Investing as a Millenial

It’s been expected exponential growth year on year since the first industrial revolution which makes us believe that history will always repeat itself, but the reality is history definitely rhymes but doesn’t necessarily repeats itself perfectly.

Below you will find the World’s GDP Growth (%) since 1950. I must reiterate the trendline in green. Whilst the Baby Boomers enjoyed world’s average growth around 5% in the 50s & 60s gradually declining for Generation X to 4% in 70s-90s, the Millennials are currently experiencing 3% in 2015. It’s true that we have also decreased the number of children per household which contributes to a greater GDP per capita, but this is still bad news for investments.

trendline
Font: Self Elaboration based on data provided by World GDP in 2011 Int.$ (OWID based on World Bank & Maddison (2017)) (int.-$)

The layman then wonders: “Why is that even important?”. Well it’s simple: the more the world’s GDP grow, the more your investments grow with it.

Holy cow!! Should I freak out then!? Not really… Indeed our grandpa and parents were very fortunate to experience greater boom, but the reality is there will always be valuable opportunities waiting out there to be explored, we just need to expand your horizons:

Have a look at the growth across the world from 2010-2017 and find the most exciting opportunities: Emerging Asia & Africa (around 50-60% growth)

growth overall
Font: Self Elaboration based on data provided by IMF 2017 (Real GDP growth – Annual percent change)

Remember: Investing is all about compounding interest which means that your interest year on year is the most important thing. Had you kept your money in North America during this aforementioned period, you’d have attained approximately less than 20% return (taking as an assumption that the country growth is followed by stock market: this hypothesis is usually true in the long term but not necessarily in the short term due to the madness of what Warren Buffett would call the “Moody Mr. Market”). In the European Union this would be worse at around 13% growth during all these 8 years! Even worse than that: Japan (11.5% growth) even though has utilised all the known economic tricks: negative interest rates, helicopter money printing money like crazy and boosting aggregate demand via government praising Keynes vs its contemporary Hayek.

But why is that? It’s simple. It’s much harder to grow on a bigger base! Does that mean we all shall emigrate to Emerging Asia & Africa? Well, you surely will have more investment opportunities, however you won’t have necessarily achieve a better quality of life. Well-developed countries such as Germany, France, UK, US & Nordics are growing their GDP per capita on an already high base (GDP per number of the country’s population and is therefore a real key performance indicator for financial quality of life of the people living there). Conversely, Africa & Asia will take years just to get to the same point and then they will most likely face the same challenges that developed economies are facing now. Indeed It’s true that their learning curve will probably be much steeper: almost every single country in Africa didn’t really adhere to the home fixed telephone but rather jumped to the innovation of the mobile phone making its growth curve much faster. But at some point, China will end up having the same challenges of Europe:ageing population; global competition; innovation increasingly harder; high debt over GDP constraining the economic growth; high wealth inequality also depressing the purchasing power of the population; social pressure to reduce working hours; political pressure to avoid their dumpings (currency wars, children labour, etc)

So I’m lost now! What should I do? Diversification is key. As Tony Robbins would say in his Unshakable book, you want asymmetric risk-return ratios which means in plain English lower risks with higher returns and diversification provides that. “Diversification is the only real free lunch” quote popularised by the Nobel prize-winning economist Harry Markowitz in the 1950s.

Ray Dalio, “Da Vinci of Investment”, through Money Master the Game book by Tony Robbins selflessly shared his family “all weather” portfolio as follows:

The All Weather Portfolio

“First, Ray said, we need 30% in Stocks (for instance, the S&P 500 or other indexes for further diversification in this basket). Initially that sounded low to me but remember, stocks are three times more risky than bonds.”

This is key – this doesn’t necessarily mean that you couldn’t diversity with 10% Emerging Africa index fund, 10% Emerging Asia index fund, 5% EU index and 5% US S&P 500 index fund. You’d certainly increase your risk doing that but also your potential reward. Furthermore, you need to look at these index funds and apply value investing theory (reduce your stake on the indexes that are in all time high i.e US and increase your stakes in the ones that are low i.e China & Japan). Also remember that we all have home-country biases which we over invest in our home country because that’s what we know the most and feel more comfortable with, but this means you’re missing out!

“Then you need long-term government bonds. 15% in intermediate term (7- to 10-year Treasuries) and 40% in long-term bonds [20- to 25-year Treasuries].” “Because this counters the volatility of the stocks.”

Developed countries offer lower returns on the bonds because the risk of country default is much lower than developing countries. Let’s for instance take the US vs Venezuela example – the bond return in the US is very low because the country only defaulted 3x times since 1841, whilst Venezuela defaulted 11x times. Defaults frequently mean: i) Renegotiation of your return by decreasing it or ii) No return for a certain period of years parking your money there unexpectedly – meaning: avoid it like plague! Answer to this: again diversification. Higher risk bonds i.e Brazil (real return after inflation of 5.5% per year – almost like the stock market but guaranteed by the government) offset by lower risk bonds i.e UK (around 1 to 2% real return variable to inflation).

The reason for the split between 15% mid and 40% long term bonds is because you can use your liquidation from mid term bonds to rebalance your portfolio i.e buying more stocks, gold, FX, etc; whilst your long term bonds which is your bulk investment will certainly offer higher returns than mid terms, but you cannot touch them.

Ray Dalio rounded out the portfolio with 7.5% in gold and 7.5% in commodities. “You need to have a piece of that portfolio that will do well with accelerated inflation so you would want a percentage in gold and commodities. These have high volatility. Because there are environments where rapid inflation can hurt both stocks and bonds.” – Tony Robbins

There is in average a 10% correction every year and an economic crisis every ten years. The major mistake of investors is trying to time the market. Nobody really knows what will happen. No one regardless of how articulate they are can predict precisely what is going to happen. Therefore, you and I must protect our downsides against “rainy days”.

Lastly, the portfolio must be regularly rebalanced. Meaning, when one segment does well, you must sell a portion and reallocate back to the original allocation. This should be done at least annually and if done properly, can actually increase the tax efficiency which will be the subject of another blog post. This is important because what has gone up will eventually go a bit down and what has gone down should effectively correct itself up in the long term.

Testing this portfolio

When Tony’s investment team showed him the “back-tested” performance numbers of this All Seasons portfolio he was astonished. During what he called the “modern period,” 30 years from 1984 through 2013, the portfolio was rock solid:

1. Just under 10% (precisely 9.72%, net of fees) average annualized return. (It’s important to note that this is the actual return, not an inflated average return.)

Remember avoid admin fees from banks and investment operators, they eat your compounding returns!

2. You would have made money just over 86% of the time. That’s only four down/negative years. The average loss was just 1.9% and one of the four losses were just 0.03% (essentially a break-even year).

3. The worst down year was -3.93% in 2008 (when the S&P 500 was down 37%!)

4. Standard deviation was just 7.63% (This means extremely low risk and low volatility.)

The ball is now in your court. Let’s recap in a short summary:

  • 30% Index Funds across uncorrelated regions including developed and emerging markets – remember this is key as stocks are still the best performing assets just behind venture capital (investing in startups = highly risky) and bitcoin bubble (one day will burst = highly risky)
  • 55% Bonds = nationally and internationally (15% mid term so you can use it to rebalance your portfolio and 40% Long term)
  • 7.5% in gold and 7.5% commodities – however other specialists such as James Rickards (see: The Road to Ruin) would also defend real estate and fine art as these usually retain their values even in crises. So if you’re not a fan of commodities or gold and have abundant capital, you can also retain a bit of fine art, real estate, physical gold, etc.

If you’re a more aggressive investor: you can try bitcoin and venture capital but assume that this money is already lost. Cryptocurrencies technology (Blockchain) is here to stay and has the potential to be as big as the Internet, however the current cryptocurrencies are also suffering of a bubble with no regulation opening space to charlatans to “paint the tape” transferring coins to themselves and whales dumping their coins to plunge the market just to buy it again at a much lower price – so please be careful! Limit this aggressive investment to a 10% max (by switching your long term bonds to 30% and include 10% of bitcoin to your portfolio this will include your risk by over 10x – also watch out for admin fees and use Cobinhood as they offer 0% admin fees).

Last but not least: Save cash for a rainy day. Cash is not an investment and therefore is corroded by inflation, however you don’t want to be in a situation when you need to prematurely liquidate your position and lower your returns due to a bill to be paid or an emergency. So always save some cash which the amount depends on your personal situation.

Okay, now you have all the info you need, but you and I know that Knowledge is potential power and only becomes POWER when we execute it.

Execution Plan:

  1. Avoid admin fees: you’re probably being stolen in plain sight!!

Mutual funds which are the most common funds charge you a fee of 0.5-2% a year. This means that if your return for that year was 5%, you’re only receiving 3-4.5% return before taxes. The truth is that 96% of actively managed mutual funds do not beat the market over a 15-year span. Active managers are trying to beat the market by being a great stock picker. And the 4% that does beat the market is changing all the time, so betting on a jockey that won the last race does not mean that he will win again. Chasing performance is a fool’s errand. These highly educated managers charge you for their poor performance!

How badly does this actually hurt us? Over a 20-year period – December 31, 1993 through December 31, 2013 – the S&P 500 returned an average annual return of 9.28%. However, the average mutual fund investor made just over 2.54%, according to Dalbar, one of the leading industry research firms. That’s nearly an 80% difference!

What’s an index fund? Your fund provider will automatically balance your portfolio via algorithms with the biggest companies in the region you have your fund. Let’s take the S&P 500: you essentially have tiny bite-sized stocks in every single top 500 US companies across a diverse array of sectors and services bringing your asymmetric risk return. What a beauty! Moreover, like Darwin’s natural selection theory, if a company goes through the cracks as soon as they occupy the 501st position, guess what? That’s right you no longer own then, but rather have a rising star coming up to replace it.

Lowest admin fees of an index fund:

Fidelity

  • UK index fund = 0.06%
  • S&P index fund = 0.07%

Vanguard:

  • UK index fund = 0.06%
  • S&P index fund = 0.05%

2. Take advantages of tax allowances: this is very dependent on the country you live and therefore I will focus on the countries I’ve lived myself. That’s the time that I advise you to do your own research, read books about it and even call a professional (the stakes are high here my friend – so put in the time, your family will thank you):

If you live in the US: Read Unshakable from Tony Robbins and if you want to go further Money Master the Game as well – he sat down with more than 40 most successful investors in the planet, it summaries very well and gives you plenty of tools. Even if you’re not in the US, the principles are still amazing and versatile so read it.

If you live in the UK: ISA, Lifetime ISA and Pension Funds.

ISA: You can invest around £20,500 per year without paying any capital gains taxes.

Lifetime ISA: You receive £1,000 top up per year by the UK government as long as you invest £4,000 (that’s right 25% government top up per year and it’s all tax free!). This money can either be accessed to buy your first house or when you retire.

Pension Funds: When you achieve 55 years old, you will thank yourself for saving! What’s more? When you have a Pension Fund you reduce your taxable income and pay less taxes! Your gross salary is deducted before is effectively taxed and therefore for the government seems like you’re receiving less gross salary, but in reality you’re saving in a different fund which you will be able to access in your retirement. Contact your employer to know more about this.

Avoid “expensive” apps that charge high admin fees like Etoro, Nutmeg, etc. The only financial app in the UK I follow is Monzo due to its high capacity of providing insights on your spending and helping you to budget.

If you live in Brazil: Tesouro Direto (National bonds) with no regular interest due to “come-cotas” which essentially you pay taxes as soon as you receive regular interest. That said, aim for NTB Principal notes only for as long as possible if you can afford the wait.

3. Understand compounding interest and Don’t lose money.

Example: Imagine you start with £100,000 and your return is 10% a year. How much money will you have after 10 years? £200,000 [£100,000 (initial investment) + £100,000 * 0.1 (10% return) * 10 years)? Wrong!

You’d have £259,000. That’s right! Additional £59,000 due to compounding. How come? £100,000 * 1.1 * 1.1 *1.1 * 1.1 * 1.1* 1.1 * 1.1 *1.1 * 1.1 * 1.1 = £259,000. Further explanation with Tony.

Thus, if you lose money, it’s just much harder to recover. Let’s imagine you have £1,000 again and you need 10% return in 10 years to get to £2,590. But let’s suppose you lose £500 in high risk hedged operations (been there, done that). Now you will actually need 19.5% return over these 10 years to simply get to the same place (£2,590)!

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