Achieving Economic Independence
This is my first post in this blog, and I would like to address to a topic I may come back in the future to people without much time to analyse the different financial options for their future.
Nowadays, the future economic outcome is a constant headache for many people across several countries: inflation, economic recovery, pensions, etc.
There are many options out there for each type of investor: shares, bonds, real estate, crypto currencies, gold, etc. Each person has his preferences and depending on the age/risk-aversion different options can be multiple.
More sophisticated investors are not discovering anything new about this story. If you continue reading, I am focusing on what I think is the best for most people, with the least possible risk: the indexed funds or exchange-traded funds.
The behaviour for index funds and ETF is similar. Both replicate an index or basket of assets, meaning that with one single instrument you gain exposure to multiple securities (e.g., S&P 500 companies). Between those, the main difference is that ETFs are traded in real-time, whereas the funds are just redeemed at the end of the day. The fees for the ETFs tend to be slightly lower too. On the other hand, they are subject to transaction fees, but many brokers offer transactions on the most popular ETFs for free.
For a person without knowledge and looking for long-term returns, I am of the opinion of using a broad index and not a niche funds, which are focused a specific sector (e.g., eCommerce, video games, etc). Furthermore, although previous returns do not guarantee future returns, in the long-run most indexed funds outperform actively managed funds. The latter ones are famous for high fees, and although they may outperform passive funds in short periods, this is normally not the case in the long run. If you want to dig deeper, there are some formulas that determine the performance of the fund: For example: The Sharpe or Trentino ratio.
Depending on your risk-aversion, you may choose different funds depending on the allocation. People near the retirement age should be more conservative. The way to do in this case is focusing on bond funds, which are less risky than equities.
A famous rule is the “100 — age” rule. The result should be the amount of your portfolio invested on share funds. However, given the current situation, if you are young, there should not be problem on having a 100% equities asset location.
Below, there is a list with the most famous ones for different profiles.
SPDR® S&P 500® ETF Trust
Probably the most known ETF, which tracks the performance of the S&P 500 index. This is also the one with less expense ratio. It is considered one of the benchmarks.
Invesco QQQ Trust℠, Series 1
This ETF tracks the Nasdaq 100 index (non-financial companies) and it is riskier than the SPDR. Taking into account the returns from the past 15 years, it is the best performing large-cap growth funds.
Vanguard Global Stock
This fund tracks the MSCI World Index (around 1,500 shares). Almost 70% of the exposure of the fund is in the United States with almost 70% of the fund. The second largest market is Japan with around 6%.
Vanguard Global Stock Information
Vanguard Total Bond Market Index Fund Admiral Shares
For more conservative investors, we have this fund, which focuses on U.S. bonds (Treasuries and Mortgage-backed-securities). The returns are lower compared to the other 4 funds analyzed here, but it is also less risky.
Vanguard Total Bond Market Information
iShares MSCI Emerging Markets ETF
This is an ETF tracking the equities from companies located in Emerging markets (China, Brazil, India, etc.) For that reason, the fund is considered riskier than those included above. Furthermore, the expense ratio is also higher in these funds tracking shares from emerging markets.
iShares MSCI Emerging Markets ETF Information
Please note that depending on the location, you may not be able to access some of these (e.g., most European investors do not have access to US funds). However, you should always be able to find similar funds to these.
Some of the ones listed above are ETF or index funds, but you may always find the equivalent depending on your preferences. In these cases, the expense ratio is considerably low. The more specific you go (e.g. specific sector) the higher the expense ratio tends to be .In my case, my preference is the ETF because the expense ratios are slightly cheaper and you can track the price as in the case of shares.
The impact of currency
Although the USD has been dominating for many years, nobody knows when other contenders may appear. For the long-term, the recommendation would be to pick up an ETF or fund quoted in your local currency.
One-shot versus Dollar cost averaging
From my experience, the most dificult process is starting to invest, making sure that is it the right time. For this reason, although there are different studies showing that one-shot gives on average better results (time in the market beats timing the market), most people would not be comfortable dumping all the savings in one single transaction.
For that reason, the Dollar Cost Averaging is the preferred method for common investors. By using this method, whatever happens in the market, you buy every month the same amount of units/shares of the chosen fund.
The way you are taxed on the returns from investment funds may have a huge impact. The main difference is whether the fund/ETF is an accumulation or distributing investment vehicle.
In accumulation funds, the dividends received from the fund are reinvested. While this event is not seen as taxable for investors in many countries, it is seen as taxable for investors resident in countries such as Germany or Switzerland. Please consider that may be also other rules: For example, in Norway, the tax rate differs depending on whether the fund is an equity fund or a fixed-income fund. Therefore, please consider your situation in advance before choosing a specific fund.
Thus, depending on the country you may want to look at what options are best for you. Furthermore, there are some tax-savings accounts in some countries that may be useful to make sure that you get benefited from the best product-
Together with the expenses and commissions, taxes may be the most important factor eating your total returns. Imagine that you are paying 25% of tax in the dividends you receive. You are already not receiving this money, and more importantly, this amount is not used for the compounding, which reduced considerably the future value of the fund.
Now that we have seen the theory, it is time to jump into the action. Depending on the location you may have just access just to some brokers. Here are some examples where you may start investing in some ETFs or investment funds.
As discussed above, some of them are just available on certain locations. However. You will certainly find one available
These are some of the books or that I have read and that I recommend if you would like to know more about this topic can be also found below:
- The Bogleheads’ Guidex to Investing by Taylor Larimore Goodreads link
- If You Can: How Millennials Can Get Rich Slowly by William J. Bernstein Goodreads link
- The Psychology of Money by Morgan Housel Goodreads link
- The Intelligent Investor by Benjamin Graham Goodreads link
Originally published at https://mrfreire.net on March 20, 2022.
