A Masterclass in Investing

Introduction

• Disclaimer: This is not investment advice.
• My background: Experienced investor with a focus on financial independence.
• This is a single lesson that could be an entire course - go do further research!
• What is FIRE (Financial Independence, Retire Early) and why do it?
  • Earning more
  • Cutting costs
  • Investing ruthlessly
• Frugality is very important.
• Think about your investment & financial goals upfront. What type of lifestyle do you want?
• Playing with FIRE Retirement Calculator
•  The Early Retirement Grid

Scenario: Average Income & Saver

• Age: 25 years old
• Annual Income: $60,000
• Annual Savings Rate: 50%
• Initial Investment: $10,000
• Investment Return: 8% per year
• Retirement Goal: $1,000,000

First-year Calculation:

• Annual Savings: $60,000 * 50% = $30,000
• Annual Investment Contribution: $30,000 + $10,000 = $40,000
• Total Investment Portfolio at the end of the year: $10,000 + $3,200 = $13,200

Time to Retirement:

• Approximately 22 years to reach $1,000,000 (assuming consistent market conditions).

What is Investing?

• Investing, broadly, is putting money to work for a period of time in some sort of project or undertaking in order to generate positive returns (i.e., profits that exceed the amount of the initial investment). It is the act of allocating resources, usually capital (i.e., money), with the expectation of generating an income, profit, or gains.
• What are the most common assets (briefly):
  • Stocks: Ownership in Companies (ACTIVE investing)
  • Bonds: Fixed-Income Securities (PASSIVE investing)
  • Mutual Funds and ETFs: Diversification Made Easy
  • Real Estate: A Tangible Investment Option
  • Alternatives (whiskey, paintings, etc.)
• Investing is not trading:
  • Trading is a speculative form of investing where a trader buys or sells securities usually based on price patterns. This form of investing is not advised for most. 80% of traders lose money, 10% break even, and 10% make money consistently.
  • As Nassim Taleb outlines in his book Fooled by Randomness, many of the traders who do make money do so through random occurrences. There is a high knowledge barrier to entry in day trading and a likeliness to eventually implode.

Wait! Before You Start Investing

• Create a budget
• Write down investment goals (short-term, long-term)
• Create an investment thesis
  • Sample investing thesis:“This year, I will be Investing in SPY. I will invest 70% of my paycheque at $1500 per month. This strategy has averaged a return of 10% over the past 20 years.“
• Consider seeing an investment advisor/financial planner
• Assess your Risk Tolerance
  • More risk (volatility) = More return. [CAPM 1960]
  • Most people cannot handle volatility.
  • Generally, younger = more risk
  • Concentrated vs. diversified

Before You Start Investing, Do These Things:

• Have a six-month emergency cash pile
• Pay off credit card or other high-interest debt
• Invest in yourself
• Eliminate your worst spending habits
• Think about your time horizon
• Max out your pension contributions (Roth IRA, 401K, or other pension vehicles)

Creating a Portfolio

• Diversification can be accross:
  • Asset classes
  • Market cap
  • Domicile
  • Number of assets
  • Weighting

Ray Dalio, the founder of Bridgewater Associates, suggests holding 15 to 20 uncorrelated investments to achieve optimal diversification.

90% of fundamental fund managers have failed to beat the market over the past 15 years. Indeed, over the past 20 years, fund managers have averaged a return of just 4.67%!

Case study 1: CXO tracked the results of 6,582 predictions made by 68 investing gurus made between 1998 and 2012. Despite having some well-known names in the sample, the average of the gurus' accuracy (47%) didn’t beat a coin toss. Indeed 42 of the gurus had accuracy scores below 50%.

Case study 2: UC Davis professor Brad Barber studied the buy and sell recommendations of Wall Street analysts. What he found was that the analysts' buy recommendations underperformed by 3% per month, while their sell recommendations outperformed by 3.8% per year!

Okay, so clearly the professionals have a very hard time making any stock market predictions. If the professionals can’t do it, why would the everyday investor even try? If we can’t beat the market, why don’t we just match it!

This is why 45% of funds in the US are now passive. Investors are realizing that most of the time it is futile to try and beat the market using traditional means and flocking to ETFs which track well-known indexes, holding a basket of stocks. ETFs are distinguishable due to their low fees, performance, and simplicity. A well-known example is the SPDR S&P 500 ETF (SPY), which tracks the S&P 500 Index.

Indexing is a great strategy for millennials; it is simple to do and most of the time performs better than picking individual stocks. Some of the biggest and best-known ETFs are:

• S&P500 (SPY)
• Total US stock market (IVV)
• NASDAQ 100 (QQQ)
• FTSE Emerging Markets (VWO)
• FTSE All World (VWRL)

U.S. ESG ETFs:

• iShares ESG Aware MSCI USA ETF (ESGU): Tracks the MSCI USA ESG Focus Index, composed of U.S. companies with high ESG ratings.
• SPDR S&P 500 ESG ETF (EFIV): Seeks to replicate the performance of the S&P 500 ESG Index, which includes companies meeting certain ESG criteria.
• Vanguard ESG U.S. Stock ETF (ESGV): A low-cost option that tracks the FTSE US All Cap Choice Index, emphasizing ESG criteria.
• Xtrackers MSCI USA ESG Leaders Equity ETF (USSG): Follows the MSCI USA ESG Leaders Index, which includes large and mid-cap U.S. companies with high ESG ratings.

Global ESG ETFs:

• iShares ESG Aware MSCI ACWI ETF (ACWF): Offers exposure to global stocks by tracking the MSCI All Country World Index (ACWI) with an ESG focus.
• Xtrackers MSCI All World ex U.S.A. ESG Leaders Equity ETF (ACSG): Invests in companies outside the U.S. with strong ESG practices, tracking the MSCI All Country World ex USA ESG Leaders Index.
• iShares ESG MSCI EM ETF (ESGE): Focuses on emerging market equities with strong ESG performance, tracking the MSCI Emerging Markets ESG Select Index.
• SPDR S&P Global ESG ETF (EFIV): Global exposure based on the S&P Global ESG Index, which includes companies meeting specific ESG criteria.

Being a Good Investor (Psychology)

• The FIRE mindset: long-term, equanimous, quantitative, don’t touch, don’t look, set it and forget it, etc.
• Occam’s razor (Don’t overcomplicate the stock-picking process. Use just a few, easy-to-follow rules. Use a model.)
• Little Book of Common Sense Investing:
  • Diversify widely
  • Be frugal
  • Keep fees low
  • Rebalance in a disciplined fashion
  • Stop watching the stock market
  • Work less on investing, not more
• Automate your finances; know the exact breakdown of what is going where each month
• Don’t sell just because the market goes down
• FOMO/Envy: Don’t be jealous of the Dogecoin gambler winning big. Using a model/strict methodology tends to remove these emotions as you are following the algorithm like they are your money manager.
• "If you can't describe what you are doing as a process, you don't know what you are doing" - W. Edwards Deming
• Make important decisions without emotion - Use an algorithm - Systems, not stories. Live a rules-based life.
• “The best investment strategy is the one you can stick with” – Wesley Grey