If I could tell a loved-one just five things about finance and investing, here are some of the things I’d say…
1. The 80/20 Rule Applies.
The 80/20 rule applies to many things in life, one of those things is investing. The rule says that we can do 20% of the work and get 80% of the results.
I believe this rule can work for most people who are investing in the sharemarket, whether they are buying shares or ETFs directly through a brokerage account or via their Super.
What I mean is, many investors in low-cost and/or diversified index fund ETFs might do as well as — or better than — 80% of active fund managers by doing just 20% of the work they do — but probably a lot less!
What type of ‘work’ am I talking about? It could be as simple as clicking your mouse a few times and investing in ‘the entire share market’ via low-cost diversified ETFs.
How do I know this?
Various studies, such as S&P’s SPIVA research for June 2019, show that over five years around 80% of active fund managers performed worse than the ASX 200 sharemarket index.
As most people know, Aussies can invest their money to track the return of the ASX 200 for less than 0.1% per year in yearly management fees. That’s like… $2 for every $2,000 invested!
Please note: I’m not flying the flag for passive fund managers versus active fund managers. Far too many Aussies have been confused by the ‘false choice’ presented to them by financial advisors and institutions. Investors do not need to ‘pick a side’.
I’ll happily drink Coke and Pepsi. Just Pepsi. Or Coke.
Likewise, I’ll happily invest in ETFs or individual shares or property or all of the above.
2. Compounding.
I wish I truly understood the effects of compounding sooner than I did. To be sure, I’ve always known the math. Heck, I’ve even lectured and educated really intelligent people on compounding.
Nevertheless, it took me far too long to appreciate the true power of compounding. And here’s the thing: it doesn’t take that long to feel its effects on your wealth — and you don’t need a lot of money to make it work.
In fact, it takes just over 7 years for your money to double if you achieve a 10% return. I dare say that’s a return many sharemarket investors would have achieved over the past seven years.
With a 5% return, it’ll take just 15 years to double your investment.
Try it out for yourself using our free calculator.
3. Tax matters.
It doesn’t take a rocket scientist to understand the most important tax rules. The 80/20 rule applies here too.
It wasn’t until I realised that most Aussies sit inside the 37% tax bracket that it dawned on me we’re working more than one-third of our lives (think of it as January, February and March, each year) just for the tax man!
Tax bills could be the single greatest expense most of us pay in our lifetime, so we should make a note every time we pay for it.
As I said, the most important concepts and rules are straightforward:
- The more we make (less deductions), the more tax we pay.
- The more often we buy and sell an investment, the more capital gains tax we could be forced to pay (typically speaking). That means, the ‘trader’ or ‘flipping’ mentality can put property investors and day traders well behind the eight ball when tax time rolls around.
Many smart people make lucrative salaries from advising on tax, so I can’t explain everything here.
Fortunately, as with most things, if you can make an effort to know the basics of individual income tax, deduction rules, capital gains tax, and the impact they have on your investments, it is time very well spent.
As they say, a dollar saved is worth more than a dollar earned. Why? You don’t pay tax when you save money.
Finally, to paraphrase a former business tycoon: “if anybody in this country doesn’t minimise their tax they want their head read.”
4. Good Habits Crush Good Budgets.
Goals and budgets might work for some but the most successful people I know have good habits — not budgets. Sure, they might have started with a budget, or a plan, but it’s not the secret to their success.
People who form good habits are more content, self-assured, confident, open-minded and motivated. They’re brilliant savers. They’re better investors.
Good habits, or systems, take time to instil. They take training. They’re something you work on each day until you’re 30, 90 or 365 days in and you’re doing it without noticing.
One of my favourite quotes of all time is, “The chains of habit are too light to be felt until they are too heavy to be broken.”
Understand your lifestyle habits to truly appreciate why you’re making poor choices with money. Then set extremely short-term targets (e.g. 24 hours) to ensure your feedback loop brings positive information back to your brain as soon as possible — providing the motivation you need to keep moving forward.
5. EQ Trumps IQ in Investing.
I’ve met some pretty smart people in the past 24 months. Bloody smart. So smart it makes my brain blush.
But you no wot, m8?
The overwhelming majority of wealthy people I know couldn’t tell you what the weighted average cost of capital is — let alone how to calculate it.
They don’t know how to do a Monte Carlo simulation in an Excel spreadsheet.
And they definitely don’t use six computer screens to ‘trade’ stocks.
The best investors I know and have met — some of whom might consider themselves amongst Australia’s wealthiest — aren’t geniuses either. They do basic math, market themselves really well and take back-of-the-envelope calculated risks.
What these people do have in common is extremely high levels of emotional intelligence or EQ.
Google defines ‘EQ’ as: “the capacity to be aware of, control, and express one’s emotions, and to handle interpersonal relationships judiciously and empathetically.”
In finance and investing, a high level of EQ lowers your ego, boosts your humility, juices your curiosity and eagerness to understand the world, enables you to live and manage money without envy, and to avoid harmful biases.
Basically, if you want to make better investment decisions, drawing on your level two thinking, you should start focusing on your EQ.