Investing is not rocket science. Things are being made unnecessary difficult by brokers and advisors so they can catch their fees. I found out you don’t have to learn anything new, just know where to go. And you can automate everything.
The ultimate goal of investing is to build your own freedom fund, also known as “fuck you money” or FIRE (Financial Independence Retire Early).
This is a strategy of extreme savings and investment that allows you to retire far earlier than traditional budgets and retirement plans would allow.
The principle is that your investment portfolio should be worth 25 times your annual expenses, so you can live solely of small withdrawals from your returns. This means you are spending 4% of your portfolio annually, while the average long term return is between 7% and 8%. So you keep gaining money over time.
I’m spending €2.000 a month, so I aim for €600.000 worth of fuck you money. The goal is to reach financial independence as soon as possible. By investing €1.000 a month, for example, with an average return of 7% this will be in 19 years, when I’m 54 years old.
Let’s see how I plan to do this.
There are three things you should do to start building your freedom fund:
- First and before everything else get out of debt and stay out of it. Debt is killing and costs you more money every single day (negative compound).
- Spend less than you earn. Get crystal clear insights in how much you spend on what. Work with budgets to master this. Be strict with yourself on what you really need.
- Keep a safety bucket for unexpected expenses and invest the rest in the right funds.
There are different types of investments with different levels of risks and different levels of return. You can put your money on a savings account at your bank, with zero risk, but interest rates are so low that you won’t make any gains.
On the other end of the spectrum there are investments with very high risk and very high returns if it is successful. Examples are equity in a startup or crypto currency.
You might want to be in the middle of those two; index funds.
On the long term, you might want to aim for 80% low risk and 20% high risk in your portfolio. But to start, focus on index funds to start building the core of your investment portfolio.
Index funds match the components of a financial market index of the biggest companies in a certain market. Examples are the S&P 500 index (500 biggest companies in the United States) and the AEX index (25 biggest companies of Netherlands).
All investors as a group own the market and therefore share the market’s gross return. By simply owning the entire market, index funds also earn the market’s return at minimal annual cost.
Another advantage is that index funds take a passive approach that eliminates almost all trading activity. You buy once and you sell once in 30 years, that’s only two transactions with fees involved. And in the long run, the stock market news will be good and returns positive.
These are low risk investments with a decent profit over time. It’s a long term game that uses the power of compound interest.
The earlier in life you start investing, the more you will have in the end. You should start as soon possible because compound interest is exponential, not lineair. Einstein called this the eight wonder of the world.
"Compound interest is the 8th wonder of the world. He who understands it, earns it; he who doesn’t, pays it."
— Gijs Heerkens 👨🏻💻 (@gijsheerkens) November 4, 2019
Compound interest is interest on interest and calculated on the initial principal, which also includes all of the accumulated interest of previous periods of a deposit or loan. It can catapult you to a life of total financial freedom.
Some great examples:
- If you invest €500 a month from the moment your child is born, you’ll have invested €150.000 and around €256.059 of compound interest when it turns 25. A total of €406.059 to buy a house.
- If you start investing €250 a month at age 20, you’ll have invested €99.000 and around €244.577 of compound interest at age 53. A total of €20.969 of interest per year which is enough fuck you money if you spend €20.000 annually.
- If you start investing €500 a month at age 35, you’ll have invested €180.000 and around €426.438 of compound interest at age 65. A total of €606.438 to enjoy your retirement.
The earlier you start, the more compound interest works in your favor. I wish I started 20 years ago.
Psychology and stress are the biggest pitfalls of investing. That’s why you should choose index funds. They are following the market as a whole and have had a positive trend over years.
To let an index fund plummet all companies in the market should collapse at the same time. That’s not realistic. When one company in an index fund collapses, this company will be replaced by the new best company in the market.
The prices will fluctuate over time though, so you have to keep in mind that it’s a long term investment. At least 20 or 30 years. Market corrections have occurred about once a year since 1900. You don’t need this money right now, so you are safe.
The biggest mistake a lot of investors make is selling when the market goes down (bear market) because they get anxious and buying when the markt goes up (bull market) because they get greedy. Historically, bear markets have happened every three to five years.
"Be fearful when others are greedy, and greedy when others are fearful."
— Gijs Heerkens 👨🏻💻 (@gijsheerkens) November 4, 2019
But you can’t beat the market on the long term, so stay with index funds and own the whole market. Don’t forget that nobody can predict consistently whether the market will rise or fall and the stock market rises over time despite many short-term setbacks.
It’s best to spread though. Choose 3 to 5 index funds and invest a fixed amount each month, not all your savings at once. Like this, you are eventually paying the average stocks price.
Brokers and advisors don’t have skin in the game. They don’t have an incurred risk in achieving the goal to make profit with your money, but they do take their cut when you have success. One of the simplest yet most important rules of investing is: fees matter.
Their fee might be only 1%. That seems low, I know. But due to compound interest this 1% per year will be a very large cut of your profit in the end. We are talking about long term here, about 30 years.
An example. Let’s say you invest €1.000 a month for 25 years with an average return of 7%. This means your compound returns will be €1.026.876 in the end. If your broker takes 1% each year, then your profit will be “only” €819.620 in the end. So you are paying €207.256 to a broker who didn’t do anything because he can’t beat the market anyway. That’s 20% of your profit!
So now you understand why things are being made so difficult. Otherwise there can’t be made profits. Your broker is not your friend.
Investing directly, without a platform, isn’t possible and you won’t find it any cheaper than this. Beware that your bank will probably charge you at least 2% in fees, which in the same example would be €190.000 more in commission over 30 years. That’s an extra house.
Don’t invest all your savings, I keep about 6 months of spending (€10.000) in a safety bucket for unexpected situations.
After signing up to a broker app, pick two or three index funds that you find interesting and buy them each month on the first of the month, whatever the price is.
I started with the most obvious ones for myself that I can buy once a month without fees;
- Vanguard All-World (3100 companies worldwide)
- iShares AEX (top 25 companies in Netherlands)
- S&P 500 (top 500 companies in United States)
That’s all you have to do. Remember it’s a long term investment, so stay cool. There is no need to check the stocks more than once a year, you are not going to sell it now anyway.
"The greatest danger is being out of the market"
— Gijs Heerkens 👨🏻💻 (@gijsheerkens) November 5, 2019