Category Archives: Passive Income

How to invest intelligently in a Bull market

bull-market-investingIt has been a happy new year for investors. Global stock markets have stormed into 2018 with a bang. Several “round figure” number milestones have been achieved during the first week of the year; the S&P 500 has passed 2,700 points for the first time and the Dow Jones has gone over the 25,000 mark. In Japan the Nikkei 225 has surged to 23,714.53, its highest mark in over 26 years. The UK FTSE 100 (at 7,724.22) and several European markets are now at all time highs. All this has added to the 2017 end of year “Santa Rally”.

As my investment portfolio is internationally diversified, the gains made this week have also trickled down to boost my net worth to an all time high. I have to admit that for the first time I have felt tempted to take the profits and set them aside. This would be simply irrational and against the principles of the intelligent investor; the key is to buy and hold for a long period, while paying little attention to market gyrations and the news.

It just shows how powerful human nature can be, as even the most diligent investors can be moved by emotions to make mistakes. Fortunately, I will not make any moves that change my strategy but will stick to the approach stipulated by my Investment Policy Statement (IPS).

The image above shows the latest CNN Money Fear and Greed index which shows the general mood of investors as a reaction to how the markets are currently performing. In general, people tend to buy more when prices are high and sell when prices are going down. *Tip – You can use the above index to your advantage by investing more when prices and optimism are low [red zone].

So what should investors do in such buoyant conditions. Should we start piling into the hottest stocks like the current bitcoin and cryptocurrency gold rush like craze or start selling funds to pocket the profits before the market tanks.

The best thing is to stay the course by investing regularly, preferably in low cost index tracker funds, as we can not predict where the market will go to next.

Despite various predictions by “experts”, no-one knows where the top (or bottom)of the market will be, the current bull market has been raging since March 2009.

Despite various predictions by “experts”, no-one knows where the top of the market will be, the current bull market has been raging since March 2009. Some are even incorrectly claiming that they had something to do with the stock market rally. If one had sold their holdings along the way, the loss of potential future gains would have been crystallised forever. Even worse would be the regret that the person would feel for selling at the wrong time.

2017 Progress Review

As it is the beginning of a new year, here is a brief outline of my progress towards financial independence. My most important metric, Savings Rate, has climbed to an average of 51.19%. This is important because the rate will largely smooth out any ups and downs in the market along with minimising the impact of any mistakes that an investor can make. Another metric, the expenses covered by portfolio income has reached 34.15%, meaning that over a third of my expenses can now be covered by passive income!

On top of this, in 2017 I started exploring other methods of generating income including e-commerce, blog income and digital products. Initial income has been low but very encouraging as this is income which did not exist a year ago and can be improved on with more effort.

2018 looks very promising as I will continue to optimise expenses, keep learning new skills and read more about various subjects. These incremental improvements should all add up and help achieve financial independence.

Stealth Wealth – How you can become the Millionaire next door

millionaire-next-door-coverThe millionaire next door is one of my top books of all time. This great financial manuscript was one of the reasons which got me serious about saving and investing in 2014. Even though this was a good thing, it is a shame that I had this awakening when I was just about 30 years old.

Had I discovered this text before this, things would been a lot better financially. Since there is no point crying over spilt milk, I will lay out some of the best lessons in the book and other useful advice in this post and on this site. Hopefully, this information will help others as much as it has helped me. This stuff is like gold dust and makes me want to keep learning more and more about personal finance.

The real millionaires are not what you think


What is your idea of a millionaire?

In order to think like and develop the plan to be wealthy you need to acknowledge that the perceptions which most people have of the rich are baseless and often misleading. Wealthy people are often thought to be big spenders who splash their cash at every opportunity possible, for example by driving Chelsea Tractors (huge cars in an urban environment), owning McMansions or flashing shiny blinging jewellery.

Despite what it seems, these may be cases of “big hat no cattle” with the individuals drowning in all kinds of debt, just to look the part. It is important to build a solid financial foundation by living well within your means rather than trying to keep up with the Joneses.

Playing defence is great

One of the first things that people think of when they want to become wealthier is “How can I earn more money?”. Even though it helps if more income is available it is a lot more achievable to become wealthier but cutting expenses. The millionaire next door book describes the process of earning money as “offence” while “defence” is cutting down on expenditure. Employees would have to jump through a few hoops if they concentrate on the offence side. Getting a pay rise is getting tougher these days with earnings failing to keep up with inflation. Therefore it is more effective to be frugal where necessary to free up cash for investing.

Think Net Worth rather than income

In an income focused society, you hear more of “How much does that person earn?” than how much the individual is actually worth. Governments, politicians and other authorities are well aware of this obsession and they do their best to strike where it hurts. By this, I mean that higher taxes are usually aimed at the easy pickings of higher earners’ incomes rather than at accumulated capital which would be hard for them to deal with. This is how the rich keep getting richer. Highly paid professionals such as doctors can end up struggling financially when a loss of income is experienced as evidenced in the book.

uk tax bands and income 2

UK Income Tax rates and bands – from

The table above illustrates the impact of taxes on income in the UK. In contrast, investments held in Individual Savings Accounts (ISA) are completely tax free. UK investors can put away up to £20,000 a year into these ISAs and therefore can build substantial assets in these accounts over time. Imagine all this being tax free for life, including capital gains and dividends! Income will appear overrated – the more you earn and harder you work, the harder you get taxed.

Avoid economic outpatient care for adult children

Other interesting insight from the book is the impact of parents providing excessive financial aid to their grown up children. This “economic outpatient care” is usually for things such as car purchase, private school fees and help to buy property (Bank of Mum and Dad). Such assistance can lead to lack of initiative and crippling the finances of the recipients.

An example cited in the book is when wealthy parents assist with a deposit on a house in an expensive area for their less well off adult children, leaving the children to struggle with high mortgage payments, fees and property maintenance costs. Living in such a neighbourhood would also leave the children to handle pressures of fitting in within a high status area. Indeed, the research presented shows that those who have not received financial handouts are more likely to be wealthier than those who did.

The millionaire next door is truly a great read and it is also available as an audiobook. The most important thing is to have a mindset of continually optimising you lifestyle choices, so that as much saving can be done to release cash flow for investing into the appropriated funds. Focus on building income generating assets and reducing liabilities. By following these steps, you may not become an actual millionaire but close to it and certainly be more prosperous than you would otherwise have been.

Why you should invest only for the long term

long-term-investingIt is often recommended by financial advisors that people should only consider investing in stocks and shares if they intend to not need the money within the next five years. The main reason for this is that the stock market can be very volatile in the short term. For example, the United States’ S&P 500 index lost nearly 40% of its value in 2008.

This would not have been a good outcome for an investor wanting to utilise investments in this fund shortly after the drop. However, there are other benefits of adopting a long term approach to investing, which are often overlooked or which are not widely taken seriously.

The early bird catches the worm

By definition long term investing also means that the investor would have established their portfolio relatively early and after several years of regular investments the portfolio would have grown to a substantial size. When you look back at prices for shares it is often astonishing how “cheap” they were a only a few years back, as the prices generally go up over time. Therefore, you want to buy as many shares as you can as soon as you can.

The UK FTSE 100 index was valued at 3,530 in March 2009 and it is currently valued at 7,438, nearly double the value after only seven years!

A good example of this is that the UK FTSE 100 index was valued at 3,530 in March 2009 and it is currently valued at 7,438, nearly double! This means that you would need significantly more money to buy a unit of a FTSE 100 fund today than if you had started early. Instead of you working harder for your money you want your money working harder for you.

It is all about dividend income

The advantages of investing early would have been further significantly magnified by the regular payment of dividends, every year, for example since 2009 in our case here. An index tracking fund for the FTSE 100 would have been paying dividends with an impressive annual yield of over 3%. The power of this effect is better illustrated by the following example.

An initial amount of £1,000 invested in the FTSE 100 in 2009 would have yielded approximately £30 in that year, considering a dividend yield of about 3%. Assuming an achievable annualised growth of 10% for the FTSE 100, the portfolio would have grown to £2,144 in 2017. Using the same 3% yield, in 2017 the portfolio would yield £64, an ever increasing amount with each year for the long term investor.

Here is the interesting part – How does this £64 compare in relation with the amount initially invested. In just eight years the £1,000 initial investment would be paying dividends with an ever increasing yield of 64/1,000 = 6.4%. This is particularly significant as there are very few investments which can offer yields like this without taking on immense risks.

Long term investments can eventually pay you back and more

When done in the right way, long term holding in business or stocks and thinking ahead should eventually repay the initial investments and keep on giving. Warren Buffett has been quoted saying “our best holding period is forever” and that the best days of the economy or business always lie ahead.

Case Study: See’s Candy

Buffet has also mentioned that See’s Candies, the manufacturer of candy, particularly chocolates, has been his best ever investment. In 2007 Buffett described See’s as “a prototype of a dream business”. See’s is now a business wholly owned by Buffett’s Berkshire Hathaway. Founded in 1921 by the See family, See’s was acquired by Berkshire Hathaway in 1972 for $25 million. At that time, See’s was generating annual pre-tax profits of $4 million. By 2016, over 40 years later, See’s was generating a phenomenal $100 million in annual profits. This means that the company now makes four times its original cost, each year! In 2011, Buffet noted that See’s had brought in an astonishing $1.65 billion of profits since the initial purchase.

This just shows how shrewd investments, including others like Coca Cola which has more than tripled in value, held over long periods of time, have enabled Buffett to build enormous wealth.

I believe that all investors, large and small, should take this very sensible approach while avoiding trading in and out of positions impulsively. This not to recommend investing in individual company stocks, but instead to invest by buying and holding low cost passively managed index funds such as those provided by the Vanguard investment management company.

Eventually, the patient investor will start reaping the benefits after employing this long term buy and hold strategy and reinvesting dividends while making regular investments. This is a solid path to building a machine capable of generating passive income, which will help in attaining financial independence.

Top articles on investing

More of my thoughts are on Twitter.

A dollar of passive income is worth two of active income

paasive-income-new-pound-coinImagine getting paid without lifting a finger or breaking some sweat. This situation is a dream to most people and very difficult to achieve without being fortunate enough to win the lottery, receive some inheritance or some other windfall. For the rest of us, it is up to hard work, saving hard and strategic investing to achieve this status. Passive income is the holy grail in the personal finance space and in this article I break down how valuable this type of income really is.

An elusive dream?

Although it appears an elusive dream to many, a reasonable stream of passive income can be realistically achieved by most people. Methods for doing this by investing in stock market index funds are detailed in my previous posts here and here. It is a challenging journey which feels like climbing a mountain. To get to the summit, the investor needs to raise sufficient funds by working hard at saving a large proportion of their income over a reasonable length of time. Keeping an eye on expenses is crucial too. Once a sufficient portfolio has been constructed, it will be able to deliver passive income without any further work needed.

Case study – Active income

To earn active income, a person must put in the work and time. It is not as simple as that; there are many other costly and time consuming factors to consider when looking at active income. For example, in terms of costs a typical office worker may need to pay for expenses such as commuting to work, lunch, clothing for work and early morning latte.

Additionally, active income payments are taxed at a rate dependent on your salary. The more you earn the more tax you pay. Time is the other factor to look at; an hour’s commute each way and an hour’s lunch will take up 3 hours a day of your time. An 8 hour work day ends up looking like 11 hours, while costs are incurred along the way – this makes the hourly pay rate look far less appealing if you do the math.

Passive income – a comparison

It is all about working hard now to reap the benefits later. It takes a lot of work upfront in-order to start earning passive income. There are several perceived ways to do this such as real estate, online selling and blogging. However, these methods are not fully passive and need some input, big or small, from time to time. Here and in the financial independence community we focus on investing in stocks, one of the few ways which are truly passive.

When you have a portfolio of investments every dollar in it is like a little worker tirelessly putting in the work for you. This industrious army of workers never calls in sick, complains or goes on strike. It literally is the definition of making money while you sleep! The key to building wealth is to keep on increasing on this base; more workers equal more production.

At a high level, portfolio growth comes from both generation of dividends and capital growth. Income from the portfolio can come in the form of dividends but the 4% rule can be applied to safely withdraw funds. The 4% rule stipulates that if this proportion is withdrawn annually, it is almost impossible to deplete the portfolio.

Passive income benefits

It is important to understand the difference between these two types of income to see how they can impact your finances and lifestyle. In comparison with active income, passive income is beneficial in that it frees you to earn additional income if required. If this additional work is voluntary, then you are able to choose the kind of work and how much of it to do.

Stress is reduced as there would be no ongoing pressure to keep on earning to pay the bills. A constant stream of income can also come in handy when emergency strikes or if you become unable to keep on working. Imagine getting fired or let go at an inconvenient time such as an economic downturn or when you have a family to support.

Being your own boss can become a reality too as you will be more capable and have time to start a business venture. You may also have more motivation to do your best work when not in a 9 to 5 environment. Depending on where you hold your investment funds it may be possible to not pay or pay very little tax on investment income. Location freedom is an additional benefit – without being tied to certain place of work you can choose where you want to be at any time. This could be on the beach, at home or in a cafe instead of a cubicle.

Generation of wealth would also happen faster as dividends can be reinvested to buy more units in future. All these cost related and intangible benefits make passive income at least twice as powerful as active income. This makes it appealing and well worth striving for.

Top articles on investing