Good morning RIPvestors,
welcome to another post in the investing series, where I gradually introduce you to the world of investments and go deep on topics I have some experience with, mainly related to investments in Switzerland.
Other posts in the Investing series:
- Investing basics
- Financial Investing
- Funds Investing
- Fees & Taxes
- Stock Price and Market Model
- Investor Profile and Lifelong Investing Strategy
- ETF 101
- Stick with it
- My take on Cryptocurrencies – Part 1: The Ugly
- Interactive Brokers 101
In this post we’re going to talk about… ouch, I forgot what we’ve seen so far!
“RIP, I’ve been following you throughout the series. We’ve seen all the basics and I’m ready to invest my money! I know that I should keep some money cash, something between 3-12 months of living expenses. Then invest the rest. Some on bonds and some on stocks. Index funds more than individual stocks, to differentiate and reduce risks associated with individual stocks. I know that fees matter a lot, so I should shop for a cheap broker. I also know that I should invest as soon as possible and stay in the market for as long as possible… I’m not sure I fully understood that btw… Anyway, a lot of theory but I don’t know how to convert it into some concrete steps…”
Ok, cool. Thanks for the recap! Well, brace yourself: we’re going to see something concrete here!
“Yeeeah! So? How should I invest? Which actual assets should I buy? Which bank/broker should I use? When should I buy/sell??”
Relax, calm down. Not yet, not all together. Here we’re going to devise a plan for your lifelong investing strategy. We’re not going to look at what you should actually invest into (btw, we’ve gone very deep there, you should tell me on what to invest right now) and not even which bank/broker services to use. Just how to design your support infrastructure.
Did you do your homework? Did you write your IPS? Do you have an assets allocation strategy? If not, go and come back once you’ve done with that.
Ok, welcome back!
Disclaimer: my view is biased toward Switzerland in several aspects:
- No capital gain tax, but wealth tax.
- Tax deferred accounts (Pension Pillars) essentially not investable but they don’t matter for wealth tax.
- Investments are funded mostly with after tax money.
Ok, let’s move on! I assume you’ve your asset allocation strategy.
“Well RIP… yes, I do. I’ve put 10K cash and the rest 75% Stocks and 25% Bonds… is that ok? Is that anything else I should invest in?”
Cool! Well done! You asking me if you should invest in something else? Let’s face this soon so we can move on quickly. I don’t know. Surprise! I don’t really know. It depends on your personal taste, on your investor profile and on the amount of time you’re willing to spend to become an expert in a field.
Your investor profile, according with Wikipedia:
An investor profile or defines an individual’s preferences in investment decisions, for example: Short term trading (active management) or long term holding (buy and hold) Risk-averse or risk tolerant / seeker. All classes of assets or just one (stocks for example)
Your investor profile defines what kind of investor you are. Please, take time to assess it. Don’t invest mindlessly, be sure to have your investments and your strategy aligned with your profile. There are people who invest in safer assets like structured notes. There are investors who invest in precious metals and mining companies and those who invest in options (it’s kind of meta investing). There are literally plenty of “paper assets” types. You’ll find people who recommend X over Y all the time. I do recommend stock funds that track market indexes (and bond funds, eventually, for bonds). Because they are better? No, because they are simpler. You don’t need to know much to jump in. We already covered all you need to know to avoid panicking, trying to be smart and trying to time the market. So the bottom line on this is: if you really want to spend your time and energy on other investment areas, please do. I’m just here to show you a simple strategy that worked well enough in the last 150 years of recorded financial history.
Back to us: you’d like to invest 75% of your current investable NW (your NW minus cash/emergency fund). Before moving on, let’s split your financially aware life in few ages:
- The first investment time. Here you probably are, my friend. You have some savings and want to start investing them and you don’t know how, on what, when, what to do if you lose money,…
- The income (or accumulation) age. Here’s where I am. You are investing and still earning a salary, you’re saving and you want to invest what’s left each month (or spend what’s left after investments).
- The transition age. Your investments are producing enough money but you’re not FI yet. You may want to take a sabbatical, switch to part time, take some risks in new activities or careers or simply follow your passions being aware that this may reduce your earnings. Here you probably can manage to keep your expenses below your earnings but you won’t be investing much more. Maybe you even need to withdraw a little from your invested capital. I will explore this sooner or later, since I may actually take this path.
- The withdraw age. You’re living off of your investments, you’re FI (and retired). You need to withdraw continuously to support your expenses.
I assume you’re either in the “first investment” time of your life or in the income phase, i.e. you’re still working, earning, spending and saving at least 25% of your earnings, possibly 50% or more (what about 80%?) which means you want to invest every month a good portion of your savings, am I right? Awesome!
You wrote your IPS, so you probably have your guideline written down and your differentiation strategy, am I right? Not yet? Listen… take your time and do something like this:
Here you can see an example market analysis and diversification strategy. On the first two columns you can see the indexes and their descriptions. This is just a screenshot, the original document (that I’ll clean and share sooner or later) contains links to justetf, a popular funds search engine where I do all of my researches. Third column is the target percentage of my investable NW. As you see not all the indexes made it. But it’s good to spend a little time researching indexes, markets and sectors. You don’t do this very frequently, just every once in a while. Let’s assume the whole Travel industry collapses, then you probably want to remove the Travel index from this list!
“Wow RIP, what a deep analysis… do I need to do the same? And btw, what are those strange codes in columns 5-9?”
No, you don’t have to do such an analysis. I did for… fun! Well, I wanted to know what’s around to differentiate more than I do today. These percentages are WIP and subject to change. I remember to have signed off to provide my IPS by end of year (update: here you go), I still have time 🙂
Anyway, you’ll probably be ok investing in few indexes like… wait, that’s your job! I can’t help you in this. Find your differentiation strategy and come back. If you want to keep as simple as possible, find a WORLD index and go all-in with it. Vanguard has total market fund. Sadly, Vanguard in Switzerland is slightly harder to manage thus they are not so recommended. We’ll cover it later in this series.
Ah, and those strange codes are ISIN, a.k.a. International Securities Identification Number. Identification numbers for your funds. Just don’t care about that for now (psst… those are actual funds!).
Now you have your assets allocation strategy! What’s next? Oh right, buying actual funds! There are several funds type, and for each index you want to have in your portfolio, there are tons of funds that track it. We will cover the problem “how to chose a fund, given an index I want to have in my portfolio” in another post in this series, so please let’s assume for now that you already have a preferred fund for each of your indexes.
[Note: you can even diversify within the index and buy several funds that track the same index. I don’t know if that’s useful. My personal opinion is that it is not. Plus it complicates things at tax time. The more asset you have, the more complex your system will be.]
So now you have your funds list each one with its desired target percent of your investable NW. cool! Let’s put that into a spreadsheet:
Note: previous screenshot is my new (WIP) strategy, while this one shows current strategy. Refactoring in progress.
Here you can see few things: current allocation, target and delta for each asset class and within stocks funds (ETFs, we’ll learn more about them in another post) allocation by index. If you’re curious, I’ve explained a little bit about this structure in a previous post.
How does this spreadsheet work? How can it help me during my entire life? The schema we’re looking at easily supports income age (as well as first investment time), let me show you how.
You can monitor your desired allocation among funds and your actual investments. In case you’re at the first investment time all the actual would be zero. You periodically take a look at the deltas and if they are greater than a certain threshold, you act on it. Either buy buying more of asset X or selling asset Y. For example, according to the old plan, I’m short of STOXX 600 Europe fund by 37K. I should buy 37K of that fund. I’m investing 33K too much in S&P 500 Tech Cap, so I should sell it.
This way you can monitor diversification. The system is also self balancing: if a fund grows too much and sooner it will dominate your portfolio, you sell a portion of it to rebalance and achieve the planned diversification. If a fund loses too much to go below its target, you buy more of it. This way you also “buy low and sell high” automatically.
Why did I mention a threshold? Because in doing that I’m trying to minimize frictions: if my broker charges me 10 CHF minimum trade fee or 0.1% of the trade value, I try to never buy/sell less than 10K, to avoid paying fees at a higher percentage. So I don’t act on deltas smaller than 10K.
How frequently to buy/sell? Don’t get obsessed by it, you only need to take a look once a month o once everytime your accumulated savings are above the threshold. So, only you know when to look at it. If you save 500 a month and the threshold is 2K you go looking once every 4 months. In any case, better to not let more than 6 months pass, else your portfolio may become unbalanced on its own.
“Cool RIP, so everytime I have new savings all my deltas will grow… once I have 10K (or the fee-based threshold) available, I’ll throw them at the asset with the bigger delta!”
Yes, you got it right! You’ll find that in this accumulation phase you won’t need to sell, since even if an asset performs very well, your overall NW is going to increase, leaving you with smaller deltas and a cash surplus.
“Ok RIP… so I’m essentially NEVER selling my stocks, am I right?”
That’s not totally true, you’re going to switch from “accumulation phase” to “withdrawing phase“. Eventually transitioning to intermediate phases, in case you’ll reduce working time or switch to a semi retirement.
“Ok RIP, I mean I’m not going to buy and sell frequently. I have friends who do that. I know you already told me it’s not the right way to go… but this friend of mine says he makes Godzillions…”
Ok, let’s clarify this once and for all: there’s no right and wrong. I showed you how it’s hard to be smarter than the market, but you’re free to try and you may actually succeed! You may have better intuition than the investors crowd. You may bet on the oil price going up, or on banks going up, or on tech going down or whatever. If your guesses are right, you may be rewarded by tons of money. Go for it! The way I see it is like gambling, but in case you buy/sell frequently you’re paying a lot of trade fees that will make the expected return lower than just following the crowd. Thanks to trading fees, if you do a lot of operations with expected zero impact you’re losing money. It’s like betting on red or black on the roulette without considering the green number zero.
That’s because my investor profile is different that your friends one. I’m a Buy & Hold investor, while your friend is probably a Day Trader. The day trader’s job is to beat the market and perform better than average. The buy and hold investor is ok with matching the market. The first is driven by short term gains, while the second prefer to play on long terms.
I’m kind of Risk Averse, while your friend may be more Risk Tolerant. I’m a Fund investor, your friend may be a individual stocks investor (or, as we’ve seen before, an investor focused on other asset types). Different people, different profiles. Seek out yours! Write it down in your IPS.
“Cool… then, what to do when in withdraw phase?? I’ll soon be FIREd and living off of my investments, how to handle withdraws?”
Nice question! I have no idea 😛 I’m not there yet so I’m not the best person to ask. But let’s try to figure this out together: in withdraw phase you probably want to reduce stocks exposure over time. You will probably change your investor profile becoming more risk averse. You should continually change asset category allocation and experience deltas changing. You act accordingly. I don’t see a big difference here. You may try to switch to distributing funds instead of accumulating, so you have the dividend in hands instead of having it automatically reinvested – so you can disinvest it.
I have another idea that involves defining your “Stocks FU Number“, a desired total invested amount in terms of number of years of expenses (say 20x). If you’re lucky and your investments grow above 110% of that, you disinvest the extra 10% and buy more bonds. If it gets below 90% you take the missing 10% from bonds and invest them in stocks. This way you can reduce market collapse risks and you have a clear signal that you need to go back to work: when you hit the 90% and have no reserve.
But I still have plenty of time to tune my strategy!
Last but not least: Dividends.
In this very long post I talked a lot about stocks but almost never introduced the concept of dividend. A dividend is a tool companies use to redistribute profits to the shareholders. You own a stock of a company the day the dividend is distributed, you get the money. Some companies don’t distribute dividends by choice. I don’t like to focus on dividends since they are mostly neutral factors in stock decision for me (but need to tell there are investors who love dividend stocks: 1, 2, 3). Actually, from a company point of view issuing a dividend is a damage in the long term. Let me explain: when a company issue a dividend of X per share, the stock price instantly loses X. It’s logical, the company is worth less. If a company doesn’t issue dividends, the not issued dividend is still in the stock price. A company that reinvest the not issued dividend is more likely to make more money out of it, with a final result of having more chances of growth in the future. There’s more value in stocks who don’t distribute dividends. Here’s a list of very successful and growing companies who don’t distribute dividends.
Have a nice day.