Month: September 2016

First Investment … Index Funds … Sounds Fun!

stock-exchange-1426332__180OK … the cushion is sorted and we are ready to start on the path to financial independence with our first investment.

However, we are just starting and our first plunge into the share market shouldn’t be with an individual company … this is too risky … exposure to the whole market through an index fund is a good first step.

The main reason for this strategy is that Slack Investor has found that – despite his great prowess as an investor (?) there are many unknowns when it comes to an individual share or stock.

Slack Investor does a great deal of research on a company before he parts with his dollars and, despite being convinced at purchase time that this company will be a great winner, this does not always turn out to be the case.

Slack Investor has been in this investing game for a considerable time and despite this 30-year experience and diligent research his documented win probability for an individual company (Selling the share for more than I bought it) is surprisingly (to an optimist like me!) low.

Slack Investor win probability ... is just over 50%.

This sounds like I don’t know what I am doing … However, bear with me …If you follow Slack Investor and use the enduring wisdom of many successful investors

“Cut your losses short and let your winners run.”  

… You will be well on the road to financial freedom.

This is because individual stocks that you keep in your portfolio (Winners) may increase in price by 5-500% (or more!) but if you limit your losses on losing stocks to around 15% you will end up with a solid investment portfolio. For the record, the Slack Investor portfolio has between 20-30 individual shares/managed funds and, including dividends, has achieved a 5-year average annual Internal Rate of Return (IRR) of 14.6% (as at 30/06/16)

If you don’t want to get involved with a stock broker, and you have $5000, then the most excellent Vanguard Funds offer exposure to the whole Australian, US or World markets through their managed funds. For example the Vanguard Index Australian Shares Fund offers exposure to the whole Australian share market for a management fee of 0.75% p.a. with a published 5-year annual average return of 8.7% (after fees)

Or, you could take the plunge and sign up with an Online Broker. Slack Investor uses CommSec. After a bit of paperwork you should then be able to trade on the ASX online and get exposure to the world of Exchange Traded Funds (ETF’s). You will have to pay brokerage for each trade but otherwise, costs are low.

Two such Australian ETF’s are SPDR S&P/ASX 200 (STW) and Vanguard Australian Shares Index Fund (VAS) . They have management costs of 0.19% and 0.15%, respectively, with 5-year average net total returns of 9.98% and 9.32% respectively (31/08/16).

The stock market is a capricious beast and susceptible to whims and world events. Of course, past returns on the stock market are no guarantee of future returns – but, if you put your faith and money into the whole market through an index fund for 3-5 years you will usually be rewarded.

Shares? … What about a house!

washington-d-1607766__180Dipping your toe into the stock market can be a daunting experience. A lot of people feel more comfortable with investing any saved money into residential property. In Australia, this has been usually a great idea – As well as income provided by your renters, there are tax advantages in negatively gearing your property. However, residential property has run long and hard and property yields are looking a little bit skinny. Corelogic reports that, as of September 2016

  • Australian gross rental yields for houses are currently recorded at 3.1% and unit yields are 4.1%, both of which are record lows.

Prediction of future property yields and capital growth rate depend on a complex mix of supply, population growth and interest rates. The low yields and the large sums required to get into the housing market make housing a difficult first investment in capital cities – and Slack Investor thinks the days of big capital gains for residential property are behind us.

I am not against residential property and it is one of the Slack Investor foundation blocks that you must have a plan to own your own home – in a place that you like – before financial independence and retirement.

For many, the forced savings commitment that a home loan provides is a great way to wealth accumulation – the money disappears from your account prior to you having a chance to spend it! It is a pity that much of the home loan payment is portioned to loan interest – but this is not such a concern for a long term commitment, especially in times of capital appreciation.

Owning a home gives Slack Investor a great joy that cannot be measured in financial terms alone.

glennstevens
Glenn “Sexy” Stevens, RBA retiring governor and Slack Investor favourite.

So where should you start investing … Bank cash rates are low (1.5% from August 2016) and several punters think that they may be low for some time. Slack Investors favourite banker, the Reserve’s Glenn Stevens has just cut the cash rate to 1.5% and thinks that the low inflation environment and conditions for Australian economy growth are expected to remain the case for some time.

Cash is safe and reliable though, and is the best place for your cushion while your are saving up your first investment bundle. But putting your money in the bank will not make you financially independent … you have to take some risk.

Share investment, is not recommended for very short time frames as the stock market can be very volatile  … but If you have some money set aside that you can afford to leave in the market for 2-3 years – It is an excellent place to start your investing journey. Most Australians already have exposure to shares through their superannuation funds … and if you look at share investment as a chance to become a company part-owner, why wouldn’t you give it a go!

 

One More Marshmallow Please …

marshmallows-788771__180Once the financial cushion is established the hard graft of saving must commence … Fortunately, Slack Investor has always been a good saver and a lot has to do with the mystical trait of delayed gratification. A famous experiment was conducted at Stanford by Professor Walter Mischel. It is worth expanding on this research as Slack Investor finds this trait to be fundamental to the pursuit of financial independence.

The Stanford study was published in 1972 under the dry academic title of Cognitive and attention mechanisms in delay of gratification. And started with a preschool child sitting in a chair, and placing a marshmallow on the table in front of them. The researcher then told the child that he was going to leave the room and that, if the child did not eat the marshmallow while he was away, then they would be rewarded with a second marshmallow. However, if the child decided to eat the first one before the researcher came back, then they would not get a second marshmallow.

The researcher left the room for 15 minutes and the child would either gobble the treat … or wait patiently for what must have been a very long 15 minutes. In the original experiment, one third of the preschoolers managed to get the second marshmallow.

The really interesting part of the Marshmallow Experiment happened years later where follow up studies tracked each child’s progress in a number of areas.

The children who were willing to delay gratification and waited to receive the second marshmallow ended up having higher university entrance scores, lower levels of substance abuse, lower likelihood of obesity, better responses to stress, better social skills and generally better scores in a range of other life measures.

The children were followed for more than 40 years and the researchers concluded

… that the ability to delay gratification was critical for success in many of life’s challenges.

You might think that this ability might be part of your natural make up,  but Slack investor and a bunch of Behavioural Analysts think that this delayed gratification can be learned (i.e., Older children were better at the task)… And the best way get this delayed gratification going … is to start saving. Some tricks you can use are to get a portion of your pay paid automatically deducted into a separate account … or set aside a review day at the end of the month so that you can slide any money that you don’t need right away to a separate online savings account.

These accounts are easy to set up and are offered by many banks. Slack Investor has a few accounts with ME Bank, but there are many offerings in the Australian Market. In addition to your transaction account, start a “Cushion” online a/c and a separate “Savings” online account. With your regular contributions they will grow and the delayed gratification vibe can warm your heart! … and you will eventually have all the marshmallows that you could possibly eat!