Category Archives: Financial Independence

Why I am Optimistic about future investment returns

New York City Skyline at DuskFuture stock market investment returns are likely to be very substantial, even more so than past returns. This is an interesting topic as I have had a few conversations recently with people who believe that future returns will be lower than before or even negative. Their reasons do not seem logical to me; particularly because they are mainly based on short term thinking, ranging from a few months to a few years and lack of understanding of how the stock market works. 

A crash is coming!

The most common reason for pessimism about future returns is that a stock market crash is imminent because the market has sharply risen to very high levels recently. Having been a stock market investor for nearly 10 years I have heard this all the time but it has not deterred me from investing.

In fact, I have often taken advantage of this negative sentiment by buying more shares at depressed prices. Without fail prices have always come back to where they were, sometimes after what felt like forever, but the end result is an outsized gain.

The key is to believe in “reversion to mean” of stock prices and remaining invested by not touching yourlong term investments when volatility happens. It is best to take the long term view, typically 5 to 10 years or more.

Dow Jones Index Chart (1985-2019)

The chart above of the Dow Jones Industrial Index shows investment returns since 1985. Red bars are years of negative returns. It is clear that over the long term, buy and hold investors have benefited, despite a few short term shocks along the way.

Here are a few reasons why the future of investments is bright.

The rise of new industries

The S&P 500 index is packed with great companies which have thousands of workers striving everyday to bring value to Shareholders. Over time we have seen new industries come, becoming bigger and superseding what was there before. It is hard to imagine that Amazon, Facebook, Netflix and Alphabet did not exist 30 years ago.

New industries are always developing according to the needs of the time and the new companies providing the required services or transforming accordingly will surely reap the benefits. In-order to participate  in this, the intelligent investor will realise this fact and construct a portfolio which invests in the stock indices that will hold such companies.

Billionaire Space Race

A good example is the new Space Race. Private entities like SpaceX, Blue Origin and Virgin Galactic are jostling for stakes in this space and the potential is huge. Space tourism would be highly profitable and take various forms. Governments are already contracting such companies for International Space Station missions. Mining operations in far off places like Mars may become possible. Establishing a true industrial base in space is another objective. Reusable rockets drastically reduce mission costs, accessibility and time.

Innovation

The pace of technological innovation in this Digital age is staggering. Take investing for example. A few decades ago the process was very cumbersome as one needed to hold and mail a lot of stock certificates. Information was not readily available therefore very few people had access to this and brokers charged astronomical fees to everyday investors. Today one can research and buy global stocks instantly on a handheld device.

In this and other sectors, automation is increasing productivity and has potential to drive up returns. It is certain that innovation will continue to happen, offering new opportunites, products and services.

Population growth

I remember a time when the World population was hovering around 6 billion. Today this has jumped by nearly 2 billion and is trending higher.

World Population data estimate - 8 Sept. 2019

World Population data estimate – 8 Sept. 2019

The graphic above from here is very interesting. Net population growth appears to be very high. This fills me with optimism; many more potential users of goods and services than ever before. Astonishingly it took 200,000 years to reach 1 billion; and only 200 more to 7 billion. More importantly, these bigger markets will be more and more prosperous than ever before, fuelling the growth of current and future corporations. 

Too much Information

Every time I turn on the news it seems like the world is about to end. From trade wars, geopolitics, questionable economic forecasts to severe weather events it is not hard to see why some believe that a recession is around the corner. The facts outlined above lead me to believe the opposite. It is best to have a low information diet and focus on the facts.

Gaining financial independence requires discipline in saving and investing so staying the course is vital. Staying optimistic will provide motivation over the long term.

50% FI (Financial Independence) in 7 Years! – What it took to get here

net-worth-chart-2019

Today marks a significant milestone in my journey towards Financial Independence (FI). According to my calculations I have reached the halfway point of achieving this goal. This endeavour started almost exactly 7 years ago in June 2012. The purpose of this blog and my book is to document how I am striving to complete this task within 10 years.

Motivation

There are many factors which have motivated me to embark on this journey. I moved to the UK from a developing country which was facing a severe economic crisis and went on to study engineering at university. This was particularly tough due to the very high international student fees, living expenses involved and having to adjust to a new culture.

Uncertainty and job security in the workforce were other major factors. Money was always scarce when I had to work all throughout my studies which was not ideal. It was therefore no surprise that when I got my first professional job I thought I had made it. I was thinking in terms of income rather than net worth. This led to an episode of lifestyle inflation in my mid to late twenties. 

The Big Three – Housing, Transportation and Food

2007: £1,000 Debt

In order to get your finances on track you need to keep the big three (housing, transportation and food) under control. I did the opposite while working at that job. Moving from shared housing to my own rented flat greatly diminished my savings rate as I faced an explosion of monthly bills.

On the food front I was equally terrible; I never prepared my own work lunch, instead opting to buy costly unhealthy food every lunch break. Anything from burgers to fish & chips and kebabs. Life was good I thought.

I wasn’t done yet! As if all this was not enough I decided to embark on my next wasteful adventure: car ownership. At that time I lived in Manchester where commuting to work by bus was incredibly cheap. A bus pass which I used was something like £5 a month. I convinced myself that I needed to drive so did a lot of lessons and got my licence. Soon after I went car shopping. I barely did any research into this and quickly bought a used Peugeot 206 for £2,000 in 2009. 

This car turned out to be a real lemon. It was dangerous and very expensive to keep. I remember at least three times where the car left me stranded on the motorway due to major mechanical faults. One situation was the clutch snapping during heavy snowfall and the other was parts falling from underneath the car in the dark. Such breakdowns are often accompanied by other extra costs such as repair bills, recovery and using alternative transport. As a new driver, the insurance was ridiculous at over £1,200 a year.

Recession and plugging the hole

2010: £2,000 Debt

In the height of the global recession in 2010, along with many others, I had to leave my first job as the company was facing big financial problems. Obviously this was not good but it turned out to be the greatest thing to happen to my situation. Immediately I left Manchester to go and stay with my mother as I had managed to save exactly nothing in three years due to the above. In addition, I had maxed out my £2,000 credit card. I managed to get a new job soon after though so did not need to sleep on the floor for too long.

Seeing the light

2012: 0% FI

It was as if the reset button had been pressed. Realising that my previous lifestyle was unsustainable I moved back to shared accommodation and started to keep spending under control. I also started aggressively paying all of the credit card debt. However, I still did not have a good financial education and lacked long term thinking.

The only thing I was saving for was a car. When the Peugeot finally died I bought a used BMW.  This one final major mistake ensured that 5 years after starting my first job my net worth dipped back to zero. I consider this the beginning of the journey to Financial Independence as I have not made any drastic purchases since. The BMW was a nicer vehicle which i kept until it was written off in a crash in 2018. Again, after massive ownership costs (estimated £470 monthly over 6 years) there was nothing left to show for it. 

2014: 5.52% FI

In 2014 I came across Financial Independence by reading a few blogs; in particular Dividend Mantra and Mr Money Mustache. I did not need any convincing at all and hopped on to the movement. I learned about Vanguard investments and the Bogleheads, reading a few investing books such as The Millionaire Next Door and listening to several podcasts along the way.

2017: 25.87% FI

Going through all of Warren Buffett’s letters to Berkshire Shareholders and watching the live stream of the meetings on Yahoo Finance was fascinating, giving me access to the mind of the greatest investor in history. By applying these principles and living frugally, my net worth has been increasing exponentially.

Lessons learnt

July 2019: 50.04% FI

Car ownership is very expensive.  By only looking at the purchase price it is very easy to ignore the true cost of car ownership when making a purchase. It is more useful to look at total ownership at around £0.50 per mile. More detailed typical costs are provided by the RAC here.

I would recommend to avoid car ownership if you have access to other reliable means of transport. This is very difficult for me as I enjoy researching the latest cars, watching Top Gear and going for a Sunday drive. In future I will ensure that such a purchase is made from a position of strength and once all options have been thoroughly vetted.  Going car free has boosted my savings rate by more than 10% which can drastically reduce the time to FI.

Automation and consistency are critical to building wealth. I find it very useful to budget every month by estimating upcoming expenses as accurately as possible. Once done the projected amounts can be directed to investment accounts while aiming for a 50% plus savings rate. Tracking net worth is also a good motivator (see example chart above); it gives a snapshot of where you are in relation to the goals.

It takes a long time to see big gains. During the first few years of investing seriously little or even negative progress will be experienced. It is only at this point that the effects of compounding can be noticed. Giving up early is not an option.

Take advantage of market crashes. When the stock market is down it means prices are cheap. It is best to invest as much as possible during such times. If I look back 5 or 7 years ago I am astonished at how low prices were compare to today. Keep calm and do not sell.

Don’t get too excited in the good times. As stocks hit an all time high today (The S&P 500 closed at 2,995.82 points and the DOW at 26,966.00) it is tempting to claim to be an investing genius. However, we should aim to be rational and not start investing more now when there is irrational exuberance. Focus on the long game not day to day market movements.

Keep learning and building skills. I am amazed at how much knowledge is out there. Just pick up any good book to find out. Try out many new ideas; most will fail but you will learn a lot. I have picked up a lot of skills from running this site including SEO, Analytics, Adsense, graphic design, improved writing, web design and digital product creation. I did not know most of this stuff a few years ago. it may come a time when one is FI that such skills will be useful in a new occupation where you are self employed.

Avoid keeping up with the Joneses. It is tempting to acquire flashy material possessions (cars, houses, clothes etc.) to appear successful or impress people you don’t care about. This can backfire and you will be the one left to pick up the bill. Best thing is to obtain what you actually value and is affordable to you.

The point of Financial Independence is to open up more life options, not necessarily early retirement. I look forward to covering the next half of the journey. I know that this will not take as long and the gains will be ever bigger as the snowball keeps rolling bigger and faster.

 

 

 

 

How to give yourself a perpetual pay rise through index investing

Getting a pay rise is the ultimate dream for many workers. How can you get a pay rise without following the usual frustrating processes in the workplace. By taking a different perspective at building and maintaining an investment portfolio it is possible to take the initiative give yourself a pay rise. Even better this can be set up so that it happens perpetually, regardless of what your employer does.

Taking a personal initiative and interest are imperative. This realization came to me as I was sat in a work webinar Q&A session between management and employees.

The general theme was that employees were not happy, and to be honest they are completely powerless about most of the issues raised such as new graduates starting on higher pay than older ones, why pay rises are 2% when profit margins are far larger, who and how one gets a bonus etc.

All this on top of external factors which may affect the company due to the wider economy and a recent corporate takeover of the organisation by a larger competitor which has an unsavoury past. Hence it is important to have control of the situation.

Taking control

The process is not simple as all the traits of pursuing financial independence should be applied, mainly; patience, discipline, frugality and the appreciation that simple arithmetic works.

Like many, I used to wait around to get the bog-standard 2% or so annual pay rise which, at the whim of management, is often distributed with little regard to the employee’s performance. Depending on the industry, some will also get a bonus if they are lucky. This seems to be standard practice for a lot of companies.

At an early stage I realised that this was going to be the likely scenario in the workplace so I decided to take action. Having control over the growth of my net worth meant taking control of my finances, rather than relying on a manager at work using some esoteric means to determine my future.

Taking control meant living within my means, cutting back on unnecessary expenses like motoring, self-educating on business and finance, achieving a 50%+ savings rate and investing in the stock market. Obviously, this approach has not been easy – spending big always seems more attractive than saving.

Dividend growth and investment returns

With the annual growth of Global dividends currently running at 8.5% according to Janus Henderson, it is clear that by holding a sizeable investment portfolio you can grow your income substantially. I would rather have 8.5% than a paltry 2% any day. Coincidentally, this 8.5% growth is not too far off from the long term return of the stock market so we can use it to run a few scenarios:

Suppose you have two workers at the same company who make £40,000 each. Worker A has zero interest in investing or perceives it as “risky” while Worker B is well on their way to financial independence and has been diligently saving and investing for a number of years. Worker A assumes that their pension is secure and someone else’s problem to manage. Their company does not offer bonuses and Worker A is always complaining about how little his pay rises every year therefore feels powerless to do anything about it.

Worker B, however, is not worried at all as his personal financial hacks have unlocked additional income which is unrelated to his employment. Instead of frivolous spending and accumulation of liabilities, Worker B has built a diversified portfolio of stocks and shares, real assets. As an example Worker B has a portfolio of £250,000. Using the typical 8.5% return this means that the portfolio earns an additional £21,250 a year for Worker B, which would be tax-free when invested in an ISA account. As this figure is equivalent to net pay, the worker would need to earn a gross salary of about £26,500 to take home the same amount.

Impact of investment returns on salary

Adding this to their pay we find that Worker B theoretically earns £66,500; substantially more than Worker A and an impressive 66% on top of the standard salary (see above). This would occur at an ever increasing rate every year depending on savings rate. Now that is what I call a pay rise. It is also interesting to note that the investor would easily stealthily grow their income to such a state that they would be better off than other people above their pay grade or other higher paid professions.

These gains would actually be bigger if higher tax rates were considered but that calculation would be a bit complex to do for our example. Gains would vary and may be bigger or smaller depending on yearly market fluctuations but it is important to focus in the long term. When not withdrawn, the gains are unrealized and therefore reinvested to form an ever larger snowball.

Financial Independence – the journey is as important as the goal

This perspective shows that there are multiple benefits to striving for financial independence, even way before the goal is achieved. The greater the savings you have, the more the opportunities which appear to you. It is time to say no to zero or below inflation pay rises. I honestly no longer worry about pay rises or bonuses like I used to when considering the perpetual (and growing) impact an investment portfolio has.

Interesting reading:

How to react to a Bear Market and invest wisely

It has been a wild ride for all those heavily invested in stocks and shares. The past few months, culminating in a huge drop on Christmas Eve have been testing the nerve of diligent investors. With no sector industry spared, a lot stocks have dropped by over 20% from their all time peaks.

A Bear Market is defined as a condition where the stock market has fallen at least 20% and there is widespread negative sentiment around it. The past few weeks have definitely felt like this. When heading towards Financial Independence how should one react? Here are some tips on how to best handle a situation like this.

Do nothing

Sometimes the wisest thing to do in certain scenarios is absolutely nothing. This is certainly true in a volatile market situation.

When share prices are swinging up and down or dropping like a stone, the worst thing you can do is to sell your holdings.

I certainly had a close family member who was contemplating selling their shares recently and vowing to never invest again. Selling is clearly not the way to go so I tried talking the person out of it. Instead they should hold and do the next step.

Buy more shares

This will always be tricky for me as I always aim to have most of my funds invested in income generating assets such as low cost index funds. Therefore I can only take advantage of low stock prices with my latest income. If you have the funds available; buying shares at depressed prices will provide additional firepower when the market eventually bounces back, which it will.

Maintain a low information diet

Avoiding constantly checking the news is a good idea. Vanguard Investments’s Jack Bogle said you should rarely peek into your portfolio. Once you do after a very long time you will probably need a cardiologist when you find out how much is in there.

There is always something going on in the news, from trade wars, elections, interest rate hikes, military conflict, government debt piles, company profit warnings, taxes etc. You name it and someone always claims that it influenced a stock market move.

I must admit that I haven’t been able to fully commit to this step; instead I enjoy reading about business activities of interesting companies such as Tesla and Apple, along with all the FAANG super technology players. This often leads me to places such as the CNBC site or various business news Apps.

To try and resolve this, I previously deleted all the apps and bookmarks to various sites when prices were falling. However, when prices began shooting app I could not help but reinstall everything so that I could monitor what was going on.

I have not yet found a way around this as the information is easily available on our fingertips 24/7; but I am sure that with long term experience of different market conditions this will become a non issue. Fortunately, I have not had an urge to sell anything but have been eager to buy more.

Enhance your financial education

To best understand how the world economy works and how investor behaviour can be influenced it is useful to read a few books on investing and finance.

Top reads are A Random Walk Down Wall Street, The Millionaire Next Door and The Intelligent Investor. This activity should be able to fill your time by adding value, rather than being swayed by sensationalised headlines from Wall Street and City’s giant marketing machines.

Focus on the amount of units you own

A tip which I have found very useful is to not worry about the share prices or a net worth chart’s gyrations. These metrics, by nature fluctuate heavily particularly when you have a larger portfolio, so they are not a true reflection of where the real value is. Instead, track and focus on the quantity of units of stocks and shares that you own.

Tracking investment fund units

You will realise that you will pick up more units when prices are lower. This has the effect of boosting dividends over the long term. As shown above, there appears to be an exponential increase in the units within my portfolio, despite market swings and a largely similar savings rate.

Stay the course

The final tip is to not be worried and maintain investing according to your plan. This is where an Investment Policy Statement (IPS) would be crucial. When things seem edgy you can always refer to the document to remind you of your overall objectives.

The same strategy works even when investing during a bull market. I have covered how to invest in a rising market here. It is impossible to predict where the market will go; at the the time of writing the markets had been staging an impressive recovery from the December 24th lows when they dipped into Bear territory.

Interesting reading: