Your biggest danger is not a correction or a bear market, it’s being out of the market.
Compound interest is the magic of interest over interest. It’s the magic of watching your money grow without you touching it. It’s the magic of retiring a millionaire.
‘If we are to have any chance in meeting our long term financial goals, invest we must’.
It can all be summarised in a great passage from Tony Robbins’ book ‘Unshakeable’:
Two friends, Joe and Bob, decide to invest $300 a month. Joe gets started at age 19, keeps going for eight years, and then stops adding to this pot at age 27. In all, he’s saved a total of $28,000.
Joe’s money then compounds at a rate of 10% a year (which is roughly the historic return of the US stock market over the last century). By the time he retires at 65, how much does he have? The answer: $1,863,287. In other words, that modest investment of $28,800 has grown to nearly two million bucks! Pretty stunning, huh? (yes it is, Tony).
His friend Bob gets off to a slower start. He begins investing exactly the same amount – $300 a month – but doesn’t get started until age 27. Still he’s a disciplined guy, and he keeps investing $300 every month until he’s 65 – a period of 39 years. His money also compounds at 10% a year. The result? When he retires at 65, he’s sitting on a nest egg of $1,589,733.
Let’s think about this for a moment. Bob invested a total of $140,000, almost five times more than the $28,800 that Joe invested. Yet Joe has ended up with an extra $273,554. That’s right: Joe ends up richer than Bob, despite the fact that he never invested a dime after the age of 27!
Tony then goes on to describe why this is the case. Joe is incredibly successful simply because he started earlier. By the time Joe is 53, the compound interest is adding over $60,000 per year to his balance. By the time he’s 60, it’s adding $100,000 per year! And what if he had continued investing $300 a month until he was 65…? The number would be a pretty astounding $3,453,020! 🤑
Little Joe was able to turn a modest sum into a massive fortune. And although I do feel Tony’s number a pretty optimistic (10% every year? Damn boy), I think the fascinating thing here is the simple fact that Joe stopped investing at age 27 and still ended up with more money than Bob.
And that, my friends, is why I will never stop telling students and young adults to start investing NOW! Because your biggest danger is missing out on this amazing opportunity to literally make your money work for you. And all you have to do is put aside £100/month (or less!).
So, following on from Tony’s book, here are some things to take into account when investing:
1. Stock markets do fall. They happen every 3 years. It’s a cycle
The biggest reason people don’t invest is because they are scared of the stock market and have heard it’s risky. I have already debunked this myth but I’ll debunk it again – stock markets do fall. It’s normal and it happens on average every 3 years. It’s part of the normal cycle of the economy.
Take right now, early February 2019. Everyone is jittery because there’s going to be a crash soon. Personally, I don’t care. Crashes are normal, the value of my investments will plummet, and then they will go back up again in a few years. This is because I have diversified my investments, I have a cash cushion to protect me and my investments aren’t charging me high ass fees.
So yes, as long as you’re prepared, you shouldn’t give a rat’s ass if the stock market falls, because it’s part of life. Here’s a cool diagram of all the past stock market crashes in history:
2. The average returns 7% over 20+ years
Tony Robbins said 10%, I prefer a more conservative 7%. Now, the important thing to take into account here is that you want to be investing long term in order to get that 7%. If you only invest from 2019 – 2029, the stock market does not guarantee 7%. It might be -23% one year, and +10% the next one. It is a volatile place, which is why you do not want to be depending on that money. This is money for your future, not to be used now.
If you’re investing short term, then we need to get into asset allocation and balancing stocks and bonds – something for another day.
But if you’re in your twenties and you follow Joe’s steps… you’ll be pension will be in the millions. And it doesn’t have to be $300 a month – a simple £50 or £100 can make a huge difference. Play around with these compound interest calculators to check it out yourself.
3. Do not stock-pick. Diversify
Who has time and energy to pick the right the companies to buy shares in? Not me. Your best bet is going all out with ETF and index funds. Track the market, and you’ll do better than 96% of the rest.
Nope, I’m not kidding. Here’s another great passage from Tony to convince you:
One of the most shocking studies I’ve seen on this topic of mutual fund performance was by an industry expert named Robert Arnott, the founder of Research Affiliates. He studied all 203 actively managed mutual funds with at least $100 million in assets, tracking their returns for the 15 years from 1984 through 1998. And you know what he found? Only 8 of these 203 funds actually beat the S&P 500 index. That’s less than 4$! To put it another way, 96% of these actively managed funds failed to add any value at all over 15 years.
So, stick to tracking the market – it’s simple, easy and you’ll be doing better than most.
4. Beware of fees
Another huge reason to stay away from active fund managers: the huge fees. How do you know if a broker is good? Because it’s cheap. Here’s another cool extract:
In case you think I’m being too extreme, let’s consider the example of two neighbors, Joe and David. Both are 35 years old, and each has saved $100,000, which they each decide to invest. Over the next 30 years, the universe smiles on them, and each achieves a gross return of 8% a year. Joe does it by investing in a portfolio of index funds that costs him 0.5% a year in fees. David does it by owning actively managed funds that cost him 2% a year (I’m being generous here by assuming that the active funds match the performance of the index funds).
By the age of 65, Joe has seen his nest egg grow from $100,000 to approximately $865,000. As for David, his $100,000 has grown to only $548,000. They both achieved the same rate of return, but they paid different fees. The outcome? Joe has 58% more money – an additional $317,000 for retirement. 😱
(then there’s a cool chart and my good friend Tony explains how Joe is able to withdraw $80,000 a year – 33% more than David – and his money lasts till he’s 88. Even if David took out $60,000 a year he would only last till 79)
So I hope by now you are convinced that active fund managers are not the answer – they are very unlikely to beat the market, and the high fees mean what’s the point in trying anyway? 🤷♀️
5. Use tax advantaged vehicles
Another type of fee: tax.
It’s very important to put your investments in something that shelters them from tax. This really depends from country to country, but it’s important to look at pension options and what vehicles you could use to invest tax free and take out tax free.
In the UK we have this beautiful thing called an ISA, where we can invest max £20,000 tax free every single year. This is pure gold.
What about in your own country? What kind of taxes do you have – do you have capital gains tax, or wealth tax? (or both? Hem hem Spain) With this pension scheme, do I pay tax when I sell or when I buy? But most importantly, what are the financial vehicles I can use to invest tax free? Look for those, investigate and get started.
Another option that I yet have to explore is setting up a company in Estonia and managing investments from there. You don’t get taxed on reinvestments, only on distributed profits (so the money I pay myself) – however you will get taxed if you are tax resident in a country that taxes your worldwide income (Germany, Spain, UK, etc). So make sure you do your research.
6. Beware of scams
Another huge reason people stay away from the financial markets: scams – and they are totally right.
Most financial institutions will try to take your money, whether its through hefty fees, selling products you don’t need or giving bad advice.
For this reason, never take advice from someone who is trying to sell you something.
It’s frightening. We’ve all heard plenty of horror stories of the scams out there, and it painful to hear. But this is why it is so important to be financially educated be able to do your research properly. Do not buy the next hot stock. Do not do something because your neighbour told you to. Ask as many people as you can before making a move.
7. Use consistency and a couple of minutes a month
So now you’re investing in passive index funds. That’s amazing! You’re very close to becoming a rich pensioner.
How? Consistency. Don’t try to time the market, don’t get obsessed with the daily financial news and don’t panic. Every single month, send a set percentage to your brokerage. Set up a direct debit, and then forget about it. It takes a couple of minutes to set up, and as Tony Robbins has demonstrated, next thing you know (at the age of 65) you’re a millionaire thanks to compound interest. I think we can all find a couple of minutes to set that up – and the returns will stay for life.
If you want to see the magic yourself, take one of the compound interest calculators above and see how much would accumulate if you invested £100 per month for 10 years, or £50 a month for 25 years. Play around, and you’ll see with your own eyes the amazing power of compounding.
8. Read, read, read
And finally, books. This is the ultimate piece of knowledge. Books are life. Books are wisdom.
If you understand what you’re investing in, you won’t be scared to do it. So read about ETFs, index funds, stocks, bonds and the rest. You don’t need to be an expert, but you need to understand the basics. Warren Buffet himself said it:
‘Don’t invest in something you don’t understand’.
Here is a great list of books to learn more about investing:
- Jack Bogle, The Little Book of Common Sense Investing
- Tony Robbins, Unshakeable
- Benjamin Graham, The Intelligent Investor
- Mike Piper, Investing Made Simple
And there you go – a long post to show you that compound interest is beautiful, amazing and we need to take advantage of it. Pure maths, and yet it will give you a very comfortable retirement. And all you need to is start with a little bit every month. If £100/month is too much, start with £50. The important thing is to take action, and slowly see compound interest do it’s magic.
Questions on how to get started with investing? Check out these posts:
And you can always pop me an email 😉