One of my favourite investing books is Free Capital. It profiles a dozen successful private investors, with insights into their lifestyles as well as their methods.

Free Capital is unusual in focussing on UK investors. Most investing books are about Americans. At a time when you’re more likely to meet someone in the pub who’d rather smash the system than buy shares in it, it’s nice to know you’re not the only optimistic nutter in the asylum.

As I said in my original review, Free Capital also appeals to me because I dream of achieving financial independence through investing, just like its subjects.

All the investors profiled live off their money. They are free to invest their capital how they like, but they are also free to take the day off to go to the zoo and see the monkeys. They need never do another day in the office, unless they want to.

Given that many people live paycheque-to-paycheque, are wilfully ignorant about managing their money, shun shares, and save little towards their retirement, this drive to achieve financial freedom through the stock market is far less common than it might seem to the typical Monevator reader.

DIY private investors

What else do the private investors in Free Capital have in common?

Most obviously: They made it.

The book’s author didn’t interview a dozen people who failed to invest their way to millions. Survivorship bias looms large.1

This is especially important here, because all the ‘free capitalists’ profiled are active investors, and the academic evidence is clear. Most active share traders will fail to beat the market, and would do better in index funds.

Were the stock pickers in Free Capital skilful or lucky to end up on the right side of the bell curve of returns? Let’s leave that for another day.

In this post I want to focus on the lifestyle choices that enabled them to amass their wealth, which are equally important.

Earning returns of 20% a year makes achieving financial freedom quicker and likelier, no doubt. But without the habit of socking away cash and risking the market’s ups and downs, you’ve got no chance, whether you’re in passive funds or Bolivian small caps.

All the private investors in Free Capital:

• Saved a large chunk of their income instead of spending it.

• Learned about investing and managing money – often via a painful apprenticeship period of losing it.

• Risked their funds in the stock market for superior long-term returns, compared to bonds or cash.

Those are the fundamentals, whether you’re a passive investor, an active investor, or like me some hybrid of the two.

As the Australians say, “You’ve got to be in it to win it!”

What else?

Guy Thomas, the author of Free Capital, says there is no single thread that we can replicate for success. No surprise there.

But there are things that most of his successful investors have in common.

1. Future time perspective

Psychologists have discovered we tend to see our experiences through a past, present, or future time perspective.

People with a present time perspective, for example, might be more interested in making a big salary now (and perhaps spending it!) than in seeking uncertain future gains from the compound interest on their capital.

Most of the successful investors in the book seem to have been born with a forward-looking mindset. Many got interested in making money at an early age. None had big debts to pay off or other bad financial decisions to undo before they started investing

2. Few responsibilities or dependents

Several of the investors achieved financial freedom before they got married or had children. That’s no mean feat given the sums involved, and the fact that people typically pile on responsibility in their 20s and 30s.

I noticed several of the investors remained unmarried, too, even after achieving success.

Children and a non-working spouse are a big drain on anyone’s financial resources, which means less money to invest and compound.

There’s surely also a freedom in being unanswerable to a long-term partner. Given how weird dedicated stock market investing seems to many people these days, the chances of you marrying a like-minded soul are slim.

I’ve seen friends make money despite marrying at an early age and having kids, but invariably it’s been through career success (albeit with some carefully judged risks, including starting their own business).

I suspect throwing your life into your job is more socially acceptable than saving 50% of your income and investing it in the stock market.

3. Not career-minded

One advantage these investors had is they weren’t turning their backs on a great career to start investing.

Just as I wouldn’t say anyone should avoid kids to become rich – not if you really want them – I don’t think anyone who loves their job should quit for investing. (Especially as the evidence is most would do better putting money into a passive portfolio, leaving plenty of time for even the most demanding career).

But how many of us really feel a vocation when the alarm goes off in the morning?

If active investing was a skill you could definitively learn and profit from, I think many would prefer it to the 9-5.

4. Invest for freedom, not consumption

Most investors in Free Capital live unflashy lives. Like a Zen martial artist on the fringes of a Saturday night brawl, they could show off if they wanted to, but they prefer self-determination to sports cars and bling.

It’s important to be honest with yourself. I recently realised that if I made a great deal of money, I’d probably buy a fancier property than I once thought. But otherwise I’m certain I wouldn’t start throwing money about.

Anyone wanting to flash the cash will likely prefer the quick hit of a big salary. Investing your way to £1 million takes time – unless you start with £2 million!

Once you’ve made money the slow way, you’ll probably find spending it is more of a challenge than a temptation.

5. Avoid borrowing to invest

Virtually all the investors profiled avoid leverage – that is borrowing to invest. Even those who use spreadbetting do it without gearing up much.

Again, this is a small sample set, but I’d argue survivorship bias actually teaches us something here. Using debt in volatile markets works until the market turns down and takes all your geared-up capital with it. One severe dislocation can lose you more than you started with, which can’t happen unless you borrow to invest.

There’s a case for running a mortgage alongside a share portfolio. Otherwise I’d avoid borrowing like an England football team avoids World Cup glory.

6. Not team players

All the investors in Free Capital work alone. No great shock. Most people who want to be in with the crowd wouldn’t even think about investing in shares.

The only time investing has been popular in my lifetime was during the Dotcom boom. That it ended with a bust should tell you all you need to know about seeking comfort from others in the stock market.

As Steve Jobs said, “Better to be a pirate than join the navy.”

7. They enjoy investing

Everyone profiled in Free Capital clearly enjoys investing. Some – those spouses you need to avoid, for instance – might even say they’re addicted.

All the featured investors could put their fortunes into passive portfolios and spend their time doing whatever they wanted. However it’s pretty obvious that being in the thick of the markets is exactly where they want to be!

It’s like when people ask why billionaire entrepreneurs keep on working despite having all the money they need. The answer is they weren’t doing it primarily for the money. That’s just a way of keeping score.

I’ve mentioned before that “because I love it” comes far above “because I might make better returns” on the list of reasons why I pick shares rather than solely investing through trackers.

Yet spend time with Monevator’s passive fund hound The Accumulator, and it’s obvious he’s almost as gaga for investing as I am – even though he hands his money over to an index-tracking computer every month.

I can’t tell you to love investing if you don’t, and happily it’s not a prerequisite. By regular investing a chunk of your earnings into a well-diversified portfolio, you should do fine.

However there’s no doubt that loving it makes it easier.

I’ll happily read company reports on my iPad all day, turn to the Business section first in The Sunday Times, and I actually look forward to bear markets for the thrill of securing cheaper bargains.

I could – and do – tell people I invest because it’s intellectually stimulating, and it keeps me engaged with science, technology, and other developments.

But the truth is it’s not even a chore, because I love it.

You can learn more about successful private investors by reading their full profiles in Free Capital. I notice it’s now available on Kindle, too.

1. Survivorship bias is the error and consequence of focussing on winners because the losers are not so visible. For instance, you might go into Waterstones and see thousands of novels available, and conclude it is easy to write a novel and get it published. You are forgetting the hundreds of thousands of rejected novels lying around forgotten in bedroom drawers or on hard drives, because you cannot see them. Also remember that the range of novels in a bookshop is the cream of at least 200 years of novelist output! [↩]

Good reads from around the Web.

I could make every post of the week in my regular weekend reading slot one from Mr Money Mustache. The guy drops more bombs than Wile E. Coyote.

Besides being wise and funny, his blog is also stuffed with swearing, shouting, and uncompromising stances. It’s what my blog might be if my prosencephalon didn’t insist on compromises, caveats, and complicated clauses (not to mention ad hoc alliteration).

Some people think they hate Mr Money Mustache. I point them towards it, only to hear how they’re annoyed by the cursing and his made-up words like ‘complainypants’ and ‘Mustachianism’. 

They’re still telling me how annoying it is two months later, when they’re clearly still reading it.

A couple more months more, and it wasn’t them who ever said a word against Mustachianism, oh no guvnor. They’re his biggest fans!

Like this, Mr Money Mustache is taking over the U.S. blogosphere. He’s going to end up bigger than Dave Ramsey, Suzie Orman, and all those other people we’ve never heard of.

And when he does, it will be because beneath the love-him-or-love-him-a-bit-later fireworks, he’s got a rare talent for writing.

Here he was this week writing about a piece of junk mail. Just some junk mail!

I sometimes try to deny it, circulating in my privileged life of bicycles, library books and You the Mustachians.

I pretend that the shopping malls have closed and the former customers are all out there chipping up the asphalt to plant great community gardens. The Escalades are all gliding slowly along their Final Conveyor Belt, about to hit the carbide blades of the grinder which will shred them for reprocessing into wind turbines and solar panels.

But yesterday, someone had the nerve to stuff the mailbox at the Mustache residence full of colorful flyers advertising a huge array of Absolute Crap. And these flyers reminded me that that our work here is far from done. And they enraged me sufficiently that I was forced to grab a pair of scissors and some school glue in order to make the following Infographic for you. Study it, and try to keep a handle on your pulse rate, for it is horrifying indeed.

Beneath the pen, paper, and glue infographic, he asks:

Are people out there still buying scaryass white-bread fast food and jugs of “soft drinks”, a substance only barely less toxic than drain cleaner?

The food is sold with big closeups of deep-fried batter, when instead the image should be of the decaying 720-pound corpse of a man who died in his mid 40s of diabetes and obesity complications.

Read the full post, and find your mind being tweaked and re-tuned by his deceptively spectacular prose.

[continue reading…]

I don’t know why any investor would worry when a financial regulator predicts lower future returns.

The regulators have no notable skill in making long-term market calls. And nor should they – it’s not their job.

So I’m not particularly saying it’s incompetent of the regulators to lower the pension forecasts that financial firms are allowed to use to illustrate what you might get by investing in their products.

No, if I wanted to question that, I’d point to:

• The enormous financial crash we have just lived through, which happened on their watch.

• The boom and bust in most property markets, which happened on their watch.

• The fact that they permitted provincial High Street banks to gear up to an extraordinary degree and spend money on commercial property like it was going out of fashion – just as it was about to.

• The PPI insurance scam that they allowed for over a decade with nary a care – where the bill for cleaning up the mess is on track to hit £12 billion.

• Their genius at forcing pension funds to load up on bonds at record low yields.

• The 50% of mortgages in London and the South East that are interest-only. (Though they can be a useful tool for a few, they have blatantly been misused by many to chase soaring house prices, with no plan to repay them).

I could go on, but happily CityWire has already done so with its 10 scandals the regulator could have prevented.

The point is that financial regulators seem adept at rolling up to the scene of a horse absconding and nailing the stable door shut, even though the nag has been headbutting the walls and braying like a wildebeest on heat for years.

Which brings us neatly to the lowering of pension returns.

What goes down can go up

It takes a special kind of rocket scientist to be employed in the financial services industry – to be steeped in the investing world, and to have unique access to clever market participants at the highest level – and to somehow have missed the most fundamental truth about markets.

Which is that they go up and down.

So here we have the regulator rolling up to the scene of the crime not long after the worst decade for equities relative to bonds (the worst two decades, even) to warn us – wait for it – to temper our expectations.

As far as useful advice goes, this is a bit like Eva Braun showing up in London in the middle of the Blitz to warn Churchill that her boyfriend seems a bit obsessed with guns.

What was the regulator doing in 1999, when the UK stock market peaked at nearly 7,000 and shares traded on a P/E of around 30?

Evidently not tempering expectations, given that the sanctioned projections are only now being lowered, 12 years and two bear markets later.

The long-term means the long-term

Go and look at the historical returns for UK and US assets, and you’ll see there’s little historical basis for radically chopping your expectations down to a smaller size.

Stock market crashes are nothing new. Low yields on cash and bonds aren’t either, although they have been five or six decades coming. Somehow we coped before.

It’s true that the returns from bonds are probably depressed from here, and I can’t really fault anyone who warns to that effect. The 30-year bull market in bonds is surely bumping along the bottom at best – there’s only so far a yield can fall.

But the corollary in my view is equity returns will likely be at least average, if not higher, from here. That’s what studies like the Barclays’ Equity Gilt Survey reveal.

True, we’ve already had some saucy returns from shares since the low point in March 2009.

And I’ve had a couple of years of occasionally being called an idiot for writing on this blog that readers should consider sticking with shares for better long-term returns since then, too.

Never mind. I’d far rather be right, laughed at, and richer, then to stand with the consensus in the corner and lose my money in company.

Sure, latecomers to the post-crisis rally probably shouldn’t expect the 20%-plus returns that looked likely for the following decade back in 2009.

The major markets have moved pretty far already. Nobody knew when those returns would come, and they came a lot sooner than anyone predicted.

But in my view there’s no reason to panic. I think that over appropriate timescales, returns are likely to continue to be healthy from here.

It’s worth pointing out, incidentally, that the job of projecting the new forecast returns was delegated to accountants PricewaterhouseCoopers. The regulator hasn’t just conjured up these new figures in the pub one day.

What’s more, the PwC research is extremely detailed, and well worth reading if you’re an investing nerd like me.

So please note I’m not having a shot at the mathematics, or the endeavor.

It’s the timing – at the end of a very bad period for investors and a near-catastrophic one for financial services, and in the middle of a grinding stop-start recovery – and the recency bias that I suspect informs both the motivations and the conclusions of this report. That’s what I’m questioning.

The new normal (it’s nothing new)

What about that big picture, I hear you ask? The mountains of debt, the inevitable low-growth future, the terrible demographics, peak oil, China taking all the proper jobs, the aversion to shares that will last for generations, and all that?

And do I hear somebody muttering about Japan at the back?

Where do I begin?

I’ve dealt with Japan before, so as far as I’m concerned I’ll scratch it off the list.

As for peak oil, notice you don’t hear anybody talking about it much anymore?

That’s because exactly as skeptics like myself predicted, capitalism responded to higher energy prices by finding new sources of energy.

In the few years since peak oil talk peaked, America has found so much natural gas that it’s now being touted by some (maniacs) as the Saudi Arabia of the 21st Century.

True, fracking is environmentally questionable, and burning fossil fuels could well contribute to environmental collapse (something you should worry about).

But that’s never stopped Americans filling up their SUV before.

The point is, those supposedly nailed-on energy shortages have now been punted – again – decades down the road by new discoveries. And that’s just one example. Go and investigate the rate at which solar technology is improving, or the advancing fuel efficiency of cars and airplanes.

I doubt we’ll ever run out of oil. We just won’t need it one day.

That’s a good cue to write-off most of the rest of the concerns of the fearful masses. Whether it’s their love of ‘real work’ sweatshops or their concern that the West is not making PCs and cars anymore – abandoned handily ahead of PCs becoming commodities and the margins on brute force car-making collapsing – low-growth Luddites suffer from an enormous failure of the imagination.

Their worldview (and I appreciate this includes some of you) is stuck in the past and looking further backwards.

Imagine it’s 1910. Would these visionaries be anticipating mass air travel, nuclear power, television, nylon, the pill, and Facebook?

No, they’d be bemoaning the loss of some rubber plantation in India.

Would I have predicted Starbucks and Twitter? Like heck. But I have the humility (just!) to know that the future is inherently unknowable.

And unknowable doesn’t mean automatically doomed.

I see plenty of reasons to be optimistic about the potential for humanity and Western companies in the years ahead.

Huge new markets stuffed with consumers have replaced closed countries building tractors nobody needs. When not making stuff we want at unbelievably low prices, these young nations are now innovating, too – all good, it keeps us on our toes – while the Internet is spreading knowledge that once took decades to leave academia in milliseconds.

Masses of promising technology stands ready to remake our world again, from bio-pharma to 3D printing.  Most of this research is led and owned by Western companies, who also own by far the biggest brands on the global stage – in a world where emerging markets have proven even more gaga for brands than us.

But apparently we’re doomed because the Chinese make our dishwashers.

Right.

The bear case always sounds smarter

I am not some happy-clappy Panglossian optimist. (Again, go read my post on environmental degradation for a touch of the Apocalyptic).

I do think though that if you are gloomy about our society and our economic system, then you need to realise optimists like me don’t have to prove anything is different this time.

Whereas you do.

The FTSE 100 is on a P/E of about 11, and yields nearly 4%, far more than cash and bonds. I doubt there’s any historical precedent for UK shares doing badly from these levels over the long-term.

As for globalisation, financial panic, deleveraging, and all the rest – none of this is anything new.

Trade between nations has been making us richer for hundreds of years. Financial crisis come along like clockwork.

As for deleveraging and the suffocating mountains of debt:

• The early 1990s saw a massive property crash in the UK that led to hundreds of thousands of homes being repossessed. Just a few years later, London was booming again.

• The $1 trillion US budget deficit that dooms the world’s biggest economy to endless grinding misery? Even leaving aside whether the US really needs to address its budget deficit1, as recently as 2000 the US budget was in surplus.

• The mountains of debt that will take US wage slaves generations to repay? The graph below, from February 2012, shows how far the US has delevered already, in the midst of falling house prices and the lousiest recovery anyone can remember.

You can see from the graph that much of the work was done by the end of 2011, and that’s without the benefit of rising house prices (which painlessly reduces debt-to-asset ratios). A similar argument can be made for the UK.

There’s further to go, the overhang will likely continue to curb the recovery, and as I’ve written before, income inequality must be addressed if the middle-classes are to get back to their feet to drive Western economies forward without the crutch of excessive borrowing.

But beware tidings of doom from every corner from people who were silent (or more likely oblivious) on the economy and its debt issues when they really were a mounting problem – five or six years ago.2

The only way is up! (And down and up and down)

I agree every instance is different. History doesn’t repeat itself, it rhymes, and with a lisp at that.

But the point is Western capitalism has dealt with all this and more – total global war, seemingly imminent nuclear destruction, the influx of half the human race into the workplace as the jostling of men and women refashioned the basic tenets of our economic way of life – and yet we’ve motored on.

Could the worst predictions come true? Unlikely, but anything is possible.

In particular, I absolutely guarantee that at some point over the next 30 years you’ll be able to pick the price of shares, gold, property, bonds, or anything else in one instance, compare it to another instance some number of decades away, and make the returns look bad.

But that’s a long way from saying that a 30-year old who begins regularly investing into a pension now is doomed to expect less than his or her parents did. They have many years of ups and downs ahead of them.

I strongly believe that – to simplify – as long as you keep the equity dial turned to full for the first half of your 40-year investing horizon, and then de-risk and rebalance over the years that follow in case you’re hit by a crash, you’ll do fine.

Be prepared, but not downbeat

None of this is to take anything away from The Accumulator’s advice to stress test your retirement plans.

And I’m not just happy he highlighted the latest pension forecast figures on Monevator – I’m proud he did.

It’s by taking control and being informed of these developments that you have the best shot of reaching your financial goals.

Hope for the best but plan for the worst will always be the best advice.

I don’t even mind the regulator dialing down those projections, as it happens, even if I won’t be losing any sleep over them.

While I don’t think investors should panic, that doesn’t mean the changes are harmless for everyone.

On the contrary, if it means that financial firms are less able to bamboozle us, and to hide their bloated fees inside flabby projected returns, then cutting them back is all to the good.

I don’t even have anything against the regulatory profession. Rather like the much-maligned ratings agencies, they have no incentive to do anything other than what the masses and their political masters ask of them – which is to step out of the way and let the money-making merry-go-around continue until something goes wrong, and then to be seen to do something.

It would be an absolute tragedy, though, if a young would-be investor plugged the lowest of the new projections into a calculator, and was so daunted by the prospects that they threw in the towel before they even started.

It’s rational to be optimistic about stock market returns

Nobody ever got rich by being pessimistic. But if you’re going to be gloomy, you’ll do better to get that way when everyone else is optimistic.

As Warren Buffett says, you pay a very high price in the stock market for a cheery consensus.

Buying at cheap to fair value is what drives good long-term returns. Not waving your hands above a darkening crystal ball.

Think long-term, live well within your means, and save and invest all you can. Unless you’re already a millionaire, learn to cope with volatility and equities, rather than trying to stretch a 2% return into a viable pension fund.

Oh, and if you do all that and this site is still around in 30 years time, then please come and tell me how you fared.

I’m confident I’ll have no reason to nail shut the flapping barn doors.

1. Ten-year Treasuries yield less than 2 per cent, which implies borrowing is bargain basement cheap for America and so might be perfectly rational. [↩]
2. As a quick litmus test, when they cite some seemingly insurmountable debt figure, ask them what the size of the US economy is. Few will get within $5 trillion of the real figure. US GDP was $15 trillion in 2011. Many latter-day prophets of doom are suffering a severe dose of sticker shock. [↩]