Part 6: INVESTING - Financial Independence Series
07 Apr, 2024
Congratulations, you have made it to the final blog post in this series of six: INVESTING
Investing can be incredibly complex, but I found a way to simplify it. I used to feel overwhelmed by the options available, but now I don't. I’m hoping to help you feel the same way. But still, this is one of the most challenging blog posts I have EVER written. Condensing “investing” into a single document is no easy feat.
The Happy Saver was born out of my search for information about what I could invest our money in. It took me years to arrive at our current strategy, which combines KiwiSaver and ETF investments. I don’t want you to take so long to settle on your own strategy. I’m no different to you when I say, “I wish I knew then what I know now”. We had some margin in our budget, and I was looking for something to make us money. I started by asking my bank's opinion and followed a trail of crumbs of information from there. Ultimately, I finally found good information, which I want to share today.
A different type of disclaimer
If it is not apparent already, I’m not a financial anything; I’ve got zero financial qualifications. I have a personal interest in money, so I talk about it a lot. I can’t say “invest in this”. This is no help to you, I know. When you search for guidance on investing, I know you will become overwhelmed by the available options and be advised to ‘go away and do your research’. Or pay a financial advisor. As an avid reader of everything in my inbox, I understand the volume of companies vying for your and my investing dollars. Many provide pretty good resources to help you learn, but ultimately, they want to sell you one, or preferably many, of their many products. It led me to write about The Temptation to Sign Up to Endless New Investment Products. At the end of this blog post, I am still going to tell you to “do your research”, but I’m going to narrow your brief significantly and encourage you to engage deeply with some essential resources and then make your plan. I have discovered over the years that most of us can manage our own money. Still, the complexity of the financial industry has led us to believe that we can't. I’m telling you that if you keep your approach simple, you can.
Let’s cut to the chase
I have found that investing in ETFs (exchange-traded funds) is the most cost-effective and easiest way to make money. Bold claim! You will also hear them referred to as Index Funds. Mixing the two terms drives fund managers crazy because there are differences between them, but I think that using either term is acceptable for the average person on the street.
I wrote about the differences way back in 2018. It was entertaining, and you can read it here: Mutual Fund, Index Fund, ETF. Please explain?
For the rest of this blog post, for simplicity, I will refer to ETFs.
I have chosen to invest in ETFs for the following reasons:
Their fees are low
They are passively managed, which means humans are primarily removed from the process (which lowers fees and bias)
I don’t have to pick stocks and research companies
They are lower risk because they are so diversified
I can manage the buying, monitoring and selling of them myself
My investments will provide me with passive income.
Everything I have learned about ETF investing started with American investor JL Collins, author of The Simple Path to Wealth. If you only engage with one financial resource in your quest to learn about investing, let it be this one. I’m quite serious.
Here are different ways to engage with The Simple Path to Wealth:
Read a Book: JL Collins - The Simple Path to Wealth
Watch YouTube: Talks at Google: JL Collins, The Simple Path to Wealth
Listen to a Podcast:
Choose FI #19 - JL Collins from jlcollinsnh - The Stock Series - Part 1
Morningstar: The Long View: #156: JL Collins: The Case for Simplicity
Read a Blog*: JL Collins Stock Series. This series of blog posts formed the basis of his book.
Search The Happy Saver for blogs on Index Fund/ETF investing. I’ve written extensively about this over the years. His most recent book, Pathfinders, is also an excellent read. It is a collection of stories from people who have followed The Simple Path to Wealth.
NOTE: I have copies of each book; if your library does not have them, you can borrow mine.
Please use any of those links and follow up on the bits that jump out at you. If you hear a term mentioned that you don’t understand, just google it. This is how you learn. You will become familiar with a lot of investing jargon very quickly.
JL Collins taught me that less is more when it comes to investing. While in other parts of life, the more we engage, the greater our success, the opposite is true regarding ETF investing. Investors who consistently buy low-cost, passive ETFs over a long period will outperform most others.
Don’t believe me?
There is a research company called SPIVA. Their job is to compare actively managed funds (investment funds where the fund managers are actively picking and choosing investments to make up their fund) against an index benchmark, such as the US 500 (the top 500 companies in the USA). Visit SPIVA and play around with the results by region. In America, 59% of managed funds underperformed the benchmark in the last year. In the previous five years, 78% underperformed. And in the last 15 years, 88% underperformed.
SPIVA shows that in the short term, most managed funds underperform the benchmark or the average of the share market they are monitoring, and it gets worse with time. This begs the question: How are you and I going to pick the right managed fund to be in the 12% who manage to beat the index over a 15+ year period? Our chances of getting it right are so incredibly slim. Once I read this, I knew I had to keep searching for better investment options.
If you extend the thought that colossal fund managers do a poor job of beating the share market average, then just think about how an investor buying single-company stocks could fare better. Over time, most of us simply can’t predict how a company will continue to perform. Who is the exception? Warren Buffett. Are you also the exception? No.
What is an ETF?
An ETF is a basket of stocks designed to mimic a part of or an entire index. “They invest in the same assets using the same weights as the target index” (Investopedia).
New Zealand has an ETF that tracks the top 50 stocks of the New Zealand share market (NZX). They are a basket of companies selected to match precisely how those companies appear on the NZX. America also has funds that track the top 500 companies as they appear on their share market. Again, they create a basket of companies selected to match how they appear on the S&P 500 as precisely as possible. At the time of writing, the largest company was Microsoft Corp, which made up 7.11% of the S&P 500 ETF. The smallest, or the 500th company, was Paramount Global Class B, making up just 0.01%
Many countries offer ETFs that match their share markets' top performers.
The Simple Path to Wealth taught me that, over time, investing in an ETF will outperform most, if not all, people who actively invest by buying and selling stocks.
Why would we want to buy this basket full of companies?
This is how the share markets of the two countries listed above have performed over time. Share markets go up and down in the short term, but they go up over time.
S&P 500 All Time Market Summary. Over time the share market goes up. (Source: Google)
S&P/NZX 50 Index All Time Market Summary. Over time the share market goes up. (Source: Google)
By buying an ETF that holds all of the top companies, I am following the share market's upward trend, meaning that the value of my investment will increase over time.
A quick word on risk
You will notice on those two graphs above that while the trend is up, there are some peaks and troughs showing the share market has increased and decreased. Currently, the New Zealand share market is a bit flat, but given time, it will wander higher again. While investors feel no risk when things are up, they feel they are exposed to risk when things drop. My view on risk when it comes to ETF investing is that movement up and down is typical and expected, and because you only invest money in the share market for the long term, even if the value drops, it will go back up over time. I’ve been through a few decent market drops and come out the other side just fine. If any part of you thinks you might panic and sell, you need to toughen up and also go back to learning how this type of investment works in the long run. That will make you feel more comfortable.
Alongside risk is the well-worn phrase, “You don’t put money in the share market that you can’t afford to lose.” This rang true when buying individual company shares, but it is less true with an ETF investment strategy. I don’t invest to lose money, and having committed to buying all the companies all the time, my investment goes up over time.
To be an investor, you need routine, consistency, planning, and the ability to work towards a long-term goal. If you fail to do any of the above, you will dive into investing, win some, lose some, chop and change, and fail to grow long-term wealth. Investing will feel terribly risky with this type of approach.
ETFs are self-cleansing
When I own an ETF, I always own the best companies. The premise is simple. The share market of a country is full of companies going about their business, each wanting to grow and succeed. I want to invest in those successful companies. However, despite their best efforts and intentions, not all companies succeed, and most die off eventually. The trouble is, I don’t know which companies will succeed or fail. No one does. However, when I zoom out and look at all of the companies on the share market, collectively, over a long period, they all go up.
If the share market only goes up over time, then buying ALL the companies instead of picking and choosing a couple makes sense. I no longer have to buy and sell to continue holding only the successful companies. An ETF will always hold the top-performing companies as they are represented on the stock exchange of that country.
At all times, I hold the best of the best in what are considered to be the best sectors, the best companies, and the best products. And when the needs and wants of the world change, the fund keeps pace with those changes. The real benefit of an ETF investment is that I don’t have to spend time trying to determine the next big thing. The US stock market currently has technology stocks leading the charge, but that won’t always be the case. What’s next? I have no idea, but I do know that when the world decides to go in a different direction and massive companies grow as a result, I’ll hold them in my ETF. If one or two companies within that fund have incredible growth and success, they will pull up the performance of the whole fund, and I’ll get to enjoy that rise. If they crash and burn and no one wants what they are selling anymore, they will sink to the bottom of the index before being replaced by the next top performer. ETFs are self-cleansing.
Buy a little and often.
All I have to do is purchase an ETF a little and often and go about my day. Jonny and I began doing just that in 2015 as we transitioned from managed funds we held with our bank into two ETFs, the NZ 50 and US 500. We have not stopped investing since. Month by month, as per the wisdom of JL Collins and as a result of doing a lot of research and reading myself, our net worth has calmly grown. Another benefit of these investments is that the fund manager calculates and pays all the taxes. Depending on your fund manager, imputation credits can also be used to offset tax owed in other areas of your life.
During the last nine years, we have experienced dips and drops in the share market, but more importantly, we have enjoyed a slow and steady rise in the overall value of our investments.
From time to time, we have had some lump sums to invest (We just received a $68,082.50 windfall!), but mostly, we have set aside a portion of every single paycheque we have received into our investments. You should aim to invest a little and often and always prioritise investing in your budget. When Covid-19 came along, we cut spending everywhere we could but still invested as we always had. Why? Because any money I can invest today will grow over time.
How do you make money when you invest in ETFs?
To achieve financial independence, we need scale. We need as much money invested into large, low-fee, passive ETFs as possible to draw an income from it. My rule of thumb is to use The 4% Rule to determine how much money we need invested. For every $100,000 invested, once a year, we can sell off 4%, or $4,000, of our investment and spend the money. The fund will continue to grow despite selling off a portion of it. This strategy is how those in the FIRE (financial independence retire early) community live off their investments.
We invest our after-tax income into our ETFs, and that money grows in two ways: capital gains and dividends. If I had invested $10,000 in the US 500 in July 2015, today it would be worth $18,000. The gains have come from reinvested dividends and capital gains due to the difference between what I paid per share in 2015 and what it's worth if I sell it today. Also worth noting is that we are taxed on the dividends but not capital gains in New Zealand.
I use the New Zealand company Sharesight to track how our investments are performing. They have a handy “Share Checker” tool so you can go back in time and work out what your investment would be worth both then and now. This is super handy/painful for those who suffer from regret and say things like, “If only I had bought XYZ back in 2014!”
Using Sharesight’s Share Checker, $10,000 invested in the Smartshares US 500 in July 2015, would today be worth $18,000.
What is passive income?
When I first started learning about investing in the share market, I thought share investors made money purely via dividend income. But that is not the case. Dividends are nice to have, but the real growth comes from capital gains and the rise in value of the ETF itself. Our net worth grows due to our small dividends being automatically reinvested into our fund and the capital gains over time.
Passive income is the income we draw from it.
You will agree that, apart from being a diligent investor for almost a decade, my input in the rise of this fund has been very passive. Apart from working to make the money we invest, I've not had to do much.
Jonny and I are now applying the 4% Rule to our investments and drawing a passive income from them on May 1st each year. We simply sell off a set amount, and the money arrives in our bank account a few days later, ready to be spent.
More is not better
As I mentioned, emails from investment companies pour into my inbox regularly, each touting their wares. However, in the case of ETF investing, less is more. By investing in a sizeable low-fee fund that buys an entire market, such as VTSAX as suggested by JL Collins, or a similar type of fund, such as the US 500 or Total World fund, I’m buying all the best companies across every sector and industry. If they are any good at business, I will own them, and my investments will be incredibly diverse.
Therefore, I see no reason to buy into any of the niche funds (also called satellite funds) that providers offer. According to JL Collins, owning one large fund provides all the diversification you need, and you can easily double up and end up owning the same companies if you invest in multiple ETFs.
I think of it in the following way. Have you ever stood at the supermarket looking for one key thing, whether it be chips, sauce, hummus or wine? You want one type of food, but the choice is overwhelming. You ask yourself why they offer such a vast array or what is essentially the same thing. It is because the original company, and then all the competitors that spring up, are looking for a way to appeal to every buyer looking for that product.
The same is true for the range of ETFs on offer. Each provider needs investors' money to flow into their platform so that they can make money via the fees and services they charge. The more they can offer, the higher the volume of investors they can attract. But that doesn’t mean you have to buy what they are selling.
I’ve tried a few niche funds over the last five years. I did it just to test the theory of a single fund being ‘enough’, and on each occasion, I proved the theory correct, managing to break even either barely or, in the case of one niche fund investment, watching it lose 75% of its value.
The longer I invest in just two ETF funds, the more steadfast I become. That conviction comes from following the wisdom of so many in the personal finance space who say to buy on a regular basis into one, maybe two, large ETFs and never stop.
Let’s talk about fees for a moment.
ETFs are cheaper to invest in because they are passive investments. Very few people are engaged in running them, meaning fewer people need to be paid because they simply track an index and rebalance the fund at various points throughout the year. Different providers charge various fees, which are all lower than 0.5%. Much like KiwiSaver fees, the lower the fee, the better. Anything over this percentage is considered high.
You don’t need to buy individual company shares.
Yes, you can have a wee dabble on the side if you have a particular fondness for a company and want to invest in it directly, but don’t kid yourself that you have the inside knowledge on where this company is headed, what it’s doing or how society will react to those moves. If you take on a single company, just make sure it’s a tiny part of your net worth and comfort yourself that whether it goes well or poorly, it won’t impact your overall financial plans, and you already probably own it in your index fund anyway!
What providers should you research in New Zealand?
New Zealand has a small range of low-fee ETF and Index Fund providers who will give you access to the type of funds that JL Collins recommends. He talks about VTSAX, which is Vanguard's Total Stock Market Index Fund. VTI is the ETF version of this index fund. VOO (Vanguard S&P 500 ETF) is another name you will hear. When I first read his book, I thought, “Great, but I bet it doesn’t exist in New Zealand”! But a variant of it did, Smartshares US 500 ETF, and since I first began to invest, more options have sprung up.
Remember how I said that the investment industry is massive? When you are looking specifically for an ETF, you have just narrowed down your search. When I first began investing this way, there were just two low-fee options in the market: Smartshares and Investnow. A few years ago, along came another provider, Kernel. There are others, but start your research with this group.
They each offer a slightly different take on the same thing, and I’m being typically VAGUE here because I want you to read The Simple Path to Wealth and really learn for yourself what you need to look for.
There are other options still, but due to their high fees (Sharesies) and complexity with foreign tax obligations (Hatch), I’d be more cautious if you are intent on growing your wealth to hundreds of thousands, if not millions. Fees matter, and the more money your provider takes, the less you have left over. Also, since I have become an ETF investor, there have been many smaller companies coming and going, so if you see a new company enter the market, just be wary. They often have large marketing budgets but don’t last the distance.
Let’s not forget the more traditional investment companies, of which there are many, such as ASB Securities, Jarden Direct, etc. They will also give you access to the same ETFs; just keep an eye out for additional fees being added to the transaction!
Which provider is best?
I’ve no idea. I believe it comes down to researching your options, all of which are low fees, finding a platform that you consider easy to use, and making a start. If you pick a social media platform of your choice, you will find a comment section full of vehement ideas about what fund, platform, etc., is better. And that puts a lot of pressure on people to make ‘the right choice’.
However, because almost no one ever back costs the decision they made (yet they are very vocal in the comments section of the internet), how do they ever really know if paying a .01% fee, either higher or lower, really moved the needle on their wealth? Getting the basics right is far more important: Pick a low-fee, passive, large ETF such as VTSAX/VTI/US 500 or the Total World Fund, set up an automatic investment and then monitor it over time. When I first began, I set a goal to invest $1,000 BEFORE I made any changes or tweaks. When I reached that number, I reassessed and then set a new goal of $5,000, at which point I would reassess. It starts small and builds. I still set these goals. You are investing for the long term, which is 10+ years. Let it ride, and don’t overthink your decision-making. But when you reach your review period, change and adjust your strategy (or provider) if you feel it's appropriate.
Why America? What about the rest of the world?
Jonny and I invest in a US 500 fund plus an NZ 50 fund, which gives us exposure to America and Aotearoa. We have capped our New Zealand investment at $100,000 and are steadily building up the US fund. We now just add $100 a month to the NZ50 and add $1,000+ each month into the US500. Plus, we have our KiwiSaver investments, which are High-Growth and, therefore, very much also invested in international share markets.
JL Collins explains well in his book why investing in America is ‘enough’, so once again, go and read/watch/listen to it. The United States of America is where it's at if you want to become a massive global company. And yes, without a doubt, there are other countries worldwide with huge global companies, but America does seem to have the highest concentration. Therefore, by investing in a fund tracking these companies' progress, I’m buying a tiny slice of all of them. Will they always be the biggest and the best? Maybe, maybe not. But for now, they are. JL Collins has said that if you can’t buy VTSAX, a US 500 fund will suffice, and that is what I’ve done. But he says purchasing a Total World Fund is not a bad option either. It still contains all those top American companies, and it includes top companies from other countries. So, it’s a valid option and one that I have considered.
But this is where I will double down on my view that there is no perfect way to invest; what you choose now is good enough for now. I am OK with sticking with my Smartshares US 500 (USF) ETF, which has had historic five-year returns of 15% (after taxes of 28% and their .34% fund charge) because the Total World ETF (TWF) has only returned 11% (after taxes of 28% and their .40% fund charge).
Despite their politics, I can’t see America falling on such hard times as an entire economy that all their massive companies crumble and fail.
I’m also happy to stay invested in my NZ 50 fund in a minor way because, again, despite politicians doing what they do, I still think I belong to an incredible country trying to do its best. If I lived in Australia, I’d probably want to invest in their AUS 200 fund. It’s OK to have some home-country bias and own a small slice of every company here, too.
This blog post is too long!
I’m sorry for the length of this post, but ‘investing’ is a massive topic. I’ve tried to weave in answers to all the questions I am often asked - and I get asked many questions. In conclusion, I would say to you that there is no perfect investment strategy. But there are perfectly good enough strategies for you and your money.
Investing is the last post in this series of six because, apart from investing in KiwiSaver early in your journey, investing in the share market needs to come at the right time in your financial life. And that time is when you have all your other ducks in a row. For those who have FOMO and are desperate to start investing, just remember that you ARE already investing with your KiwiSaver. And with every $1 you pay off your debt, you have just increased your net worth by $1.
Keep up to date with your financial housekeeping, and make sure you know your net worth month by month and that you are budgeting and managing your money well. You have an emergency fund for when life kicks you in the butt, you pay into your retirement fund, and most importantly, in my view, you get the heck out of debt. Once you have cleared debt, you will finally have money to invest.
For those itching to start, having a broad-based, low-fee ETF on the go, even if they invest only $10 a week into it, is not the worst idea. Why? You can run it alongside your other investments (such as a rental property) and see, learn, and understand, in real-time, with real money, how they are wealth-building machines over time. If your investment strategy changes over time, you will already understand how ETF investing works and could be an alternative option for you.
ETF investing is, without a doubt proving to be one of the best decisions we have made. Over the years, friends I have spoken to about ETFs scoff and disagree and go about their forms of investing. That’s fine, each to their own. But given we are friends, I stay in touch and observe the lack of financial progress they each tend to make over time. ETF investing is slow, boring and undramatic. It’s a slow burn. But as I have observed in my net worth, our steady drip-fed and occasional bulk purchase-fed investing seems to gather more momentum.
Reaching our first $100,000 was painfully slow, and the second was not much faster. However, the momentum is growing steadily due to the capital gains, the compounding returns of dividends that are reinvested, and the money we continue to add. We don’t earn high incomes, yet I’ve found a way to grow our wealth through an investment that we can use to improve our lives. There is no leverage, third parties, upkeep, or hassle. Growing an ETF investment takes a thousand tiny actions, such as making a monthly investment over decades. Now that we are almost a decade in, with many hundreds of thousands of dollars invested, I’m starting to see the power of compounding returns, and that just gives me a huge sense of peace about our financial future. I will continue to blog about the performance of our investments so you can follow along.
What do I want you to do now?
The key to our future success was that I became interested in learning how to grow our money. It took me a while, but I began to realise that we could use the income from our day jobs to invest in a way that would provide us with (passive) income in the future.
Don’t just take my word for it; spend a week doing your homework and do a fast and furious deep dive into index funds and ETF investing. Follow up on those links I have included here, and from there, google the keywords and people you hear mentioned repeatedly. Do your research and then commit to making a start. Then, observe the process, get comfortable with it, and settle in for a long and steady investment journey.
That’s the end of my six-part series 😊. The primary reason I write a blog is to help you out. I sincerely hope I have.
