“Fees never sleep.” – Warren Buffett’s bet

(The following article is an edited repost from the New Zealand Wealth and Risk blog.) 

I’m an Authorised Financial Adviser. For most of my clients, I advocate investing in low-cost, index-based investments.

I’m not alone. Warren Buffett is probably a bigger advocate than me.

In Berkshire Hathaway’s 2016 annual report, Buffett talks about index-based funds in detail.

I quote from Buffett extensively below, but you should really read the report yourself.

All emphasis is added.

Financial advice from Warren Buffett

Warren Buffett gives some clear financial advice:

“Over the years, I’ve often been asked for investment advice…. My regular recommendation has been a low-cost S&P 500 index fund.”

(I wouldn’t necessarily agree with this for NZ investors, but I agree with the key point: a diversified, low-cost index-based fund is generally a good way to go.)

Buffett’s bet

Buffett put his money where his mouth is and made a $500,000 bet that over an extended time period, a low-cost investment strategy would get better after-tax returns than a sample of hedge funds.

He provides background to his bet:

“In Berkshire’s 2005 annual report, I argued that active investment management by professionals – in aggregate – would over a period of years underperform the returns achieved by rank amateurs who simply sat still. I explained that the massive fees levied by a variety of “helpers” would leave their clients – again in aggregate – worse off than if the amateurs simply invested in an unmanaged low-cost index fund.”

He quotes some of the text from his bet:

“A number of smart people are involved in running hedge funds. But to a great extent their efforts are self-neutralizing, and their IQ will not overcome the costs they impose on investors. Investors, on average and over time, will do better with a low-cost index fund than with a group of funds of funds.”

The nature of the specific bet was as follows:

“I publicly offered to wager $500,000 that no investment pro could select a set of at least five hedge funds – wildly-popular and high-fee investing vehicles – that would over an extended period match the performance of an unmanaged S&P-500 index fund charging only token fees. I suggested a ten-year bet and named a low-cost Vanguard S&P fund as my contender. I then sat back and waited expectantly for a parade of fund managers – who could include their own fund as one of the five – to come forth and defend their occupation. After all, these managers urged others to bet billions on their abilities. Why should they fear putting a little of their own money on the line?

“What followed was the sound of silence. Though there are thousands of professional investment managers who have amassed staggering fortunes by touting their stock-selecting prowess, only one man – Ted Seides [of Protégé Partners] – stepped up to my challenge.”

“For Protégé Partners’ side of our ten-year bet, Ted picked five funds-of-funds whose results were to be averaged and compared against my Vanguard S&P index fund. The five he selected had invested their money in more than 100 hedge funds, which meant that the overall performance of the funds-of-funds would not be distorted by the good or poor results of a single manager.”

The results so far?

Buffett is a long way ahead:

“the five funds-of-funds delivered, through 2016, an average of only 2.2%, compounded annually. That means $1 million invested in those funds would have gained $220,000. The index fund would meanwhile have gained $854,000 [with a compounded annual increase to date of 7.1%].”

“Fees never sleep”

Buffett is quite explicit about fees:

“I’m certain that in almost all cases the managers at both levels were honest and intelligent people. But the results for their investors were dismal – really dismal. And, alas, the huge fixed fees charged by all of the funds and funds-of-funds involved – fees that were totally unwarranted by performance – were such that their managers were showered with compensation over the nine years that have passed. As Gordon Gekko might have put it: “Fees never sleep.”

I estimate that over the nine-year period roughly 60% – gulp! – of all gains achieved by the five funds-of-funds were diverted to the two levels of managers. That was their misbegotten reward for accomplishing something far short of what their many hundreds of limited partners could have effortlessly – and with virtually no cost – achieved on their own.”

He’s quite explicit on this point:

“When trillions of dollars are managed by Wall Streeters charging high fees, it will usually be the managers who reap outsized profits, not the clients. Both large and small investors should stick with low-cost index funds.”

Will this type of underperformance continue?

In Buffett’s view, yes.

“In my opinion, the disappointing results for hedge-fund investors that this bet exposed are almost certain to recur in the future.”

He adds:

“Human behavior won’t change. Wealthy individuals, pension funds, endowments and the like will continue to feel they deserve something “extra” in investment advice. Those advisors who cleverly play to this expectation will get very rich.”

Some people can beat the market, even after fees. Picking them is the hard part.

Buffett explains that “There are, of course, some skilled individuals who are highly likely to out-perform the S&P over long stretches. In my lifetime, though, I’ve identified – early on – only ten or so professionals that I expected would accomplish this feat.

“There are no doubt many hundreds of people – perhaps thousands – whom I have never met and whose abilities would equal those of the people I’ve identified. The job, after all, is not impossible. The problem simply is that the great majority of managers who attempt to over-perform will fail. The probability is also very high that the person soliciting your funds will not be the exception who does well.

Why don’t wealthy people and institutions invest more in low-fee investments?

“I believe, however, that none of the mega-rich individuals, institutions or pension funds has followed [my advice to invest in a low-cost S&P 500 index fund] when I’ve given it to them. Instead, these investors politely thank me for my thoughts and depart to listen to the siren song of a high-fee manager or, in the case of many institutions, to seek out another breed of hyper-helper called a consultant.

“That professional, however, faces a problem. Can you imagine an investment consultant telling clients, year after year, to keep adding to an index fund replicating the S&P 500? That would be career suicide. Large fees flow to these hyper-helpers, however, if they recommend small managerial shifts every year or so. That advice is often delivered in esoteric gibberish that explains why fashionable investment “styles” or current economic trends make the shift appropriate.

“The wealthy are accustomed to feeling that it is their lot in life to get the best food, schooling, entertainment, housing, plastic surgery, sports ticket, you name it. Their money, they feel, should buy them something superior compared to what the masses receive.

“In many aspects of life, indeed, wealth does command top-grade products or services. For that reason, the financial “elites” – wealthy individuals, pension funds, college endowments and the like – have great trouble meekly signing up for a financial product or service that is available as well to people investing only a few thousand dollars. This reluctance of the rich normally prevails even though the product at issue is – on an expectancy basis – clearly the best choice.”

Trust me. Read the report yourself. It’s worth it.

(Sonnie Bailey is the author of this article and is an Authorised Financial Adviser (AFA). A disclosure statement is available free on demand: click here.)

Where are you on your journey to FI/RE?

One of my favourite podcasts is ChooseFI and over the weekend I listened to a cracking episode with with Joel of Financial 180.   The topic was the “Milestones of FI” and I thought it would be interesting to think about where each of us is on our journey.

Milestone 1:  Positive net worth

You hit your first milestone when your debts no longer outweigh your assets.  Some folks are fortunate and never start out with debt but, for most of us, we will normally start out with some debt e.g. a student loan.

Milestone 2:  $100K net worth

If you are a Personal Capital (financial tracking tool – US only so not much use for us) user then apparently when you hit $100K they start phoning you up to try and sell you their paid services.  It’s a somewhat arbitrary point but I think there is something deeply satisfying about hitting round numbers so I think it applies to us Kiwis as well.

Milestone 3:  F#$% U! money

F#$% U! money is classified as having about 2-3 years of expenses saved up.  Your amount will vary depending on your risk tolerance.  I’m reasonably risk averse so for me it would probably be at least 5 years!  It’s called “F#$% U” money as it enables you to walk away from a bad job if necessary.

Milestone 4:  Half FI

You need to know your “number” in order to know when you hit this mark.  You need to know how much you spend/want to spend and multiply that by 25 to get the standard FI amount.  Divide that by 2 and you have your half FI milestone number.

Milestone 5:  Lean FI

Lean FI is the amount you need to basically just survive with very little discretionary spending.  This is a bit extreme for me as I like some of life’s little luxuries but some folks are quite happy being relatively hardcore.

Milestone 6:  The crossover point

This is where you start to earn more from your investments than you are managing to earn from your salary.  You may feel that this makes you FI but realistically investment income can fluctuate so it is just a milestone.

Milestone 7:  Flex FI

Flex FI occurs when you are close enough that you are likely to be safe especially if you retain flexibility in your spending patterns or are willing to return to some form of work if your investment returns drop dramatically.  The value for this milestone is a net worth of 20x your annual spending.  I personally exclude my home from my net worth as it doesn’t generate an income but you may wish to include it if you are happy to sell up to support RE.

Milestone 8:  Financial Independence

You are technically financially independent when you hit a net worth of 25x your annual spending.  Any work you do now is by choice.  You could retire early and be reasonably sure you would not run out of money.

Milestone 9:  Fat FI

Fat FI is what you aim for if you are very risk averse or you want a retirement that has room for a large amount of luxuries.  The value for this milestone is a net worth of about 30x your annual spending.

The journey to FI can often seem long and boring.  Having a list of milestones that you can tick off seems like a good idea.  I’d strongly urge you to listen to ChooseFI and visit Financial 180.

Which milestone are you up to?

Accelerating your path to financial independence and retiring earlier

(This is an edited repost from the New Zealand Wealth and Risk blog, originally published on 30 May 2017.) 

Life is full of seasons. There are times in life when it’s harder to build wealth, such as when you’re a student, or you have a new-born child. And there are times in life when it’s easier, such as when you’re a working empty-nester with no mortgage and serious savings.

There are a number of life events that can put you in a position to turbo charge your path to financial independence and early retirement. It’s valuable to be aware of these situations and taking advantage of these opportunities when they arise. If you’re not mindful, you might find that your excess cash gets eaten up in lifestyle expenses that, while nice, may not help you with your ultimate goal of becoming financially independent and retiring early.

For example:

When you couple up for the first time. When two people move in together, they often find that many of their expenses reduce. You often find that something that you would’ve had to buy on your own, is now effectively half the price because you’re sharing the item and its cost. It’s valuable to use this as an opportunity to increase your savings rate.

When you pay off your student loan. If you have a New Zealand student loan and you’re working in New Zealand, you effectively have a 10% additional tax on your income in the form of student loan repayments. Once the loan is repaid, you essentially get a 10% pay increase. If you were able to live without this 10% before, it’s a good idea to “pay yourself first” and let it bump up your saving rate.

When you pay off your mortgage. Paying off the mortgage is a huge financial milestone. Once the mortgage is out of the way, you’ll have a lot of extra cash flow to put towards building up wealth. (The sooner you can pay off the mortgage, the better your long-term situation is likely to be. Consider the difference between repaying a mortgage at the age of, say, 40 compared to the age of 60. That’s an extra 20 years of extra cash flow.)

When you’re able to self-insure. For any given level of cover, personal insurance premiums will generally increase over time. (The biggest risk factor for most health issues is age…) Ideally, however, your insurance needs should reduce over time as you become better positioned to self-insure. The sooner you can get into the virtuous cycle of having enough wealth to be able to self-insure in relation to most events, the less you’ll need insurance, and the more you can put the money that would have gone towards premiums into building more wealth.

Whenever you get a decent raise. If you’re used to living on a certain level of income, a raise is a bonus – you have money that you previously didn’t need. Consider pre-committing to saving a portion of any future raises, which over time, will result in the percentage of your income that you save continuing to increase.

Don’t get me wrong – when you have an event that frees up cash flow, it’s great to increase your spending and the quality of your life. But as with any spending decision you make, it’s important to make decisions that align with your long-term goals and values. If you’re reading this blog, it’s likely you’ll want to take advantage of these milestones to help you become financially independent sooner and retire earlier.

Three Steps to a Freedom Mindset

Lets not sugar coat it, becoming financially independent and retiring early will be HARD. Leaving the rat race years or decades before what is ‘normal’ and having a large enough stash to last past your 150th birthday is no small feat. It will take hard work and commitment, but most important of all it will require a radical new mindset. Here are three ideas that may help along the way:

1) Redefine Successful

The biggest barrier to changing the way we spend and save is our status anxiety. The fear that if we don’t abide by the norms of modern western consumer culture and buy and do all the things the media and advertising define as ‘success’ that we’ll be miserable losers. So instead we make crazy decisions like buying fancy cars, expensive clothes and electrical gadgets which we think will make us happy, or cool or both. Of course, when we take time to reflect on the absurdity of this way of living we see it for the madness that it is. But everybody else seems to be doing it and we don’t want to be the odd one out (humans are pack animals) so we just kind of go along with it anyway.

The good news is that embracing a less consumerist lifestyle and not keeping up with the Jones’ doesn’t require masses of willpower (remember this is a blog post about mindset). If you really believe that the trappings of status will make you happy then denying yourself these things will make you miserable. But its not the presence or absence of things that makes us happy or unhappy, it is the presence or absence of desire for things.

 Craving and desire are the cause of all unhappiness. Everything sooner or later must change, so do not become attached to anything. Instead devote…

–  Buddha

Nurturing a sense of inner peace and devoting yourself to higher spiritual goals is one way of redefining success as many great spiritual and religious leaders have taught.

Thankfully for the weaker of spirit among us there is another way to free yourself of the desire for superficial status symbols – become an obnoxious smug know-it-all!

The Jones’ are sad, status obsessed wannabees wasting their money on frivolous crap because they are stupid.

– Me

There is something darkly enjoyable about feeling smugly superior to people and it makes frugality a breeze. You don’t want to be like the Jones’. The Jones’ are idiots. What kind of moron spends $40,000 on a car when you can get one that does all the same stuff just as well for $4000? Why would you pay full price for clothes when you can get the same stuff second hand for a fraction of the price – do you enjoy paying more to have to remove stickers and labels? All those people paying for cafe lunches 5 days a week instead of spending a fraction of that money on a packed lunched – financially illiterate fools! I wonder whether people will look back when they are 65 and still working and think “Wow – I’m so glad I spent those extra few hundred dollars on that phone that did all the same things as my old phone but had a curved edge – what a great investment of my hard earned cash”.

So there it is. It’s up to you whether you prefer to take the high road or the low road, as long as the road leads away from all that stuff you don’t really need.

2) Focus on Freedom

This might seem counter-intuitive but one of the best ways to become financially free is to become aware of the many ways your freedom is constrained. If you are lucky you have a job you enjoy, and that can be great, but it would feel even greater if you were free. While you are dependent on the income your job provides to support yourself (and or your family) then work is not optional and that makes it not fun. There is something in the Kiwi psyche that is fiercely independent and anti authoritarian, we don’t seem to like stuff that is compulsory. This can be seen in the way Kiwis (including many low income workers) rejected compulsory unionism, we rejected compulsory retirement savings, even though we know it is something we should do – we just didn’t like to be told we had to. We even rejected when the ‘nanny state’ tried to make energy saving light bulbs compulsory: “Screw you NZ government, you can’t force me to save energy and massively reduce the cost of lighting my house!”.

One of the more entertaining personal finance bloggers is a British guy called ‘The Escape Artist‘. He compares the journey to financial freedom to The Great Escape in a kind of fun way. Your boss and the system represent the guards trying to keep you imprisoned in your 9-5 workaday life till you are old and grey. Your family, friends and colleagues are mostly docile prisoners resigned to their sentence, unwilling to rock the boat or question the propaganda the guards feed them. But once you know that escape is possible you become animated by it, unwilling to accept your fate you are constantly and quietly working away towards your eventual release. Freedom is not something that just all arrives out of the blue one day, it is bought slowly piece by piece over time. Think of each investment or saving adding to your speed and altitude until eventually one day you reach escape velocity and can soar over those prison walls.

The first step for me was a bank account given the name ‘Freedom Fund’. Lots of people have a rainy day fund/emergency savings account. The difference with the Freedom Fund is it has a positive focus and long term objective. Having savings in case something bad happens is a short term goal with a negative focus, purchasing freedom from the rat race is a long term goal with a positive focus. Every dollar that is put in the fund is purchasing a tiny little slice of freedom and those pieces add up quickly

Purchased freedom has great value well before full Financial Independence is achieved. One of the recurring themes in Financial Independence blogs is the concept of ‘F – You Money’ this is an emergency fund sufficient to cover for loss of income for a lengthy period of time should you ever decide you want to tell the boss “F – You”. I can personally attest to the power of this concept. I have never told my boss “F – You” and probably never will, but having a decent emergency fund means that if I ever felt I needed to I could. It also means that the time I went to ask for a 6 month leave or the time I asked for that promotion, or the time I went to ask for flexible working hours I was able to approach it with confidence and negotiate as an equal partner rather than accept whatever was offered, safe in the knowledge that if push came to shove I could just walk away from the job. The money was still sat in our bank account unused, but on some psychological level I had spent it buying just a little bit of my freedom and that felt great!

3) Get Some Perspective

One of the foundations of financial literacy is learning to distinguish between needs and wants. In our 24/7 advertising saturated consumer culture it is all to easy to forget that human beings really have a very basic set of needs. We need food and water and warmth and shelter. We are social animals, we need company and belonging and love and affection. In a practical sense we need some form of income or employment to pay for these things. We are now on level three of Maslow’s Hierarchy of Needs and it’s about here that we start to get a little wobbly. Once we are in the area of ‘esteem’ our needs stop being absolute and start to become relative. We start caring about the Jones’ again. Before we know it we find ourselves trapped in a work and spend treadmill where we are sacrificing those basic needs like our health and well-being just to compete – madness!

So what is the antidote to this loss of perspective? One part of it is around taking a big picture view and practicing gratitude. Even the most hard up of Kiwi’s are able to live a lifestyle of massive opulence compared to 100 years ago. Even if we compare ourselves only within the present day, we live in a country of incredible wealth. We have safety and security, a fantastic natural environment, a first world healthcare system and a social safety net which means that unlike many parts of the world and many generations past it is basically unknown to see people starving or suffering from preventable disease. Of course we can always be wealthier than we are, but lets not feel too hard up just yet. Visit the Global Rich List to see how you rank, then remind yourself that you may be in the top 5-10% of wealthy people in the world and have aspirations to be in the top 1%, things aren’t so bad – then say thank you! 🙂

Conclusion:

Purchasing your freedom is a long journey and it’s not always going to be easy. But having the right mindset is half the battle. If you know what success looks like, you understand why you are making the change and you have a rational perspective on your current position and what your real needs are then that’s a good foundation. All that’s left is just to get started. Happy saving!

How to Start Investing with Smartshares and How Long will it Take

(This a repost from theSmartandLazy.com. originally published on 23 June 2017)

SmartShares is an excellent way to invest in low-cost, diversified ETF in New Zealand. Especially if you wish to invest in the top 500 companies on US stock market. Smartshares S&P 500 ETF (USF) is a great option for all investors as it is simple to understand, the management cost is low at 0.35% and has a long positive track record. I’ve been getting questions on how to start with investing with various investment service I covered and the most of the questions on Smartshares. So here is the guide on Smartshares.

How long will it take?

Let’s set the right expectation here, its gonna take a LONG time to set up a monthly contribution plan with SmartShares. For average Kiwi investor (without any connection to politician or United State), will take about 2-5 days to set up with most investment services. However, with SmartShares, you will have to spend around 27-53 days. Yes, that is not a typo. Just make sure you are prepared for it.

Sign up with SmartShares

We are going to walk through the setup process for an individual investing $500 into S&P 500 ETF with a $50/months contribution. Before we start, you will need to prepare the following items.

  • IRD number
  • NZ Drivers Licence
  • Bank account number for direct debit
  • Read the product disclosure statement

Go to Smartshares Invest Now page and click on “Apply online.”
Screen Shot 2017-06-20 at 2.51.49 PM.png

Under investment options, select “Individual”, leave it blank on “Common Shareholder Number” if you are a new investor. Put $500 (minimum) on US 500 (USF) investment and $50 (minimum) as regular saving plan.

screencapture-smartshares-linkinvestorservices-co-nz-1497302516770.png

Next page is your personal information and email address. That email address will be your main point of contact. You will receive an email during the set process to confirm your email address.

screencapture-smartshares-linkinvestorservices-co-nz-1497302559172.png

Next is your ID verification. Put in your NZ Drivers license details.

screencapture-smartshares-linkinvestorservices-co-nz-1497302622324.png

Next, confirm your payment details with your bank account no. Please make sure you have enough fund at 20th of each month.

 

Screen Shot 2017-04-15 at 10.37.26 PMScreen Shot 2017-04-15 at 10.37.34 PM

Next part you will have to review your information and confirm your contact email with an authentication code.

Screen Shot 2017-04-15 at 10.38.14 PM.png

Here is the authentication email with the code. Screen Shot 2017-04-15 at 10.38.27 PM.png

Once you completed this process, you are done with the sign-up. The next part is the long wait….

What you are waiting for?

The SmartShares signup process is straightforward and painless. However, investors need to wait a long time to check up on their holding. An investor cannot log on to SmartShares to check their holding. SmartShares will direct investor to use Link Market Service to do that. To register for Link Market Service, you will need two pieces of information: FIN (Faster Identification Number) & CSN (Common Shareholder Number). FIN will send to you by mail (physical letter), and CSN will be on your holding statement in an email. You will need those two numbers to prove you own those stock. Check out this page from ANZ Securities on what is FIN and CSN.

The long wait

So here is my timeline on signing up with SmartShares.

tumblr_inline_n3j72s94pg1rh4ky-551bcb6951a52.jpeg

4/5 – I submitted my application on SmartShares website.

8/5 – I got a confirmation email on my SmartShares application and my direct debit.

20/5 – $500 initial investment withdraw from my account, and it supposes to make the purchase at the beginning of June.

6/6 – the purchase happened

7/6 – a letter came into my mailbox with the FIN number. I still can’t log onto Link Market Services because I don’t have the CSN number.

Screen Shot 2017-06-23 at 12.18.07 PM.png

12/6 – got an account statement from Link Market Service with my CSN number.

Screen Shot 2017-06-23 at 12.22.57 PM.png

I managed to log into Link Market Service and check out my holding. Yeah!

Screen Shot 2017-06-23 at 11.16.41 AM.png

So it took 39 days for me. To be fair, I can submit my application on 12/5 or 13/5, it will still make the 20th direct debit cut-off date. So you can shorten 7-8 days there. On the other hand, if you submit your application right after the 20th cut-off date, you will have to wait over a month.

blank-May-2017-calendar.jpeg

blank-June-2017-calendar.jpeg

Why it took so long?

Smartshare is NOT an investment service or fund manager. They are an ETF issuer. ETF is not an investment fund; they are tradable shares. Usually, you will have to set up a brokerage account and pay a fee to buy shares in New Zealand Stock Exchange. The minimum is $30/trade.

SmartShares offer a service allow investor buy shares in a small amount monthly without paying a brokerage fee. If I have to do it in the with a stock broker, it will cost me at least $360/year on brokerage fee alone. I am happy to wait a couple of days to save $360.

If you don’t want to wait that long, you can open up a stock brokage account and buy SmartShares directly on the stock market. It will take 2-5 days to set up a brokage account, and it will cost at least $30/trade.

Hope this blog will set an expectation for you when you sign up SmartShares. Don’t be panic when they took your money for 2 weeks without any communication. Your FIN and CSN will arrive…eventually.

Books we love: How to Fail at Almost Everything and Still Win Big – Scott Adams

One of the books that had a really big impact on me was a book by the cartoonist behind Dilbert – Scott Adams.

The book basically goes through his various failures, how he overcame them and ended up being wildly successful.

Along the way he espouses a few principles that are particularly relevant for those of us seeking to become financially independent.  The one that resonated the most with me is that…

…one should have a system instead of a goal. The system-versus-goals model can be applied to most human endeavors. In the world of dieting, losing twenty pounds is a goal, but eating right is a system. In the exercise realm, running a marathon in under four hours is a goal, but exercising daily is a system. In business, making a million dollars is a goal, but being a serial entrepreneur is a system.

In FI terms saving more than you spend is a system.  Trying to save a specific figure is a goal.  Both have value but the system results in long-term habits that consistently move you forward.

For our purposes, let’s agree that goals are a reach-it-and-be-done situation, whereas a system is something you do on a regular basis with a reasonable expectation that doing so will get you to a better place in your life. Systems have no deadlines, and on any given day you probably can’t tell if they’re moving you in the right direction. My proposition is that if you study people who succeed, you will see that most of them follow systems, not goals…

For me, this book was really valuable as it reinforced the importance of mindset. I’m not naturally frugal and have had to work at it.  However, being frugal has become a system in my life and now I get a buzz every time I choose not to waste money.

“Goal-oriented people exist in a state of continuous pre-success failure at best, and permanent failure at worst if things never work out. Systems people succeed every time they apply their systems, in the sense that they did what they intended to do. The goals people are fighting the feeling of discouragement at each turn. The systems people are feeling good every time they apply their system. That’s a big difference in terms of maintaining your personal energy in the right direction.”

Definitely worth a read.  Try your local library!

Speculation vs Investment And How It Relates To Your Retirement

Most of us have had this colleague at least once or twice. The one that comes into work with a spring in their step (I can sense that you’re tensing up already) and over your coffee break chit chat regales you with how they’ve bought some shares or a piece of land.

The conversation usually goes something like,
‘Hey colleague, I’ve made this great decision in my life of buying this asset. I’d like to inform you that it’s been one of my best decisions, the value of it has already risen by $x! I knew it would do this because of various factors I’d taken into consideration before buying’

The inference being that they have some inside knowledge that others don’t or they really just want you to know that they’re a bit better off from last week than you are, without all that gosh darned work everyone else is putting in.

I can tell you this story in this way because I was this person for a few months and I’ve heard it from others a couple of times too.

I was 21 and was working in what essentially amounted to an insurance sales boiler room. Our customers bought reasonable insurances like car or home insurance, and we’d then thank them for their business by harassing them with multiple phone calls to buy worthless insurances that never paid out, with very high premiums compared to most and being encouraged to guilt them by asking ‘Do you have a plan for your family if ‘x’ happened to you or them?’. Not a nice job.

I decided I’d start using Plus500 on the side, an online share buying platform that uses leverage. This was my way to get into learning about shares with an eye to day trading. This was around 2011/2012 at the start of the Greek Debt Crisis.

Because I was clever and I’d watched the news, or so I told my colleagues, I’d mainly gone short on Greek shares (sold the shares before buying them, essentially I’d make money if they went down in value). I’d put in 500 of the Queen’s finest pounds and grown it to over £1000 within a few weeks. I justified this with a few of my own political biases and historical takes on the situation. I’m sure they hated me, I would have.

I continued to hold onto these shorted Greek shares and they continued to fluctuate. The news was telling the world that Greece will default at any moment and everything within it’s borders will be worthless.

Now you’re probably thinking that I’m going to tell you that it all turned to custard and I lost it all. Well, no. I cashed out at £750 – £250 profit in all.

So why would I tell you this? Well, the truth in this isn’t whether a profit or loss was made but what was learned.

The key point was that the news, and therefore my reality as far as Greece was concerned, had very little correlation to what the share price was now doing. The shares were rising in value, the opposite of my prediction, wiping out some of the gains I had made in that time. I’m sure someone can fill me in on why that happened but even then, it’s 20/20 hindsight at best.

Why didn’t I cash out at £1000? If I crystallised my gains by selling, what could I invest in next? How could I possibly know if I was buying in a peak or a trough and how quickly that might change?
The answer to all these was that I didn’t know, and if I did, I wouldn’t be working in a poxy call centre.

The only thing I learned about day trading was that I had absolutely no control over the result. Perhaps other more knowledgeable people do but little Andy here, whose credentials didn’t extend much further than filling in a Plus500 sign up form and debit card details certainly didn’t. Realistically, in this manner, what was the difference between picking a share and picking a horse? I decided to quit at £750 before one of my colleagues asked me how things were going and I’d no doubt have to sheepishly tell them I’d made a loss. This way I made a profit and didn’t lose face.

I’m certainly not saying don’t buy shares and I’m not saying don’t buy land (I might say don’t buy horses!), what I will suggest is don’t buy them like this, where you essentially guess off a hunch and make up your reasons to justify your decision after the fact.

Whilst I thought I was investing, simply because I was putting money into an asset with the intent of making a profit, I was really speculating. These terms are used relatively interchangeably colloquially but there are definite differences.


Which brings me to the overarching point.

What’s the difference between a speculation and investment? In terms of how we can separate the two in a practical sense, it’s about where you intend to draw the projected income from.

Investment – Your profit is primarily drawn from the income the asset produces. This can be in the form of rent or dividends.

Example: You buy a share in Acme Company for $100. It pays a 10% dividend which is the best return on your dollar you feel you can achieve.

Speculation – Your profit is primarily drawn from the increase in the asset’s value.

Example: Based on your astute observations, Silver is at a bargain price and you feel it’s got to go up in value. You buy at $100/oz and plan to sell once it hits $120/oz

It’s not to say that any single type of purchase, whether it be shares or property, is either a speculation or an investment exclusively. The same category of purchase can be either.

Example:

A house is bought for $500k. The purchaser buys as they expect local house prices will rise due to new transport links with the city centre, the intention is to sell once it hits $750k in value. The rent collected is secondary. This is speculation.

Another house is bought by a different purchaser. It provides an 8% return in rent, whilst the holding costs only run at 5%. The purchaser buys as they want to to use the 3% difference to supplement their regular income. The potential rise in capital value is secondary. This is investment.

Both have bought a house. Both have bought with the intention of drawing a profit but the methods of drawing that profit are entirely different.

That’s also not to say that investments can’t rise in value and be sold off at large capital gain. They can and do, but it wasn’t the primary intention of the buyer.

With speculative instruments, when you sell, you realise the loss or gain. This is your profit and you must continue to speculate with new purchases to continue to draw an income in this manner.

The risk is higher with speculation as you’re drawing your profit from an unknown variable, namely which way the price will go and by how much. If people knew where the price was going, it would already be at that price. The rewards can be massive but equally the losses can be devastating.

Even the best of us can only guess the outcome correctly a small percentage of the time which is why investments make more sense for the early retiree as the bulk of their retirement plan. Sure, you’re less likely to have that one off win where you make bank for life with little to no effort, but you’re also less likely to lose or go bankrupt if your investments are wisely chosen.

With investments, the owner draws an income from the asset for as long as they own the asset. The owner knows approximately what the income will be from the asset from day one. Investments are therefore more ideal for a steady income and an early retirement.

The risk is mitigated with an investment because if the price does drop, the owner can continue to hold on and ride out a market downturn without any cost to holding the asset as the income will likely continue to cover holding costs.

Neither investments nor speculations are inherently good or bad, and the advice here is neither prescriptive nor proscriptive. Both are necessary functions of markets and hey, a little speculation here and there can be fun, but being able to distinguish and understand the risks is really important to your early retirement and financial security.

The advice is to not bet the farm on speculation and choose strong, steady investments for the bulk of your portfolio.

SmartShares, SuperLife, Simplicity & InvestNow. ETF & Index Fund Investing in New Zealand

(This is a repost from thesmartandlazy.com, originally published on 13 June 2017)

ETF and Index Fund are simple, low-cost and diversified investment option with a positive result in the long term. It plays an important part in my plan to achieve financial freedom by only do a few smart things and nothing much else. To put my money where my mouth is, over 90% of my investment are in ETF and Index Fund. I believe everyone should have at least some investment in those products. SmartShares, SuperLife, Simplicity, and InvestNow are the four investment services in New Zealand that I am currently using. Here is a breakdown of them.

The Breakdown

Screen Shot 2017-06-13 at 9.22.52 PM.png
Compare four ETF/Index Fund investment in NZ. Best option highlighted in yellow

SmartShares

New Zealand Stock Exchange owns SmartShares. They issue the ETF for local share markets such as NZ Top 50 (FNZ), NZ Top 10 (TNZ), NZ MID CAP (MDZ) and NZ Bond (NZB). They also repackage ETFs and index funds from oversea to sell to New Zealand investor. Those ETFs cover Austraila, Europe, Asia Pacific, US, emerging markets and world markets. You can check out the list of offering here. The most popular oversea ETF is US 500. It tracks the top 500 companies on US stock example, most of them are top international corporations.

Some people mistaken SmartShares as an investment service provider but in fact, SmartShares is an ETF issuer. Their job is to manage and issue ETF for New Zealand stock exchange. That’s why investor can’t log onto SmartShares site for track their holding because they are not managing the holding for you (hence there is no annual admin fee).

If you invested in their ETF, you are basically buying a share on the share market. You can but those ETF directly on share market if you wish.  SmartShares will direct investor to Link Market Service to register and track their ETF holdings. An investor can track their holding on other services like ASB securities, ANZ Securities or Share Sight.

SuperLife

Superlife offer the most ETF and Index Funds investment options in New Zealand. They not only offer SmartShares ETF in fund format but also provide managed fund and sector fund options for the investor. All of those funds invested in a passive index fund or ETF.

The Sector fund cover different country (NZ, AUS, Overseas), industry (Property, Shares) and investment vehicle (Cash, Bond, Shares). Those are great options to build your own balanced and diversified portfolio.

The Managed Fund is is a grouping of financial assets such as stocks, bonds, and cash equivalents. The nature of those financial assets can be classified into two groups, income asset, and growth asset. Income asset includes cash and bond. They tend to carry lower risk levels and, therefore, are more likely to generate lower levels of return over the long term. Growth assets are shares and property. They tend to carry higher levels of risk, yet have the potential to deliver higher returns over longer investment time frames.

Superlife managed fund have different names, like SuperLife 30 or SuperLife 80. The number at the end show the target portion of growth asset in that fund. Superlife 30 will aim to hold around 30% of growth asset and 70% of income asset in the portfolio. So this fund is a low risk (or conservative) fund. On the other hand, Superlife 100 will aim to invest 100% into the growth asset. So the risk is high. Here is a breakdown.

Screen Shot 2017-06-13 at 10.35.17 PM.png

SuperLife offer the most options, functions in the breakdown. The entry requirement is basically nonexistent, and the cost is relatively low. That’s why I recommend the beginner to start with Superlife.

Simplicity

Simplicity started as a nonprofit KiwiSaver provider. They provide low-cost KiwiSaver options to New Zealander while donating 15% their income to charity. Simplicity recently opened up their investment fund as non-KiwiSaver options as investors can deposit and withdraw their investment anytime they want. Simplicity only offers three managed funds as conservative, balance and growth fund. The majority of Simplicity fund invested in Vanguard’s funds or ETFs. The management fees are the lowest in New Zealand at 0.31% for managed fund. However, the initial investment requirement is $10,000.

InvestNow

InvestNow is a new online investment platform. Investors can directly invest into the selected fund on their platform with as little of $250. InvestNow does not charge any transaction, admin, setup or exit fee at this stage. Investor only needs to pay the management fee on an individual fund.

The biggest advantage of InvestNow is to allow the investor to directly invest into two Vanguard index fund in Australia. They are Vanguard International Shares Select Exclusions Index Fund (currency hedged and non-hedged version) with management fee at 0.20% and 0.26%. Those two funds are not PIE fund, means you will have to do your own tax return. For under 50k holding, you will only have to do tax return on dividend received, which is not that hard. You can check out the detail in this blog post.

Fund Comparison

I picked a couple of index funds and ETFs from each provider and made a comparison. Here is the breakdown.

Screen Shot 2017-06-14 at 10.29.56 AM.png

As you can see, most of the option’s underlying asset are Vanguard ETFs and Index Fund. That’s basically what I am trying to do on my international exposure, putting money into low-cost Vanguard cost for long term.

 

Me try to invest in NZ 2
Accurate description of my international investment strategy.

Conclusion

  • Superlife have the most function, investment options and easy to start. Also have the lowest cost aggressive managed fund in NZ. It is great for both beginner and experience investor.
  • Simplicity have the lowest cost managed fund in Conservative, balance and growth aera. Great for anyone with $10,000 to start investing.
  • InvestNow user can easily invest in Vangaurd index fund in Australia with 0.20% – 0.26% fee. Great for someone who can handle their tax return on dividend recived (not that hard) or calculate under FIF rule.
  • SmartShares is good if you wish to buy ETF on share market.
  • There are other ways to invest into passive fund and ETF in New Zealand, like ASB Investment Fund, AMP, and Lifestages. However, the cost on those fund are quite high compare to these four services, which defeat the purpose of low-cost passive investing.
  • New Zealand investors can buy Vanguard ETFs on Australian Stock market. The management fee can go as low as 0.04%. I will go into that later once I’ve done it myself.

Email thesmartandlazy@gmail.com or follow me on Twitter @thesmartandlazy if you have any questions.

Choosing your free hour of power

For all Electric Kiwi customers out there, here’s how to view your electricity usage to choose best time for your free hour of power.

  1. Log in to your account
  2. Scroll down to “Analyse your usage between”
  3. By default you’ll see last weeks power usage
  4. Now change the date range to be a specific day that’s representative of your average power use
  5. You’ll get a nice easy to read graph that breaks down your power usage in 30 minute chunks
  6. Find the off peak hour in that you used the most electricity, and set it as your free hour of power
  7. Now up your electricity savings by moving any additional power consuming activities to this time slot

Not an Electric Kiwi customer? Get you free hour of power and $50 credit  at www.electrickiwi.co.nz.

Disclaimer, I also receive $50 credit if you sign up from the link above. 

Got your own tips on how to get the most out of the free hour of power? Let us know in the comments below.