enjoy consumption tomorrow, but we don’t have to swallow the notion that every pound socked away until Independence Day is somehow happiness denied.

Because that’s thinking like a good little consumer. Falling back into the trap that we can buy off our lows and woes with a new iPad, hair extensions, or a posh meal out. Essentially acting like a caffeine addict who staves off the headache with another Venti latte.

We’d do better to cheer ourselves up with the thought that whatever comes our way, the FI good times start long before you smash off the final shackle.

I want to break free

I believe the journey to financial freedom can itself create a profound sense of personal change for the good:

• You realise you’re thinking for yourself and that’s something to be proud of given societal pressures to conform. You’re no longer accepting the world as it’s presented by family, friends, and the advertising industry.

• You stop looking for answers in the wrong place. A desire for power, status and trinkets is replaced by the values of freedom, fellowship, and a sense of true worth.

• Perhaps most of all, you gain a sense of purpose. When you have a bad day, week or year, you know that it wasn’t for nothing… your efforts are still moving you towards your goal.

Like any other worthwhile pursuit, FI sharpens your skills. You get better at it. You stop seeing yourself as a number on a pay check. You’re able to value things because they make a difference to your life rather than because they’re fashionable or because they offer an off-the-peg sense of identity.

“I must be successful because I drive a BMW.” That sort of mind-rot drops away long before you reach FI.

Just knowing there’s a finishing post fills your lungs with oxygen, but something amazing happens as the financial furlongs slip past. You gallop faster and faster until you feel like you’re running downhill.

“Hey, you know what? This is easy. I feel great! I feel less vulnerable. Even if my wages are stagnating and growth rates are tunnelling out the bottom of the graph, I’m still better off than if I’d never started this thing. I’m living on 90%, 70%, 50% of my income – I didn’t even realise that it was possible before and I don’t feel any worse off.”

That’s how it can feel when you look at it through the spectacles of optimism rather than the soap opera glasses of pessimism.

The choice is not freedom or consumption. We need both.

The choice we’re making on the way to financial independence is being free to consume only what we need and to spend the rest of our time gorging on the most amazing good of all: freedom.

Take it steady,

The Accumulator

Good reads from around the Web.

The behemoth of low-cost investing is having a great year, reports Bloomberg’s Businessweek:

Vanguard is not just having its best year ever. (It shattered that record in September.) The $130.4 billion in deposits in mutual funds and exchange-traded funds that Vanguard has taken in through November is the most ever for the industry, according to data from Strategic Insight.

That beats the $129.6 billion that JPMorgan clocked, mostly for money market funds, in 2008. This year’s not over.

The article is peppered with interesting quotes about the advance of Vanguard’s business, and the rise of passive funds and ETFs in general.

But consider this section:

It’s asymmetric warfare, as Vanguard’s sole ownership and constituency is its fundholders, the savings it wrings from its buying power are passed on to them, not to shareholders or partners.

As Vanguard grows from niche player to one of the biggest beasts in the investing jungle, I think this practice of redeploying money towards its customers might enable an unbeatable feedback loop.

The Robin Hood of the fund world

Consider how much Wall Street and The City has syphoned off returns over the past few decades. Now imagine more of that vast amount of money going to lowering Vanguard’s already tiny fees on its passive products, and you see the power of the model here.

Customers owning the company would be a template for a new kind of capitalism if it worked everywhere, but it doesn’t. Usually self-interest allied to the profit principle works better. The pursuit of self-interest produces innovations and superior results at the expense of lazier competitors. That in turn generates superior profits, driving out weak competitors while making the winning companies even stronger.

But I think financial services might be different – and Vanguard able to exploit that difference – because historically it’s been the case that superior marketing – if you include the very idea that active funds beat the market – is what has generated superior profits, as opposed to superior performance being duly rewarded.

After all, in aggregate, active management can’t outperform passive funds, after fees. That is the whole point of index investing.

Passive index funds are cheaper, so will deliver better profits for most investors over time. Yet while index funds are on the rise, they don’t yet attract the lion’s share of money their performance should theoretically deserve.

The worm that turned

Because of superior marketing – which we might define to include everything from a more compelling story to established and trusted brand names – active fund management still attracts investment ahead of passive funds.

Indeed, hugely expensive hedge funds can potentially net their promoters the best profits of all – despite these funds in aggregate failing to beat a 60/40 balanced tracker portfolio!

Yet this is a zero-sum, largely zero-skill game, after costs1, which is what makes cheap passive investing so attractive.

In the past, the excess profits generated by the myth of active fund management has gone to enriching the employees and shareholders of City companies.

But because it reinvests the profits that most of the rest of the industry hives off, Vanguard is different. In its case it’s the fundholders that are going to be enriched. The more record-breaking fund flows it attracts, the more its customers will benefit through better (i.e. cheaper) performance.

Will there be a tipping point where ‘everyone knows’ that passive investing is the mainstream choice for greater returns over the long-term?

Or will active fund managers always be able to sell short-term outperformance as a more exciting long-term prospect?

[continue reading…]

1. It is not that active fund managers are not hard working and clever that is the problem. It is that they are ALL hard working and clever, as well as competing against each other. In aggregate across the fund universe there is no out-performance in returns – there is only seepage to fees and expenses. [↩]

Many people would benefit from knowing more about passive investing. But not many of those people are prepared to read about why it’s usually a superior strategy to active management.

No, not even when the articles are as delightful as those stored up by my co-blogger The Accumulator in his passive investing guide.

Indeed, a good argument as to why active funds remain so popular despite the evidence that most fail to beat index funds is that active funds are much better at marketing. The devil has all the best tunes, they say!

But what about a movie about passive investing? Surely even your most disinterested friends and family might be persuaded to spend an hour watching pretty pictures explain why passive investing is the best way to build their long term wealth?

Passive investing: The Youtube movie

Okay, so there’s no chance of a 54-minute Youtube video being sexier than Gordon Gecko’s dodgy dealings in Wall Street, but it might just be more profitable.

Grab some coffee, a significant other and/or a bag of popcorn and enjoy!

Well, what did you make of it? I think the film does a pretty good job of laying out the basics. The overall production quality is excellent.

And so many A-list stars of the index fund world!

Of course we were slightly miffed we didn’t get a call to the casting couch here at Monevator. (It’s a UK production, after all).

True, our anonymity clause would have got in the way. But then again we might have been presented as shadows cast upon on a wall, with our words of wisdom dubbed with unlikely, rough-sounding accents. It would have given an underground ‘smash the establishment’ vibe to proceedings.

Actually, that’s not a bad idea. Perhaps we’ll shoot our own art house movie!

Please share your passive investing film reviews in the comments below.