The internet can swamp the best of intentions. When you want to know how to do something, there’s nothing like 274 million Google hits to make you think that you’re never going to find the time.
This fire hose of human knowledge can all too quickly become a water cannon.
But one of investing’s oft-neglected truisms is that the important stuff is actually very simple.
If you get the basics right and resist the urge to ‘optimise’ before you even know where to start then you’re likely to do just fine.
Know why you’re doing it
Are you investing:
- For retirement?
- To pay off a mortgage?
- For your kids?
- To create a nest egg?
Is investing success critical to your future happiness or would it just be nice to have?
Only by knowing how big the task is will you be able to calculate what it will take to achieve it.
Only by knowing how important it is will you find the gumption to stick with it.
Save enough to make a difference
A big goal – a comfortable retirement, for example – takes many years to achieve. It will soak up a lot of your financial firepower.
Thanks to the power of compound interest , the more you save now, the less money it will require overall.
Also, the more you save now, the less income you will need to live on, too – reducing the scale of the money mountain you need to climb.
Don’t listen to sticking-plaster merchants who bandy around some random percentage of your salary to put away. That kind of advice is aimed at winning your business, rather than helping you win your financial freedom.
It’s not hard to work out your own plan once you know how.
Keep costs low
The only worthwhile predictor of future investment performance is cost. That’s why we recommend most people narrow the field of investment options to low-cost index trackers.
The best trackers are cheap, simple, and will beat the majority of expensive alternatives.
You can buy them yourself using an online broker.
Diversify
Famously, diversification is the only free lunch in investing. Spreading your bets across the main asset classes is the best way to future-proof yourself against dire loss for any one of them.
Choose an asset allocation that invests in funds offering broad exposure to equities, government bonds, and property. These are the assets that have a long history of solid returns.
Invest across as many regions of the world and types of company as you can for a reasonable cost.
Don’t get sucked into believing that some guru can predict whether Russia will make you a killing next year, or that an aging population means that drugs companies a sure-fire bet.
If forecasters were any better than Mystic Meg then they would make a fortune by acting on their secrets for themselves, not sharing them.
Also understand that there’s no special gain to be made from predicting future trends. Everyone else has the same information so it’s already factored into the price.
Take cover from tax
Use your pension options (workplace, SIPP, stakeholder and so on), employer matches, and ISA allowances to maximise your returns.
Every pound that someone gives you – or doesn’t nab from you – is a pound that’s working for you and not someone else.
Automate it
The less you interfere the better. Humans are psychologically geared to goof up investing.
- Use direct debits and your broker’s regular investment scheme to automatically invest monthly.
- Use accumulation funds to reinvest your dividends.
- Rebalance your funds once a year but otherwise leave your bread in the oven to rise.
The more you tinker, over-complicate and second-guess the future, the more likely you are to end up making the wrong decisions.
Don’t panic
The world always seems to be on the brink of some disaster. Slowdowns and recessions lurk around the corner. Some region or other is gonna blow. War, Famine, Pestilence and Death are always due in town.
Yet somehow civilisation soldiers on.
The media is designed to feed our fears. Ignore it, or better still don’t listen to it and then it won’t bother you.
You can expect equities to fall often: one year in every three on average. But they have always bounced back. Your allocation of bonds is there to cushion the blow in the meantime.
Rebalancing is the self-righting mechanism that ensures you buy asset classes when they’re cheap and you cash in when they bounce back.
Despite two World Wars, the flu pandemic, the Great Depression, the Great Recession, the loss of Empire, stagflation and The Krankies, UK equities have delivered an annualised 5% real growth over the long-term.
Stick to the plan, keep things simple, and remember investing is a long-term game.
Oh, and picking up a good book to help you learn more is a capital idea, too.
Take it steady,
The Accumulator
nest egg
great, sensible as always. what I needed to hear again.
its weird….monevator always seems to put up an article that’s appears to be a word in due season for me !
Great summary – certainly a post to bookmark and come back to.
For me there’s two main over-arching issues to consider – one technical and uncertain, the other closer to home and more tractable.
The first is long-term real investment returns. My financial model goes out 40 years and assumes an annual 2% real return.
All other assumptions being equal (savings rate, retirement date, asset allocation etc) I die with £1m in the bank. If I assume 5% real return per annum it’s £3m. At 0% it’s £0.4m. That’s the power of compound interest but also illustrates the difference relatively small changes in assumptions can make. And I have no control over what the stock market will do in the next 40 years.
The second issue is savings rate. For most people I presume it is much easier to spend a little less than it is to earn a little more.
If you take home £30k pa and spend £29k pa, you have to work 29 years to afford one year of retirement (assuming your financial needs are the same in retirement). If you can reduce your spending to £25k pa (a £4k drop, or 14% fall) you only need to work 5 years for each year of retirement. To me that’s a huge upside for a relatively small downside.
I aim to save half my salary, so each year worked “pays for” one year of retirement, even without the need for real terms investment growth. And, of course, each year worked means I’m one year closer to dying. So each year working lowers my expected lifespan by one year and also pays for one year’s retirement. A doubling of the benefit.
Spending less also means that you’re closer to being able to live on the State Pension or any (fixed, final salary) pension you may have coming. If you can live on (or get close to) that future, guaranteed, inflation-adjusted income stream you simply need to pay for the years between when you retire and when you get that income stream. That removes the “how long will I live” and “investment returns” assumptions.
While investment growth % can make a vast (but unpredictable) difference, I would encourage new investors to look at their current expenditure as closely, if not more so, than their investment amounts and assumptions. Saving more by spending less is a very important first step. Not one often mentioned, so a big thank you for having it mentioned prominently is this article.
great post richard
one of the uncertainties though is how ‘guaranteed and inflation linked’ any future pension promises are. I worry that my pension will be reneged on (public sector pensions in several European countries, not just Greece and other crisis ridden countries, were cut after the financial crisis). And as for state pension, there have been so many changes that it is impossible to even work out current entitlements, let alone assume they might stay unchanged for a few years!
I am looking at a strategy that takes simplicity to another level: buy VWRL. That’s it.
If you are happy to be 100% equity (I am) then it gives you complete global diversification and does not need rebalancing as it covers over 95% of the investable market. Fees are 0.25%/year and no platform charges as it is an ETF. Trading fee only as Ireland domiciled so no UK stamp duty.
The main drawback is that dividends don’t re-invest automatically or via a broker and are paid in USD. You will lose 2% on the FX transfer then have to add these into your next trade (this effectively adds about 0.05% to TER).
Any thoughts on this approach?
@ Ben – the fear I have about a one-fund portfolio is the entire investment disappearing in one go due to fraud/record-keeping problem. Foreign-domiciled funds may have zero fraud protection from your home government too. I’d prefer to have multiple global index funds at multiple brokers, and I’m thinking about moving some of my Vanguard LifeStrategy stuff to some of these:
Fidelity Index World W (clean fund)
HSBC FTSE All World Index (clean fund)
ACWI ETF from iShares or State Street SPDR
I think I need to get away from the mentality of only getting cheapest broker + cheapest fund company. We might think Vanguard is the best thing going but total loss events may be out of their hands.
@Ben @David — Occasional Monevator contributor Lars Kroijer believes that owning the total global equity market like that is the way to go, and not just for reasons of simplicity. His argument is that it represents the best guess of global capital as to where the best opportunities are right at this instance, and that any deviation from that is effectively active investing. He’s suggested an article about it in the past, in fact.
For my part if I was a passive investor pursuing this strategy, then like David I’d be too worried about some sort of unknown/unthinkable happening to have all my money in one fund, so I’d split between 3-4 management groups (and of course 2-3 brokers). But I’m paranoid like that. 🙂
*Sits in armchair*
*Reads*
*Absorbs motivation*
Great summary there 😀
“You can expect equities to fall often: one year in every three on average. But they have always bounced back. Your allocation of bonds is there to cushion the blow in the meantime” – I’m sure whole books have been written that come back to this, obviously based on historical trends…but enough to make the sample reliable I hope :). Ignoring my emergency fund, I am 100% in stocks on this basis. It’s been a nice tail wind so far, but I do wonder what will happen during the next proper market correction and if I will be strong enough to stick to my allocation. I have a good few years left, so I am happy to take the risk. I think!
The point about there being so much information on the internet and in the media in general rings so true. You only have to look at broker recommendations to see how much of a spread there is on what they think. Not that I am saying these people are stupid, far from it, but trying to suggest if something is under or over valued in such a complex and volatile system is near impossible and must need all sorts of magical assumptions. Look at Black Scholes, it’s lovely, but based on an assumption of historic volatility.
This was one of the first blogs I found on investing and the one I return to the most. Keep up the smashing work chaps!
One question – if I was to buy one book, you would recommend Tim Hale’s smarter investing? I can only look at a laptop or smart phone screen for so long.
Thanks,
Mr Z
@Richard
I’m not entirely sure that being one year closer to death can be counted as a benefit 😉
@Luke – well, in terms of financial planning and certainty, it is! 🙂
@Vanguardfan – I agree with you to some extent, although I was trying to keep my post fairly black and white.
I can see the Govt chipping away at the State Pension. Indeed by the time that workplace pensions / auto-enrolment have been in place for a working lifetime I suspect they will have replaced the State Pension altogether. Even if the joint contributions go no higher than 8% (which I doubt – indeed I hope they do go higher) then 45 years at 8% contribution with 2% real growth gives a pot of slightly over £100k which might buy an annuity of, say, £5k. If joint contributions rise to closer to 20% and if investment growth over 45 years is higher than 2% real then our grandchildren might have quite good pensions.
There might then be a means-tested pension (or more likely minimum income guarantee) for those who didn’t get a workplace pension (as they didn’t / couldn’t work).
I hope the Govt goes down that path as it will mean that by, say, 2060 most workers’ pensions will/should be reasonably generous, will be tied (to some extent) to salary (and thus lifestyle expectations) and will be – woohoo! – fully funded, and not borrowed from future generations.
Of course if the new pension rules last to 2060 then the workplace pension pot could be used to buy a supercar. I have no problem with this for investors who’ve actively invested in personal pensions (as now) but less keen for those who accumulate a workplace pension without, perhaps, taking too much notice of it. But who knows what the pension landscape will be in 2060? And I shall be dead, so it’s not something I need to put into my Excel model…
just a note on if your broker defaults on you.
im sure I read some where here on monevator that say,if invested with vanguard, that they would have your name listed with them as proof you had a fund with them. be it via a broker. where individual shares there no listing if held within a nominee account. so you’d be more vunerable with individual shares but not a fund. am I correct?
@Monevator – yet another post of the high quality I’ve come to expect from this blog! Reading this as I’ve just finally taken the plunge and relocated our pension funds from the default choice to a globally diversified portfolio of trackers was just the reassurance I needed that I’d done the right thing.
@Richard @Luke – technically only partly true, for every year you live your life expectancy increases by 3 months, so you only actually get 9 months closer to the grave, as a result of medical improvements and the way mortality figures are calculated. A little known bonus but yes could play havoc with your planning!
@Neil – Thank you for trying to boost my longevity! My Excel model assumes a fixed age at death rather than that I’ll live for another x years, so I think it’s factored in.
Re-reading my last post I notice I didn’t state my assumption of a person on roughly average earnings. I used £20k pensionable for my calculations, although the workplace pension can be calculated on a number of different bases.
I’m surprised The Accumulator’s original post is not getting more comments. I thought it was a blinding summary…
@ Monevator – a great post on a great site. Reading all of the blogs over the past year or so has really helped me sort out my thinking – and my investments!
@ TI – you suggest splitting a passive portfolio between 3-4 management groups and 2-3 brokers. My investments are held across 3 brokers but they are all in a couple of varieties of Vanguard Life Strategy funds (because I’m lazy). Are there any (low cost) alternatives to VLS that I could consider if I decided to match your levels of paranoia?
@ Dawn – if you invest through a broker rather than directly with a fund manager then the nominee system would apply in the same way as with shares: http://monevator.com/nominee-accounts/
http://monevator.com/investor-compensation-scheme/
@ Richard – I love the way you’ve found the upside to death. By fixed age of death do you mean that your Excel model tells you when you’re going to die?
@ Mr Zombie – I would recommend Hale’s Smarter Investing, yes. If you want a shorter version then go for Lars Kroijer’s Investing Demystified.
@Sir Steve — TA looked at an alternative from HSBC a while back, not sure how it’s bedded down:
http://monevator.com/hsbc-world-index-portfolio-fund-of-funds/
Not sure if others have come onto the market since then!
Well, I couldn’t find an Excel function for that! But knowing my date of death would make financial planning soooo much easier…
My model assumes that I die at 90. However one of my financial planning goals is to amass a sufficient asset base (together with lowering my spending) so that once I reach 67 and my pensions kick in the annual real return on my asset pile exceeds my expected expenditure. That way my actual date of death is irrelevant.
Put another way I want my asset base to last in perpetuity, rather than being used up in retirement (which would make my date of death assumptions more important).
Not easy to do…maintain capital and only spend the real return…so save hard, spend less…
@Richard — The goal you have set yourself is extremely high. I don’t know your circumstances, but… you only live once.
Three different friends of mine have lost parents under 70 in the past 12 months.
I’m closer to you on the spectrum then the YOLO spend-it-all mentality, but it’s always worth thinking about.
Of course, if you’re happy enough as you are working, massively saving, and deriving comfort (as a day to day utility) from your financial plan then even if you were to get hit by the proverbial bus at 70 it wouldn’t be a disaster.
(Well, this is what I tell myself. 🙂 )
@TI I fully subscribe to the YOLO philosophy – so long as I don’t start until tomorrow!
The way I’m wired means that I derive a lot of comfort from knowing that I’m financially secure, with – hopefully – a good margin. Being able to sleep at night is very important to me, coupled with the fact that I’ve never been a great spender. Genuinely there is little in life that costs a great deal of money that I would want.
What I do want, and what I’m aiming for, is to get out of the rat race and have more time to myself.
I live in a rual area with low house prices, and where a middling-ish professional job pays quite well relatively speaking.
Generally I spend sub-£20k a year, so I tend to see money in units of years’ freedom. If I can save another £40k that means I can retire two years earlier, and so on. Thinking in units of year’s freed up gives me much more impetus than just thinking about £££ in the bank.
Time seems to fly and my assets have built up almost without me realising. Sadly I’ve been in cash most of my life and only really in the last two years have I got into shares. With hindsight I should have been in equities, but at the time I thought I needed the security of cash “just in case”.
When I left Uni some 20+ years ago I read an article in the Independent (I think). It said “save half of every pay rise”. I took that to heart (I like black and white “do this” advice). As my first job was on a pittance, over time I’ve ended up saving half my salary by observing this “rule”. I’ve never felt I was missing out – I really can’t fathom where most people seem to spend their money!
My state and DB pensions will pay about £15k pa when I’m 67, so I’ll have an annual shortfall of c£5k in retirement. This should be covered by real investment returns.
Once I stop working (in 5-10 years) that will then fix my finances (subject to the whim of the stock market). I’ll then take a good look at what I will need to fund me from retirement to when I get my state/DB pensions. If I’ve a good amount extra I might splurge a little…but there isn’t too much of that nature on my wish list. I look longingly at my library and can’t wait to do it justice. Cheap and intellectually fulfilling.
@The Accumulator, thanks! Purchase made (through your link, hopefully something will go towards the site 🙂
Mr Z
@ Richard – thanks for sharing and all power to you. I think much the same way. The main difference being that I came to the game late on so in order to retire ‘early’ I’ll probably need to spend capital and income. I’m planning on checking out at 92 – at least that’s what a life expectancy questionnaire told me 😉
@ Richard
just stumbled upon your response. im exactly like you, ive always saved 50 % of my money and have been in cash all my life [age 50 this year!] its painful to think I should have been investing instead but people would always tell me disaster stories about how much money they lost in the stock market and it would put me off. but last year, desperate to save my cash from inflation any longer I came across this site and educated myself. so ive invested half my cash now over this past year. better late than never. like accumulator, I expect to live into my 90’s , so I will have 40 years of investment returns in front of me and emerging markets maybe are about to come in to their own from now onwards and the FTSE 100 hasn’t moved much in the past 15 years.so we,ve not missed the boat completely. as ive no kids I may even consider equity release later in life from my house.
@Dawn — Better late than never! Glad you’re finding the site useful. Welcome @Richard!
Hello Dawn
We seem to be kindred spirits!
I too look back at my life and sometimes wish I’d been in equities more. I did buy £10k in 2005 and sold them in the last 12m (as I no longer wish to hold individual shares). That £10k was sold for nearly £25k and I’d had another £5k or so from dividends. Even discounting for inflation it was a very good return. But it was quite a fraught journey, especially in the early years when I didn’t have much to my name and so stock market movements felt bigger, relatively.
I now have much more in equities – ISA and SIPP – but still have the bulk of my non-house assets in cash. I can’t bring myself to dump it all into equities at the moment. I’m waiting for the next crash – hoping that I’ll see it as a buying opportunity rather than financial Armageddon.
In earlier years I needed the certainty of cash – and real returns were easily available. And – if I’m honest – I didn’t fully understand just how big a difference compound interest makes over decades. Thus I was happy with c2% real returns on cash, rather than a hugely volatile c5% average real on equities. The difference didn’t seem that great, and the worry was much less…
And, of course, like most people in their 20s and 30s I was building my career, so any opportunity cost of not being in equities was vastly outweighed by the extra cash I could save from promotions and pay rises (as my spending didn’t go up as much). I was in cash and my cash pile was going up. All seemed well…
If I had my time again I’d probably do the same and stay in cash. It was the right thing for me, with my temperament, at the time. I might have needed cash for a bigger house, for a wife and family, for a new car, for foreign holidays, or to cover a period of unemployment. Cash seemed sensible. Apart from the house and car those events didn’t come to pass, but I had no way of seeing the future at the time. Of course, some of them may still happen, but I don’t need such a big cash pile as I have more assets behind me and fewer years ahead than I did in the heady days of my 20s and 30s.
And – perhaps more than anything – cash is comfortable. It causes me no sleepless nights. It’s there when I go to bed, and still there when I get up in the morning. It doesn’t “crash” and it doesn’t have “bulls” and “bears” and the opportunity cost of not being in equities is invisible. Cash is like an electric blanket on a frosty winter’s night.
Assets are not just cold hard lumps of potential goods and services. There’s an emotional aspect. And, for me, cash satisfies my need for certainty more than anything else. I don’t invest for maximum return – I invest for maximum emotional comfort. For me, the two are not the same and so I suspect I will always have more in cash that some commentators would consider “sensible”.
@Richard
Thanks , we are certainly kindred spirits!