Boring or Brave, the options for Investing

As I write this I am torturing myself watching QVC shopping channel to indulge my inner hedonistic self. This hour the show is dedicated to shimmering gold jewellery (isn’t gold an investment?!). Gosh, the stuff is absolutely beautiful and very very tempting! I’m not a QVC shopper, but I love listening to their endless chatter on how wonderful everything is. It’s a bit like watching a classic Hollywood movie, everything is so sunny it’s about to burst!

What I really want to burst however is my passive income. I want that to explode, all juicy and sweet and give us lots of tasty returns. I’ve been reading lots recently in order to strategize how we should invest our savings. I’ve only just dipped my toe in the water so far, I’m a bit worried about being so new that I make a gigantic mistake and we somehow end up as paupers on the side of the road, or realistically, just losing all our savings. I was always a cautious investor when it came to my pension fund options so it’s important to me that I do a lot of research before I commit. Luckily for you, you can save yourself some time and efforts as I’ve already angsted and researched over most of it!

What are the investing options?

Most individual investors who don’t have a PhD in Economics (- like me!) would probably choose one of the following financial products to invest in:

  • Shares/Stocks
  • ETFs
  • Mutual Funds
  • Bonds

Warren Buffett famously once said that cash is the worst investment you can make. That’s because it devalues with inflation and earns almost nothing which isn’t later retracted in taxes and account fees.

If you fancy yourself a modern day Gordon Gekko then there are lots more financial products you could investigate. I wanted to get to know the basics first though.

How can you make money?

Money can be made differently, depending on how what you choose from these products. Here were my options:

Buy stocks/shares and sell them off at an increased value, hopefully earning myself a nice profit after taxes. In Ireland, you must pay Capital Gains Tax of 33% on any gain once you sell, if you’ve owned them for a year.

ETFs are a nice way to lower my risk exposure by spreading my investment over a diverse group of companies all grouped together into one big pot, known as an ETF.  If I go down this path I would hope to earn a decent passive income by investing in high yield, high dividend paying ETF. Passive income means I just sit there and watch the money roll in in dividends every quarter. (It sounds like a lot more than it is with what we have to play with). Those dividends would need to be reinvested though in order to bloom from the magic of compounding.

Fees are an issue when you are looking at ETFs, so I choose low cost index funds. What’s an index fund I hear you say? Well firstly, it’s low fees because it’s passively managed. This is definitely not as exciting as passive income.  The money going into an index fund is automatically invested proportionately into individual stocks or bonds according to the percentage their market capitalizations (size) represent in the index. For example, if IBM represents 1.7% of the S&P 500 Index, for every $100 invested in the Vanguard 500 Fund, $1.70 goes into IBM stock. This means there is really no active management of the index fund, no manager fussing over rotating the most profitable companies in and out of the fund. They obviously do get reviewed but it certainly wouldn’t be hands-on day to day management. Nonetheless, fees eat into your profits and can actually consume them all up completely depending on how your investments are performing. ETFs can be bought and sold at any time while the market is open, just like a stock. This is a core difference between an ETF and a Mutual Fund.

Mutual Funds are sold once a day – this can make a difference if for example something happens on the day to affect the price especially if the fund is invested in companies in another timezone. They are also mostly actively managed (according to Investopedia) and typically come with higher fees – this is why I’m not interested in Mutual funds.

Bonds are basically loans. You loan money to the government or companies at a set % interest rate, for a set period of time after which you get your principal investment back. So what you make is interest per year for each of the years in the set period of time. I don’t like bonds because I don’t like interest. I prefer to take a stake in a company or group of companies and share the rewards of a business doing well. That’s just me.

Ok so basically you can see I’m heavily weighted toward Stocks and ETFs.

What the heck is an Investment Strategy?! Do I need to be a financial whizzkid to come up with one of those?!!

Lots of people go on about needing a ‘investment strategy’. Do you need one? Yes, you do. Do you need to be a mathematician, a whizzkid in economics, an investment analyst? Nope, nope, and nope.

For a simple Joe Investor like you and me, trying to improve our overall wealth but not day trading, an investment strategy is a set of answers to a set of questions. You need to  decide on your personal set of questions, but here are some ideas on what you could factor in to decide on your investment strategy:

  • Your age
  • How close you are to retirement.
  • What kind of risk you are comfortable with.
  • What kind of an emergency cash fund you have at your disposal.
  • How much you can afford to lose.
  • How soon you may need to sell off your investments to access the capital.
  • Whether you prefer to make money through capital gains or dividends.
  • How will you spread your money and diversify to protect against all your investments going off a cliff?

Remember the following points:

  1. The worst position you can be in is to need to liquidate your assets during a market downturn, losing some of your principal investment just to have some cash to hand.
  2. The younger you are the more time you have to get returns and weather any economic downturns and have time to make it up again before retirement.
  3. Nobody likes losses, but will you be left destitute on the side of the street or simply sobbing into a tissue  for a couple of days then wait for the market to recover?

 

Our Investment Strategy

For us, we are mid-thirties, with state retirement age at 67. We hope to retire long before that. We would like to retire in 16-20 years, all things going well. So, we feel we have enough time ahead to really front load our investments with some risk. We have no doubt that we may see 1, 2 or possibly even 3 market downturns during this period. We want a good mix of returns via capital gains and dividends. All gains will be reinvested to benefit from compounding. We have an emergency cash fund aside for 6 months, in case something really terrible went wrong. The main thing though is to invest and HOLD, HOLD, HOLD.  Terribly boring really, just a lot of waiting around!

Personally I like to invest in the US stock market rather than the Irish one,  because it’s more highly regulated, there’s a far wider range of individual companies to choose from for stocks – at the time of writing there are just 55 companies listed on the Irish stock exchange. On top of this, it’s far easier to find a low cost broker for the US stock market due to the highly competitive nature. The fees for example at Davy’s in Ireland are just exorbitantly higher than the $2.99 transaction fee I pay to Drivewealth.

Index Funds or Stocks?

It really does come down to research. Lots of millenial and Gen-X investors won’t even consider investing in stocks, they are there for the dividends and are following the trend for index funds, possibly without doing some deeper analysis. Let’s compare a few scenarios though:

Scenario 1: Let’s say I put $20,000 into AT&T stock – AT&T also has a great dividend paying history. At today’s current share price of $42.59 and a yearly dividend of $1.96, I will receive a yearly dividend of $920.40. Below is the Financial Times’ forecast of where the share price could go in 1 year. Note that no matter where it goes, I will still get that dividend. If it goes to the highest forecast my investment could be up 12.7% to $22,540 in a year. At median it could go to $20,660. At loss it could go down to $16,900 – but the loss of $3,100 would be offset by the $920.40 dividend, bringing the loss down to $2,179.6. If I reinvest the dividend no matter what then next year (assuming the same dividend amount) I will get an extra $50 in dividend and the share price might take a hike again. (AT&T stock trailing 12 months return is 8.87% Year To Date).

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Scenario 2:  Vanguard Total US Stock Market Index Fund (VTI) has a current share price of $122.64. If I invested that same $20,000 here, wth a yearly dividend of $2.22, my yearly dividend will be $362.03. Hmm some 2.5X less than AT&T. Reinvesting this will bring me an extra measly $6.55 next year (assuming dividend remains the same) –over 7X less than AT&T.  There are no forecast high/med/lows as with AT&T but the average return is 6.6% on the stock price since its inception. That is severely adjusted by the crash in 2002 and the crash in 2008. Trailing 12 month return is 6.48% which bring us in at $21,296.

So far, so AT&T.

Why would anyone choose Vanguard’s VTI ETF over AT&T?  Well simply put, one company could be far more exposed to a serious drop in a market downturn. But wait…in 2008 AT&T dropped 27.57%, while Vanguard dropped 36.97%. Still AT&T is winning.

My concerns?

AT&T is a telecoms company who will at some point get a slowdown in subscriber growth, reach market saturation and be forced to diversify into areas it probably is unfamiliar with so far. However they have delivered an increased dividend for 32 years.

Vanguard has AT&T in its pot, and seemed to be drastically more affected by the 2008 downturn. A downturn may have far reaching consequences for many industries hence this cliff dive.

In the end, both still recovered 4-5% the following year anyway. Neither have had a loss since. I’m definitely leaning towards AT&T in the short term (5 years) at least.

What do other people think ?

Many feel that the current US stockmarket is overvalued and could take a nosedive of up to 40%. People are holding on to cash so that when the stocks go off the cliff, they can hoover up the good ones cheaply. Time out of the market though is time your money is not earning money. I believe it’s unlikely a 40% drop would not recover if you had invested in large brand names or funds. That’s not advice, just my belief. In 2008 there was supposed to be a ‘double dip’ the analysts warned us. That never materialised. How long will the current run go on for ? Who knows!  But have your strategy decided in advance – if you will sell, at what price will you sell? If you will hold, how long will you hold for? Will you toughen it out with a grim belief in market recovery? Decide in advance, then stick to your guns.

 

QVC has now moved on to the anti-ageing products… if I weren’t trying to be frugal I might purchase something as all this thinking is giving me wrinkles!

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