The Long Bet

The case for passive investing has been well put forward by this long standing bet between the Sage of Omaha and Protege Partners.

“Over a ten-year period commencing on January 1, 2008, and ending on December 31, 2017, the S&P 500 will outperform a portfolio of funds of hedge funds, when performance is measured on a basis net of fees, costs and expenses.”

So the story goes that Mr Buffet postulates that within a 10 year period, the index of S&P 500 will perform better than a portfolio of selected stocks by portfolio managers. He actually bet US$1 million on that with Protege Partners, a hedge fund company.

To put simply, passive investing is to follow the stock market blindly by investing in all the companies listed on a particular index, such as the S&P 500. The S&P 500 index comprises of the 500 largest companies listed on the US stockmarket by market capitalization. By investing in the whole index, you are basically going to be tracking the performance of the stock market, ie. if the stock market does well, so will your investments, if it does poorly, your investments will follow suit. There is no activity in actively selecting stocks, hence the ‘passiveness’ of the investing.

On the other hand, to buy individual stocks or to invest in a mutual fund with a manager, you be will subject to picking stocks. You would be trying to better the performance of the stock market. (If not, what’s the point of picking stocks in the first place right?) However, to beat the performance of the stock market (which would the average performance of all the stocks), you would need to pick the stocks with ‘above average’ performance. To attempt to do that, you would need up to date information on the companies, knowledge on how the markets/companies/industries function, analyse all the above and then make a judgement which would be companies with the ‘above average’ performance and then you need luck as well for things to go well as you planned. And to make sure  you achieve that on a year on year basis, you would need to do that and reassess things regularly again and again.

Reasons the average investor would do better with passive investing compared to active investing more often than not:

  1. Fees
    • Current fees for passive investing via tracker funds costs as low as 0.07% (Total Expense Ratio) for instance for the Vanguard S&P 500 UCITS ETF. This is compared to managed funds which can be from anything from 1-2%. One of the more popular equity income funds Woodford Equity income fund has a Annual Management charge (AMC) of 0.75%. The Vanguard UK FTSE 100 tracker has a fee of 0.09% to compare with.
    • Hence the active funds have to perform signifcantly better perhaps 1-2% than the average market performance before fees just to meet the same returns as the index tracker fund. And this has to happen EVERY SINGLE YEAR to justify the fees.
  2. Diversification
    • The greater diversification of index tracker funds over hundreds and hundreds of companies makes the risk of investing less than choosing just a few companies. You have to be careful of certain indexes which may be overly populated by certain sectors, eg Tech stock in in S&P, Financial in the FTSE. Basically this is a case of spreading your eggs across as many baskets as possible. The first rule of investing is to protect your capital and we do this by spreading the risk.
  3. Not needing to choose
    • Not having to choose is a brilliant strategy! You avoid choice paralysis, you don’t get bogged down by inertia, you don’t have to worry about the specifics of each and every company if you are not interested at all. Owning a slice of every company on the index means you get the benefit of getting the average returns from the market regardless of what happens. And being average is mostly good enough.

As of end of 2015, the S&P index fund has been outperforming the hedge funds the past 8 years. It is surprising and perhaps counter-intuitive as to how such a simple strategy can be more potent then doing some research and picking out the better performing companies. This is apparently better shown after there has been year after year of changing market conditions. The active funds, just can’t keep up!

protege2016-720x400
 

Source: Berkshire Hathaway Annual Shareholder Meeting 2016

 

On of my favourite writers on investing proposes that active investing is a Zero Sum Game. When there is a buyer, there has to be a seller. When someone profits from the sale, someone will lose from the buy or vice versa. The total net effect is that there is no gain or loss in the market. The only net gain is from the dividends being paid out from the companies. The price of the asset on the market will be volatile depending on peoples valuations. However the tendency of prices is to go up as companies become more valuable and produce more and as inflation pushes the prices of assets upward. Joining the active game is where you might just as well be the winner or the loser just the same at the cost of a fee to the active managers or transactions costs brokers charge!

We might as well settle for average and let time do the compounding for us.

 

 

 

 

Dividends: the Fruits of the Market

So August, September and now October is just passing me by since I last looked at FIREplant. Not exactly dedication is it? I am still keeping an eye on the finance bit side of things tho and continuing to read into the markets and news about Brexit and pound and elections and stuff that happens all around the world. And life just goes on…

This is just an update on the Dividends I have earned so far this year. Fruits of the market. Some dividends are paid yearly, some are paid quarterly but the funds that I have picked pays out quarterly dividends. I think it gives me somewhat of a bit of motivation when I can physically see the returns trickling in. Another benefit of quarterly dividends is the chance of rebalancing with the dividends if the portfolio allocation gets out of their desired allocation if I need to, although my level of dividends at the moment is not enough to do anything significant.

2016 Q1 Q2 Q3
VAPX 64.85 66.2
VEUR 132 45.45
VHYL 88.91 67.89
VFEM 25.28 69.63
VUSA 13.18 15.98
Total 0 324.22 265.15

I have not bought any more units since I dipped into the markets, so the dividends are coming off the same number of units I have bought.

Each quarter of dividends current equates to roughly 0.6-1% of the portfolio value, but given that the value of my portfolio has increased 20% since April 2016 it doesn’t seem to bad. A good learning point is that % yield on a portfolio may fall when the value of portfolio increases and vice versa, the % yield may increase when the underlying assets fall in price. Hence, looking solely at the yield doesn’t tell you about the whole picture but may be indicative of how the underlying price of the asset is.

It is interesting to see also that the same number of units for VEUR paid out a third of dividends from the previous quarter or how VFEM paid out 2+x in Q3 compared to Q2. Perhaps this is due to how the underlying companies in VEUR/VFEM pay out their dividends throughout the year or could this be due to other socioeconomical factors? I don’t reckon it matters much it the grand scheme of things but it would be interesting to see what happens next quarter.

All in all, I am quite satisfied so far with my picks and the dividends. Over the course of 1 whole year, the estimated dividends on the whole portfolio would be roughly 2-3%, excluding any underlying volatility of the price of the portfolio. The challenge is to focus on the dividends and try to ignore the volatility of the portfolio. I hope when the volatility shows up as a fall in price of my portfolio, I don’t get the butterflies in the stomach. That is the true test for any investor I reckon. Hence the importance for  Cash as a buffer/reserve as an emergency fund.

What is your Cash Worth?

So the month of June and July has not been kind to me in the slightest. Not in terms of the financial side of things but all the other aspects of life. If I were to be FI, there would probably be a lot less of these mental shenanigans.

It feels like I’m rowing solo across the Atlantic. The planning is done, the course is set and all I gotta do is row.

Behind me are hundreds of miles of flat, grey ocean. There’s nothing on the horizon. In front of me, are thousands of miles of flat, grey ocean. There’s nothing on the horizon.

It’s hard to tell I’m moving at all.

An ancient mariner would pass the time by juggling mortal danger and hallucinations. A modern mariner has the same options as well as their GPS tracker and calls from home.

All four are needed to keep the rowboat on an even keel.

– Financial independence – adrift in the vastness by Monevator

So your portfolio in stocks can go up and down. You can’t predict it. Everyone says the economy will be bad bad bad post-Brexit. Maybe it is bad, but my portfolio is about 8% up from beginning of April. Amateur financiers, economists should probably not even try to explain the phenomenon. I mean even if the experts can explain it retrospectively, it is probably just academic speak anyway. And with so many experts all around, it is difficult to recognize the truth from all the ‘noise’.

Now what can steady the ship as it sails along to shores of the promised land is your Steady Cash Savings! Hence I introduce the measuring your Cash Worth!

I like to keep things simple and easy so this is how I do it.

At the beginning of the month, I review all my accounts (current, savings, bonds, credit) and record the value of each account on a spreadsheet. I add all the sums together with abit of help from Excel’s excellent in-build functions and get a total sum. I then compare this month to month to see what’s the increase of my Cash Worth.

This is what it looks like on a chart since Nov 14 till now.

Cash Worth

I shall try to aim to keep 1 years worth of living expenses as buffer rather than fixing on a fixed percentage of my entire net worth. I think it is an interesting choice to make in designing your whole portfolio, and it needs to weigh in your risk profile as well.

  • How well can you take being out of job? (Let’s face it there’s no guarantees!)
  • How long do you expect to be not working?
  • How much interest can your cash be generating in a simple current,savings accounts strategy?
  • How safe is your cash in the above mentioned accounts?
  • What is the alternative? More Stocks/Shares/Bonds/Property? What is the outlook like?
  • Savings for short term big events? Weddings/Mortgage/Holidays

So many ideas and more questions to answer. (I think I am thinking like a Independant Financial Advisor now!)

I hope the steady stream of inflow is a constant, or even an exponential growth chart as I try to avoid lifestyle inflation as much as possible with hopefully income growth! This constant is so much more soothing than the volatility of  stocks and should be thought of as the fertilizer to the FIREplant. The regular drip feeding to my FIREplant portfolio is proudly starting to show signs of its first fruits last month of 1% dividends in the last quarter!

Let’s get the snowball rolling! 😀

The Pursuit of Freedom

We can only escape so far. We can only be so free. There is a point where we can no longer be free-er. Most times our own attitudes and fears are trapping ourselves. The environment most of us live in contributes to that as well.

I haven’t been feeling great these few days as I have taken 2 weeks off work and I know the team isn’t coping too well with other people being off sick and stuff. Imagine this, away on annual leave, but not getting peace along with it knowing you are contributing to part of the problem (not really, it’s the problem with the system i think). I think it is important to learn that live goes on with or without you. You are never the centre of the universe you thought you are. On the journey I realise there are many things other side of work that is worth valuing and spending time on (family, friends). On the other hand, the act of going to work gives me structure in daily life and new experiences.

A needless anxiety I shouldn’t be suffering. I need hasten my plan to build more of the plants to fuel this freedom.

 

The Power of Freedom

How often do you have to get out there a quick monumental decision that changes relations. To be brutally honest or tell a white lie? To break up or make up?

Humans enjoy their comfort zones. They build set out bricks and fill up the cement, erect walls to build their own comfort zones, shielding themselves from the ‘outside world’. And when some sesmic event dawns upon them, it tears down the walls and forces them to face the cold hard truth. No man is an island.

My wall came down when I had to decide whether ‘To Fly or Not’ to see my grandpa upon hearing his passing. His last journey with us and I hesitated. Foolish Foolish me. My wall was ten floors high and I have been snuggling in it for the past few weeks. Everyone else was moving quickly, booking flights, settling leave, and I was thinking maybe I could get away with not going, paralysed by fear of settling leave, fear of not completing some leftover tasks, of being frowned upon.

The fear and anxiety is a very typical symptom of modern society. Just see the number of people who turn up to their GPs requiring anxiolytics, antidepressants. There’s always a feeling that someone else owns us. Your boss, your job, clients, the government, your relationship. Sometimes, it is just too much for a person to handle, or sometimes you are just oblivious to it.

climber-snowy-mountain-top
The sense of freedom at the peak where you look down on all there is before you, filling you with awe, fear and pure joy!

Freedom comes from never having to answer to anyone else but yourself. Even then, you are trapped within yourself unfortunate. True freedom may perhaps bring chaos and unruliness rather than order in this world. And Financial freedom opens will open alot more doors to you, giving you the option of saying ‘No’. When you have a choice between working and spending time with a sick relative, you will less of a dilemma.

A Brief History of Time: Compound Interest

People are living longer and longer. Back in the Victorian times, you will be lucky to make it past your 40s. 3 of my grandparents are still alive at 70s, 80s so given the average agesof my grands and ever growing medical and  technological advancements, I estimate myself living to my 90s barring any natural disasters or personal misfortune.

Now I hope I am not going to need to work for a living when my joints grow old and creeky and become deaf as a bat so I have got to plan for my financial escape!

What? Planning for the retirement fund 40-50 years in advance? Isn’t that too early?

I don’t think so and let me introduce you to the 8th Wonder of the World, Compound Interest. Taking 50 years as the average working lifespan of the average person, let’s see what compound interest can do for us.

CI graph
Compounding 100/200/300/400 monthly savings for 50 years with 5% Annual interest

Consider the following scenario,

Starting from Zero Savings,

  • Saver A saves £1200 at the end of Year 1, and at the same rate for the next 49 years
  • Saver B saves £2400 at the end of Year 1, and at the same rate for the next 49 years
  • Saver C saves £3600 at the end of Year 1, and at the same rate for the next 49 years
  • Saver D saves £4800 at the end of Year 1, and at the same rate for the next 49 years

Factoring in an annual interest rate of 5% and assuming all interest remains within the savings pot and not withdrawn, at the end of Year 50,

  • Saver A has £238,112 (From an input of £1200×50=£60,000)
  • Saver B has £476,224 (From an input of £2400×50=£120,000)
  • Saver C has £714,336 (From an input of £3600×50=£180,000)
  • Saver D has £952,448 (From an input of £4800×50=£240,000)

You can see with annual compound interest of 5%, over the course of 50 years, the sum just about quadruples (~3.96x the orginal sum saved). You can just about see that the compounding graph is an exponential equation and if time is unlimited, soon the line would be a vertical line soaring for space! 

Putting it into context, how difficult is it for us to save 100 or 400 per month over the course of our working lifespan? If you have a decent stable job, then it should only be a motivational issue to keep that consistency up for such a long period of time. For many, trying to make ends meet is a miracle by itself, so even 100/month might be difficult. But the point is this, saving any amount consistently over a period of time with compounding interests, you can make the graph exponential and for money to work for you!

5% interest? How realistic is that? The Bank of England base rate and US Federal Reserve rate is still at an all time low of 0.50%. Market savings account interest rate are roughly on average 1-2% with some accounts offering ‘special rates’ with balance limits up to 5-6%. It appears doom and gloom for savers globally. Quantitative Easing (QE) over post 2008 crash have screwed us over. Perhaps it is time to looks at other asset classes to diversify savings. Cash has historically offered the poorest return of all the asset class. Whatever the rate is, the compound effect still hold true (unless its negative rates) and it makes sense to make use of this knowledge.

Next consider this next graph where annual compound interest is 5%

  • Saver A saves 100/month for the whole of 50 years
  • Saver B saves 200/month for the 1st 10 years then 100/month for the next 40 years
  • Saver C saves 300/month for the 1st 10 years then 100/month for the next 40 years
CI 10 years boost
Compounding Savings with savings boosted in the 1st 10 Years

At the end of Year 50,

  • Saver A has 238,112 (3.96x of actual cash saved)
  • Saver B has 339,310 (4.71x of actual cash saved)
  • Saver C has 440,509.9 (5.24x of actual cash saved)

By increasing the ‘pain’ of saving more in the early years, and then easing off, the compounding on the increased savings from the early years really work its magic over the next 40 years to speed up the exponentiality of the curve! In fact, if you can squeeze in as much savings as you can into the early years of your working life, the latter part of saving life will be very much easier.The earlier you plant your seed to grow your FIREplant, the more fruits you have to enjoy later in life.

My Notes

  1. The Snowball Effect
    1. Notice that the first 10-20 years of savings might appear to be a linear graph, but after year 20, the graph becomes more noticeably exponential. Let me give you a horticultural analogy: Your plant a seed to grow a FIREplant. When the FIREplant matures and produces fruits and in turn seeds. You harvest the fruits and replant the seeds back into the soil and grow more FIREplants. The new FIREplants will produce even more fruits and even more seeds. You repeat the same, year after year and in no time, you will have fields and fields of FIREplants, more than you can ever need and it all started with that one seed! Time is your friend in this case.
  2. All You need is Time
    1. Look at the Forbes Rich list 7 out of 10 in the top 10 list are over the age of 70. I wonder how much of their wealth is due to compounding their gains over and over again over their decades. Interesting to note, the other 3 who are under 70 years old are masters of Microsoft, Facebook and Amazon. So the key to growing rich, live for a long long time.

Takeaway Messages

  1. Saving/Investing – Start Early to leverage the compound effect
    • The best time to plant a tree is 20 years ago. The second best time is now.

  2. Keep a Steady Contribution
  3. Reinvesting Interest Earned
  4. Stay Healthy and Live a Long Long life.

So Start Growing Your FIREplant Today! 😀

N.B. Try out Monevator’s excellent Compound Interest Calculator to see how fast the snowball grows!

What is your Savings Rate?

The causal saver might be saving for the next purchase; a car, a sunny holiday destination, a house, the latest electronic device. But item after item where does that end? Let me provide you with a new goal, saving for your Independence!

The single most powerful measure of how you are doing financially and best indicator of how far off you are to financial independence: Your Savings Rate.

Savings Rate: (Annual Savings*/Annual Income) x 100%

*Where Annual Savings= [Annual Income-Annual Spending]

Simply, if say you are spending more than what you are earning, i.e. more than 100% of your income, you will never be able to retire and will technically be in debt.

On the other hand if you are spending only a tiny proportion of what you are earning, for example, 40% as an example, you are still financial dependent on your income but have shown that you can survive on much less than what you earn and you are a net saver (SR = 60%).

Now the magic starts here. If…If somehow your annual spending is zero, you are technically no longer dependent on your income to live and you can retire right away, continue living your free life. If you are one of the lucky few like me, this happened when you were a kid.

The reality is all of us are somewhere on the spectrum of savings rate. We earn and spend a proportion of our income (hopefully less than our income) and save the rest. Now the interesting thing is, the amount that we stash away each year can earn some money on itself (savings interests,CD interest, Bond yields, rental yields, stock dividends, investment yields, etc). As we save more each year, this income from savings can snowball year on year into something significant and if it approaches the level of our annual spending, we can be less reliant on working to earn an income to live. If it breaches the threshold of our annual spending, we are officially financially independent and can rely on this passive income to live.

years_to_retirement
Years to Retirement vs Savings Rate*

*Assumptions

  1. 4% Withdrawal Rule – you will be withdrawing within 4% of your entire stash to meet you annual spending during the decumulation phase (retirement)
  2. Your savings are invested to generate a growth of 5% annual return.
  3. Your stash is meant to last forever.

Someone really clever (?MMM)  came up with the graph above which shows if you are able to achieve an annual Savings Rate of 64% with the above assumptions, you will be able to retire in 10.9 years time. The following table shows the number of years it take to achieve FI with the corresponding savings rate.

Savings Rate Years To FI
10% 51
20% 37
30% 28
40% 22
50% 17
60% 12.5
70% 8.5
80% 5.5
85% 4

My Notes:

  • What I like about the savings rate is it is universal to everyone from the ‘rich’ to the ‘poor’. It applies equally to the high flier who brings in an annual income of £1,000,000 vs the poor city worker who only earns £20,000. Even if you earn an infinite amount of zeros, if your SR is 10%, the reality is you still have to work up to 51 years to become independent. Conversely, if you can achieve a high Savings Rate (70%) on any salary, you will be achieve FI in 8.5 years!
  • Another note about the savings rate is that it includes the element of relative frugality to the equation. It implies that if you can survive on a lot less that what you earn, you will get to financial independence a lot quicker. Most people put a lot of focus on increasing your pay/income, but it works a lot faster if we can reduce our spendings relative to our income. 
  • There has been a lot talk about about savings rate on the personal finance blogs around. The best post about this are Mr Money Moustache’s  The Shocking Maths behind Early Retirement and Monevator’s How to work out your financial independence plan. Both posts are a good read and backs up the assumptions with historical data, analysis and many more references.
  • It is still worth taking a step back and realise this is just a model with arbitrary numbers. It might not be the perfect model (is anything perfect?) but it gives us the encouragement that mathematically the concept is sound and achievable. We just have to take action and use this as basis of our grounding principles to FI.

 

So how far are you till Financial Independence?

 

The world is much more than I.

Greece
Refugees in Greece. Mum feeding kid along railway tracks Photo: Tobias

Sometimes it is so easy to get caught up in work and life rolling on. Seconds become minutes, minutes becomes hours, hours become days, days become weeks, weeks become months and then years and decades and at some point people reach a point when they pause and think ‘what’s the point of all this?’ ‘Where is the end?’ (Midlife crisis?) I think we all have our mini crisis on a daily and weekly basis hence needing to look forward to happy hump day and weekends!

Well we are lucky that time flows in one direction and all things must come to an end (sounds morbid I know), but that means all things good or horrible will not last forever. So we should just enjoy the view, appreciate the tears of joy and sorrows along the way and consider that everyone else is on the journey as well. It is one reason I enjoy stories, real or fiction reminding me there are others out there feeling the same worldly frustrations or wonders. Reflecting on other people’s stories also reminds you that the world is much bigger than your five senses or your internal narrative.

Hence the photo narrative can hopefully be a therapeutic break for the mind. The world is much more than I.

Financial Independence? How?

Tulips
Plant your FIREplants today!                          And enjoy the fruits tomorrow!

How? How? How? I have decided I want achieve the fabled dream of being independent from all financial worries, but how do I get there?

To be honest, there are many many personal finance blogs out there describing the different ways or the technicalities of gaining FI much better than I can but the 2 main principles distilled down to its essence are:

  • Frugality
  • Building a passive income

Wait. Whaat?! This sounds uninspiring. I thought there was a bigger secret to it all. But in fact once you can build a large enough passive income to satisfy your spendings, surprise surprise, you will have arrived at FI, a land where you can shout out loud ‘I think I am going take a long holiday and travel around the world for a year,’ Or ‘I am going to try my hand at baking/cooking full time’ Or ‘I quit, you f***ing prick!’ to you boss. And know that you have a plan; a solid escape plan that will keep sustaining your daily life. You live to do what you want to. How is this not the dream of everyone alive?

 

Financial Independence? Why?

Financial Independence is an age old concept in a twenty first century lingo. In simple terms, it is what it basically says on the tin, being independent financially. In modern society, this equates to being able to afford the things you buy using currency as a trade. This implies you have enough financial reserve (ie income, savings) to satisfy your bills, meals, a roof over your head. The outcome of not having this is well summed up by Mr Micawber in Charles Dicken’s David Copperfield.

‘Annual income twenty pounds, annual expenditure nineteen [pounds] nineteen [shillings] and six [pence], result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.”

-Wilkins Micawber in David Copperfield (Charles Dickens)

The reality is it is not as simple as that. Happiness does not simply come with Financial Independence but not having financial independence will make being happy pretty difficult or a false sense of security.  Here is an article by theescapeartist on The Prison Camp illustrating how modern society has taken over people’s life and made us into a bunch of misfits trying to fit into the ‘well, that’s what just what everyone does it’ mentality. I picture it as a giant factory with conveyor belts, and society just traps you in there, making you a banker, lawyer, pilot, doctor because the economy/society needs these roles; selling you the latest TV, Driverless Car, Phones with a fancy contactless paywave function because they are a necessity of modern life. Hence the Prison Camp which never ends till you die.

Now true Financial Independence is freedom from all these struggles. It is waking up in the morning and have the freedom to chose whatever you want to do for the day and not have to worry about getting food or a roof over your head for the night. It allows you to take a step back and liberates your mind and body from the stresses modern society is feeding you with.

I believe this is an universal experience for everyone on the conveyor belt and can relate to. I hope to share my journey of growing my FIREplant, and anything that is worth learning along the way.