S1 E8 Investing

On this weeks episode of the Money Mentor Ken discusses investing. What is investing, why should we invest and how best to get started. 

team@money-mentor.ie

www.money-mentor.ie

https://www.amazon.com/Stocks-Long-Run-Definitive-Investment/dp/0071800514

https://www.amazon.com/Little-Book-Common-Sense-Investing/dp/1119404509

https://www.amazon.com/Myth-Rational-Market-History-Delusion/dp/0060599030

https://www.amazon.com/Intelligent-Investor-Collins-Business-Essentials-ebook/dp/B000FC12C8

https://www.amazon.com/Warren-Buffett-Way-Robert-Hagstrom/dp/1118503252

https://www.amazon.com/Education-Value-Investor-Transformative-Enlightenment-ebook/dp/B00KF2JU2W

https://www.amazon.com/When-Genius-Failed-Long-Term-Management/dp/0375758259

https://www.amazon.com/Dear-Chairman-Boardroom-Shareholder-Activism-ebook/dp/B00YMUODKM

https://am.jpmorgan.com/us/en/asset-management/adv/insights/market-insights/guide-to-the-markets/

https://open.spotify.com/show/71siUnIMn0iQY7Kz5BQSqJ

https://podcasts.apple.com/ie/podcast/berkshire-hathaway-annual-shareholder-meetings-since/id1445276006

https://www.imdb.com/title/tt1596363/

Thank you for listening - Money Mentor Team

Transcript

Hello and welcome to the money mentor podcast the podcast for your financial education. I'm your host Ken Mason.

On this week's episode we discuss investing. The topic of investing is a sizeable one. Investing is different things to different people, speculating and gambling are often lumped in under investing. The shorter our time horizon, the more investing turns into speculating and gambling. Investing don't ride is boring. It all comes back to our investment philosophy. As this is a financial planning podcast, I will be talking about the basics of what investing is to a financial planner, why we invest and how best to get started. Money is a means to an end and not an end in itself. Investing to make more money is of course the motive, but not an end result. An investment goal is to be financially independent, help send the kids to college, be able to give back to our communities, and create intergenerational wealth. Investing brings financial risk into our lives. Therefore, we need to ask ourselves, do I need to invest? And if so, why am I investing? What are we trying to achieve? Not to flog a dead horse, but we should hold off on investing until we know how much our current lifestyle castles spend less than we earn. Save a fully funded emergency fund, pay off all non mortgage debt and have saved for a deposit on a home if applicable. as outlined in Episode Three. Believe it or not, the greatest determining factor in building wealth is our savings rate, not investment return. Without a consistent savings rate. Investing alone will never get us where we need to go. savings are the foundations on which investing can build. our end goal will determine what our savings rate needs to be given the risk we are comfortable taking. In money turns we seek a positive return on our investment, but the outcome of our investing will hopefully allow us a return on life. In general, the word invest means to devote one's time, effort and or money to a particular undertaking with the expectation of a worthwhile result. We invest in ourselves in our families, in our careers, in our colleagues in our businesses, in our communities, and in the world at large. Investing has many similarities to planting a tree, it all starts with a single seed. we sow the seed in nutrient rich soil to give the best opportunity for growth. We water it regularly. Make sure it is getting good sunlight and weight. When we start investing, we start small, make sure we are setup right for investment growth. We contribute regularly remain disciplined and wait. As Warren Buffett has said someone is sitting in the shade today because someone planted a tree A long time ago, we save for short term needs and invest for long term needs. savings are certain and relatively risk free investing involves risk. investing money means putting our savings at risk long term in their pursuit of achieving a positive return. Long term is measured in decades, not years. The longer the better. We seek a positive investment return to preserve or grow the value of our money into the future. We invest by buying assets that go up in value provide an income and an income that rises over time we invest in asset classes. An asset class is the categorizing of assets with similar characteristics together examples of the main asset classes or businesses commonly referred to as stocks, shares or equities, government and business debt, commonly referred to as bonds or fixed income and property commonly referred to as real estate. In my opinion, cash is an asset but not an investment asset class, our fully funded emergency fund, and any additional amount of savings we need to get comfortable investing should be kept outside of an investment. Cash dragged down the performance of an investment due to little or no return, inflation, phone charges and tax if applicable. There are other asset classes but businesses government and business debt and property have proven themselves to appreciate provide an income and a rising income consistently over the long term. We invest in public businesses. Our public business is one that is registered on a stock exchange and ownership of its shares is available to the general public. Look, the primary aim of a publicly available business is to generate a profit for its shareholders. We access ownership of a public business by purchasing its shares. When we invest, we become part owners in these businesses, however small that may be. We do this in anticipation of the businesses going up in value, and receiving a share of the business profits, which is known as dividend income. Assuming the business is well managed and profitable, this dividend income can rise over time. Not all businesses go up in value, provide an income and a rising income. For collectively as a group or asset class they have gone up in value provided an income and a rising income over time. It is worth remembering that many of us work in businesses, run our own businesses and spend our money on goods and services provided by the very businesses in which we can invest. becoming part owner in these businesses allows will share in some of their growth and profits into the future. We are investing in the collective human ingenuity of some of the best businesses in the world. businesses and governments also use the goods and services of many public businesses and their subsidiaries on a daily basis. A subsidiary is a company owned by another company. Instagram and WhatsApp are subsidiaries of Facebook. When going about our day, think of all the products and services we interact with the public businesses provide from the phones we use apple, Samsung, the platforms we use, Facebook, Amazon, Google, Netflix, Disney, Airbnb, the roads and transport that gets us from A to B, C or H Apple green, Ryanair fbd insurance, the tools and software we use at work, Microsoft zoom to the medicines we use when sick or need a vaccine, Pfizer, Johnson and Johnson the food we eat McDonald's carry group Tesco, the beverage is we drink diazo CNC, the clothes we wear nyck h&m m&s a sauce are just a snippet of familiar businesses that are publicly available. Businesses as an asset class have historically provided the best returns roughly 10% per year on average over the long term. However, they can be quite volatile over the short to medium term, public businesses can be bought and sold quickly. It is a highly liquid and intangible investment, public businesses pose the highest risk and reward of our three asset classes. government and business debt have historically returned between four to 5% positive return over the long term. When we purchase shares of debt, we become part loaner to governments and businesses. We loan our money to governments and businesses by purchasing shares of their debt and in return, we receive a regular interest payment. Our mortgage is so much similar but instead of us paying interest on a debt, we are receiving interest on our investment. As we are the lender. government and business debt as an asset class is less risky when compared to public businesses. less risk means lower potential returns to government and business debt can be bought and sold quickly. It is a highly liquid and intangible investment. property has historically returned between three to 5% positive return over the long term, it is an investment close to Irish hearts, largely because we can drive down the road and see it, it is tangible, we can touch it. We can invest in property through purchasing shares in property phones, or by investing directly into a rental investment property. Buying a rental investment property is the preferred option in my opinion, property phones can do well but in general offer up a myriad of problems. The cyclical nature of property performance as an asset class, its inability to be bought and sold quickly, and fond fees make owning shares in a property fund on attractive relative to the investment return. Borrowing to invest in property adds financial risk to our lives. If we are fully funding our financial independence goal through our pension, paying off the mortgage is our next priority. If we have paid off the mortgage, we have a decision to make. Enjoy living a little more or save to buy a rental investment property to help boost income in retirement. Now that we know about asset classes, we turn our attention to how we construct our investment portfolio. asset allocation is how much of each asset class Businesses debt and property is represented within our investment portfolio. For example, we could have a balanced portfolio of 50% businesses and 50% debt, a conservative portfolio of 20% businesses and 80% debt, or an aggressive portfolio of 80% businesses and 20% death. Our asset allocation decision is the biggest determining factor in the returns we can achieve. How we choose our asset allocation will depend on our savings rate, risk tolerance, and time horizon. JACK Bogle, the founder of Vanguard once stated, a very general rule of thumb, that holding the same percentage of debt as our age with the rest invested in public businesses. So if we are 30 years of age, we hold 30% debt 70% businesses. If we are 70 years of age, we hold 70% debt and 30% businesses. This approach assumes we can still make the temporary market declines. It also clearly demonstrates the inversion of risk and time, the more time we have, the greater the risk we can take. And the less time we have, the less risk we can take. diversifying our investment portfolio across businesses debt and property is all about managing risk and return. We not only diversify across asset classes, but also within those asset classes. For example, when it comes to public businesses, we diversify across different countries, different industries, different sizes, small, medium, large, and different factors. Value growth quality. When it comes to debt, we diversify across different countries, different time horizons, different types and quality. correlation is a statistical measure of how asset classes and the assets within asset classes rise and fall in value relative to each other. In other words, if public businesses rise in value, does the value of debt rise fall or stay the same? Without getting too technical diversification and correlation seek to maximize potential returns for a defined level of risk. There are two main types of investing active and passive. Active investing involves a person or team of people making the buying and selling decisions. When it comes to picking which public businesses or debt investors money is invested in. Active investing seeks to identify research and invest in assets that are mispriced or undervalued. active managers seek out investment opportunities that may have been overlooked by the investment market as a whole. They seek to find and profit from the needles in a haystack. The objective of active investing is to outperform the market and index to which they benchmark themselves. Passive investing bypasses active managers and invests in an index fund. an index funds job is to mirror a market's performance as closely as possible. Instead of searching for the needles in the haystack, we buy the entire haystack. For example, The s&p 500 is one of the most commonly used index funds, which is made up of the top 500 businesses in the United States. When we buy the s&p 500 index, we buy part ownership of each of these 500 businesses. actively managed funds can outperform the market. 

However, it is hard to discern skill from luck in the short term, a guess or calculated guess has a probability of being right or wrong. If we make enough guesses, we are bound to be right some of the time some build a reputation on the correct outcome of a big guess. This does not mean they will continue to be correct into the future. With each year The past is the odds of an actively managed fund beating the market reduced significantly. For example, say 50% of actively managed investments beat the market in the first three years. By the time a couple of decades have passed 80 to 90% of actively managed funds will have underperformed their own benchmark. The small number of actively managed investments that do consistently outperform the market are largely unavailable to the everyday person. sovereign wealth funds, endowment funds, pension funds, family offices all falling under the umbrella of institutional investors and high net worth individuals are first in line to these unicorn active managers who have consistent track records of beating the market over many decades. Given so few active managers beat their own benchmark over the long term. It may come as a surprise that we will also be charged fees for the possibility of outperforming the market without the active fund actually having to deliver market beating returns, we take the added risk and have to pay for the opportunity of market beating performance. That rarely happens over the long term. When we deduct the fees paid to active managers, even fewer actively managed funds outperformed the market. When I talk about performance, I mean both negative and positive. So an active manager beats the market when they lose less and make more than the market. It is estimated as much as 80% of actively managed funds are actually index fund huggers, and plenty of active managers have their own savings invested in passive index funds. Passive investing doesn't pretend to be something it's not, our investment will rise and fall as the market rises and falls. Public businesses and debt can fluctuate wildly in the short to medium term, but reach new highs over the long term. Passive investing doesn't seek to time the markets but rather rewards those for time in the markets. The longer the better. The fees for passive investing are or at least should be significantly lower than active funds. This is because we are not paying for a team of individuals to identify research and transact investments on our behalf. We are buying an index fund that mirrors the market it is tracking and therefore fees can be exceptionally low. A few examples of how annual investment fees can impact our wealth building efforts. say we are starting our investment journey today and invest 500 euro per month for the next 30 years. If we are charged a total of 1.5% on our investment annually and receive an average annual return of 6% we will have accumulated are fond of 374,915 euro and have paid 114,714 Euro in fees. If there were no fees, we will have accumulated a fond of 489,629 euro or 30%. more similar to when we are paying interest on a mortgage a small percentage interest rate or fee over a long period of time adds up to a sizable amount. To give us a better picture of how fees build up over time, let's take 10,000 100,000 1 million 100 million and 1 billion and see how much a total annual fee of 1.5% is in money terms across those amounts. So 1.5% of 10,000 is 150 euro of 100,000 is 1500 euro of 1 million is 15,000 euro of 100 million is 1.5 million, and of 1 billion is 15 million in fees every year. So wherever we fall on the wealth spectrum, be sure to remember what we're paying every year. And why we are paying is the phone charge the platform charge the advisor charge the list goes on value for money and added value are worth paying for.

Sequence of return and market price are among the most underrated aspects of investing a sequence of return refers to the order of our investment returns across a given time period. Market investment returns can be positive or negative depending on the year. What investment returns we receive in our first number of years can have a significant impact on our potential overall investment returns long term. This is less important for those contributing to investments on a regular basis. And more important to those investing lump sums or folks drawing on investments in retirement. For example, the last ladder highlights what game we require to get back to where we started should we suffer losses. If we lose 10% we need an 11% gain to return to 100 euro. If we lose 20% we need a 25% gain to return to 100 euro. If we lose 40% we need a 67% gain to return to 100 euro if we lose 50% we need a 100% gain to return to 100 euro and if we lose 80% we need a 400% gain to return to 100 euro, the gains ladder is much the same. If we gain 10% a loss of 9% will have us back at 100 euro if we gain 20% a loss of 17% will have us back at 100 euro if we gain 40% a loss of 29% will have us back at 100. If we gain 50% a loss of 33% will have us back at 100. And if we gain 100% a loss of 50 percent will have his back at 100 euro. 

When it comes to risk, the idea is not to do a hail Mary and look to shoot the lights out with large returns quickly. This is because it is equally as likely we shoot ourselves in the face and lose ourselves a lot or all of our money just as quick from which we may never recover. The more risk we take the more flexible and accepting we have to be with the potential outcomes. Price of the market. The current price of the market as a whole is what we pay to purchase assets. The cheaper the price, the better the value, the more expensive the price the worst value. One of the main measures of market price is the price to earnings ratio. This ratio can fluctuate up or down. But based on the past, it provides us with a rough guide as to whether the current market is expensive or cheap. A positive return on an investment over time will lead to compounding. An example of compounding is when we invest 1000 euro, and let's say we receive a return of 3% over four years, the first year our investment value rises to 1030 euro. The second year, we also earn a 3% return on our new investment balance of 1030 euro which equals 1061 euro, the third year 1093 euro and the fourth year 1126 euro, if we had just added the 3% or 30 euro for each of the four years, it would equal 1120. But instead we accumulated 1126. This may not seem like much but given time it can have a profound impact on our wealth. The key ingredient is time and as much of it as possible, it will feel like little is happening for a long time. This is the equivalent of rolling a snowball in the snow until it has reached the point of critical mass. That is it is large enough to continue rolling on aiders wonder its own momentum. The point at which we begin to see compounding really take hold is roughly 100,000 to 200,000 euro for a 3% investment return is now 3000 or 6000 euro respectively. Compounding is frequently touted as the eighth wonder of the world. Her time horizon and self discipline are some of the most important aspects of investing. Investment markets are volatile in the short to medium term, short to medium term is anything less than 10 years. Over the long term time smoothes the volatility of short to medium term markets. Investment markets have risen and fallen in the past and there is no reason to suggest this won't continue into the future. In the last 20 years we've had the.com bubble of 2000, the financial crisis of 2008 and the COVID crash of 2020. These were all significant temporary market corrections where the value of businesses declined significantly. The NASDAQ stock exchange for technology businesses fell 77% and the s&p 500 fell by 49% in 2000, during the.com bubble, the s&p 500 fell again by 57% during the financial crisis of 2008 and 2009. And by 34% during the COVID-19 crash in early 2020. When investing in businesses as an asset class, it can be a case of taking the stairs up and the elevator down. When markets fall and fall fast. We are our own worst enemies. panic and fear are contagious. Our fight or flight instinct kicks in and screams at us to do something to Trump and investment value remains on paper and is only locked in when we take action by selling or switching into cash. Businesses rebound quickly and subsequently go on to new highs. These gut wrenching drops are the emotional price we pay for long term rewards. Oddly enough when businesses do drop in price, and we are investing regularly, we are purchasing these businesses at a sizable discount. It's the equivalent of heading into a grocery or clothing store and seeing everything at half price. If we do sell or switch to cash, we will get investor returns and not investment returns. No one can time the markets consistently. Temporary market corrections are part of the journey. We must be optimistic dance with uncertainty and have a healthy, lifelong relationship with investment risk to reap the rewards. The one certainty is uncertainty. None of us know what the future holds. If we had invested 40 years ago, we wouldn't be regretting it today. Day. Being good with money is 80% psychological and 20% knowledge the same way a healthy lifestyle is 80% nutrition and 20% exercise. If our money decisions were entirely rational mathematical decisions, I wouldn't have a job. We are the sum of our experiences are no one person's experiences are alike. We are emotive beings, instinct and emotions are what's allowed our ancestors and ourselves to survive. Our ancestors were focused on finding and eating their next meal while avoiding being eaten. The modern world is very different to the one our ancestors lived in. instinct and emotions are short term, whereas good money habits and investing are long term. Now that we have discussed what investing is, why invest our savings given the risks and uncertainty. When it comes to risk in our lives, there is investment risk and inflation risk. What happens if we don't invest and leave our savings as they are, the value of our savings will slowly decrease over many years as the cost of goods and services increase over time. Essentially, our savings stays static, whereas the cost of living gradually rises. The gradual rise in the cost of goods and services over time is called inflation. It will slowly erode the purchasing power of our money into the future, excluding 2011 and 2012. Inflation has been very low for the past 10 years in Ireland. However, inflation was very high in the 1970s and early 1980s. The average inflation rate for the last 60 years in Ireland is 4.8%. Today, the European Central Bank targets an inflation rate of 2% per year. Inflation can fluctuate wildly from negative inflation or deflation, where the cost of goods and services decrease as they did by 5% in 2009, to very high inflation, where the cost of goods and services increase by 23% in 1981. In order to keep pace with or outpace inflation, we invest the time value of money means 10,000 euro today is more valuable than 10,000 Euro in 10 years time as we won't be able to purchase as much in the future. For example, my grandparents were born in the 1920s and 1930s. a basket of Irish codes costing the equivalent of 100 Euro in January 1930 now costs 5413 Euro in January 21 or 54 times what it did in January 1930. In other words, if we held on to our 100 euro from 1930, we could only afford 2% of the basket of goods in January 2021. Our purchasing power today is virtually non existent. This is a lifetime of inflation, but simply pause 100 euro today will be worth less in 1020 4080 years time. Given the turn of the new year, the average life expectancy of a baby born in 2021 will be 105 years. Another way of thinking of how inflation affects us in our everyday life is to remember back to our childhood or young adult years. How much was a haircut, makeup, newspaper stamps, sweets, a pint a toy, pocket money or money gifted at religious ceremonies such as communion confirmation, or weddings. If we are young, ask our parents or grandparents what money they remember spending on everyday items we purchased today. Another example is the football transfer market. I remember seeing Rio Ferdinand's transfer fee of 30 million pounds back in 2002. It was jaw dropping 15 years later Neymar is bought by para Sandman from Barcelona for just under 200 million pounds. Madness. What we spent or received in the past is less than what we spend or received today. Last example, the average price of a secondhand house in Ireland in 1988 was a little less than 40,000. Irish Ponce. The average price of a house in Ireland as of December 2020 is a little less than 270,000 euro that is nearly a seven fold increase in 32 years. Based on the past we are certain to become increasingly poor if we do not invest our long term savings. Given inflation is guaranteed can we afford to not invest? Do we have a choice? We run the risk of running out of money before we run out of life. When discussing investment risk, we start with the risk free rate of return. The risk free rate represents the interest An investor would expect from a risk free investment deposit interest earned on our savings will be considered riskless. Given our current low interest rate environment there is little to no return available. Any interest we receive is subject to deposit interest retention tax at 33%. The next level of risk is government and business debt, where we receive a positive return slightly above inflation over the long term. Following this is public businesses with a positive return of double and sometimes triple that of inflation over the long term. At the absolute minimum, we want an investment return on our money that matches the sum total of inflation, fond fees and tax if applicable, or added together. example, say over the course of our pension inflation is 2% and fun fees are 1.5% annually. This means to maintain the same level of purchasing power for our money into the future, we will need to achieve a minimum positive investment return of 3.5% annually. How do we invest and where do we start? risk tolerance is an investor's ability to psychologically endure the potential of losing money on an investment, we can discover what level of risk we can handle by completing a risk tolerance questionnaire. We then use this result along with our time horizon and investment goal to determine what our savings rate needs to be. For most of us saving into our pension should be the start of our investing journey. It is always a good idea to keep and save 20% or 40%. More of our hard earned income. tax deferred accounts will almost always be preferable than taxable accounts. We start with investing our pension savings because it typically has the longest time horizon not just up to retirement or financial independence, but after to a 45 year old based on the traditional retirement age has 20 odd years to retirement and hopefully two to three decades thereafter. That's 20 years worth of saving, and 20 to 30 years of spending for a total investment time horizon of 40 to 50 years, focused on investing our pension savings in businesses, government and business debt linked to our investment goals. Back testing is not a terrible idea, but don't read into it too much. This is where we look back on historical returns over the same time horizon of our investment into the future. If we invest outside of our pension, we will pay exit tax or capital gains tax CGT on any gains. Exit tax is 41%. And this type of investment structure is ideal if you don't have an accountant and want a relatively hassle free life. CGT is taxed at 33% and falls under self assessment of tax CGT has an annual exemption of 1270 euro on any gains. CGT accounts are also useful when offsetting past investment losses on future gains. The question is often asked which is better investing regularly or a lump sum. a lump sum investment is likely to do better over the long term due to the initial size of the investment. Regular investing fosters a good saving habit and helps us psychologically with the rise and fall of the market. Because we are buying businesses and debt consistently. We buy when the market is falling rising in value, and also buy when the market is rising, falling in value. We should review our investment portfolio annually and rebalance if necessary, when there's big money to be made. And last, there will never be a shortage of exotic investments and financial trends, Bitcoin peer to peer lending and so on. Stick with the tried and trusted and tune out the noise from financial media's attempts to make you feel like you are missing out on something. If we absolutely must dip our toe create a foreign fund that is a very small fraction, no more than 5% of our overall wealth and be comfortable potentially losing it all speculating and gambling. Unless of course you have an addictive personality. We could talk about investing till the cows come home. In summary, it's time in the markets not timing the markets. If we don't invest our long term savings, we are guaranteed to get poor each year due to inflation. We invest in businesses and debt for the long term. No one knows when the bottom or top of the market is reached. If someone does forecast the future they are either guessing or lying. Investing done correctly is not trading, speculating or gambling, trading, speculating or gambling or short term in nature. 

And high risk, as always seek out advice specific to your circumstances. This week's book recommendations are stocks for the long run the Definitive Guide to financial market returns and long term investment strategies by Jeremy Siegel. The Little Book of Common Sense investing, the only way to guarantee your fair share of stock market returns by john Bogle, the myth of the rational market, a history of risk, reward and delusion on Wall Street by Justin Fox, the Intelligent Investor by Benjamin Graham, the Warren Buffett way by Robert Hagstrom. The education of a value investor my transformative quest for wealth, wisdom and enlightenment by Guy spear when genius failed the rise and fall of long term capital management by Roger Lowenstein. And last but not least, Dear Mr. Chairman, boardroom battles and the rise of shareholder activism by Jeff Graham. I have intentionally given a blend of passive and active investment book recommendations. It's never a bad idea to educate ourselves on the merits of both investment strategies. Another fantastic resource is JP Morgan's guide to the markets. A reasonable level of investing knowledge is required to understand some of the books and most definitely JP Morgan's guide to the market. I find the animal spirits podcast hosted by Michael Batnik and Ben Carlson informative and entertaining. All of Warren Buffett's shareholder meetings going back to 1994 can be found under and clad as capital on iTunes. This week's Movie recommendation is The Big Short. The movie follows a number of opportunistic investors who are betting against the American housing market. The movies characters bring a dual topic to life and portray a glamorous yet reckless industry culture where governments regulators and big business were asleep at the wheel. If you have any questions on this week's episode, ideas, suggestions or feedback, please send us an email at team at money hyphen mentor.ie. We can also be found online at money hyphen mentor.ie. And through the website you can find our Twitter, Instagram and LinkedIn accounts. If you're liking what you're hearing, please subscribe and I will be grateful if you could leave a review. Please share with family friends and colleagues if you think they would benefit until the next podcast Thank you for listening take care and chat soon.