7 minute read

Due to its scope, this article is a work in progress and will require several follow-up posts to clarify many details. Please send feedback to: hyoson.yamanaka[at]gmail.com.

Investing your savings smartly does not have to be complicated and difficult. Often people think it requires a lot of time, knowledge, capital and risk appetite to put your money into assets such as stocks. But these things are not necessarily true. Research has shown repeatedly that simple, low-risk and low-cost strategies can outperform the majority of professional investors over the long term and yield fantastic returns.

This article outlines key principles for successfully building wealth with proven methods that anyone can implement. Whether you are saving up for a big expense in a few years time, starting to think about your retirement portfolio or just looking for ways to utilize your money efficiently: this approach is suitable for any long term oriented investor and can help you participate in the success of the global (or local) economy.

Investment goal and key principles

Our aim is to build wealth with our savings rather than letting money sit in bank accounts accumulating minuscule or even negative interest that gets eaten up by inflation. Further, we want to minimize the complexity and effort required to implement the strategy.

Key principles that we want to follow are:

  1. Know what you can spend. Define a clear investment budget that is in line with your income and expenses. Stick to set limits and saving goals.

  2. Go for low risk and decent returns. Build up a widely diversified portfolio in order to minimize the risk while still reaping the benefits of a growing economy.

  3. Stay (mostly) passive. Automate every possible step of the investment process. In an ideal world we want to just transfer money into our savings plan and not worry about execution of it.

Historical data shows that strategies exist which can accomplish the above goals and principles. This of course does not guarantee success, but it does give confidence in what to expect for the future. Should, however, the landscape change dramatically, a shift in approach might be required, which is why it is good to have some trusted resources to review every once in a while.

Strategy step-by-step

Set the monthly investment amount

First, we need to understand our budget limits and how much money we can afford to invest. What we want is an exact number of how much we can put aside each month and from which we do not deviate if possible. There are plenty of good articles and tools online to help you create a sensible budget for any circumstance (Google: “How to set a budget”). If you are thinking that you cannot save enough, think again. Nowadays investing into certain asset classes such as stocks can be done with as little as 1 EUR at a time. Not that I recommend going with such small amounts, but it shows that investing can really start with any amount of available money.

Choose the investment type

There are plenty of things to invest into these days, from traditional stocks and bonds, to real estate, crypto, NFTs, physical art, trading cards, etc. In financial lingo these options are generally referred to as “asset classes”. Unless you possess expert knowledge in one of the more exotic asset classes it is recommended to stick with the traditional investment area of stocks and bonds. What that means is that we are in essence investing into companies and become partial owners (stocks) or creditors (bonds) that profit from the companies success.

Set up an investment account

If focused on investing into the stock and bond market, you will need an account with a broker. These are institutions that are allowed to trade financial products on behalf of their customers. In the past they charged a pretty penny for their services, but digitalization and competition has lowered the fees across the board and many services are even offered for free today.

The internet offers a lot of guides and comparisons between brokers, but the choices can be overwhelming for beginners. The main thing to look out for is the fee structure. One easy starting place is often ones current bank. Banks typically offer their own broker services or cooperate with an external party. While simple to set up and integrate it usually does not offer the best value.

If a good broker offering is identified it is often valuable to check if referral programs exist. Maybe a friend or colleague is already a user of that service and both of you can get a small monetary benefit in signing on.

Recommendations for German investors: Neobrokers are starting to challenge incumbents with low or zero fees, great user experiences, simple onboarding and modern app interfaces. While not all of their practices are great, they do offer the best value for beginners who want to get started right away. If you are located in Germany and would like to check out a neobroker I recommend either Scalable Capital or Trade Republic. See referral codes below to receive free cash or stocks.

Pick the investments

This is the hard part. Picking the right companies to invest is tricky and a whole industry of advisors and services is making a lot of money by helping people make those choices.

Luckily, there are ready made products that adhere to our defined principles of low risk, steady returns and passive investing. What I am referring to are index funds. These products take money from investors and buy a wide selection of company shares adhering to specific rules set by an index. The S&P500 index for example monitors and combines some of the 500 largest companies listed on stock exchanges in the United States. An fund based on that index would invest all the money gathered from investors into buying shares of the included companies in the ratio that the index calculates. Each fund investor then owns part of that basket of stocks based on their bought fund shares.

Index funds two main advantages that fit perfectly into our strategy:

  1. Cheap diversification. It offers instant access to a wide pool of companies without having to make several transactions and with minimal costs. Buying stocks of 500 companies will come at a significant cost, but buying a share of a fund that is backed by stocks in 500 companies starts as low as 1 EUR.
  2. Low management fees. The structure of an index fund is fairly simple and thus the management fees are the lowest you can get for comparable products. An actively managed fund can easily rack up fees of over 1% per year, while the index funds category typically falls below 0.5%.

Index funds are often mentioned in the same breath as ETFs (Exchange Traded Funds), but the latter does not necessarily limit itself to index funds. These days, indexed ETFs offer the lowest costs and best liquidity (i.e. ease and cost of purchase and sale) which shows in their rampant popularity.

In terms of picking the right funds, no approach is set in stone. An investor should ask themselves what they care about. Do I want maximum diversification? Then it might make sense to invest into an ETF indexed to the MSCI World, which contains over 1,500 of the largest companies from around the world. Maybe I prefer to focus on certain regions. Then indices such as the S&P500 for the USA or the STOXX Europe 600 index for European companies might fit better. There are also indexed ETFs focused on specific sectors (technology, health care, renewable energy) or themes (environmental impact, diversity, corporate governance).

Some questions to ssk yourself: What do I care about? Would I feel better about a more focused investment or a broad approach? Are there certain values I want represented in my portfolio?

Work in progress: Since this choosing the right investments is the key aspect of building a successful portfolio I will write a more extensive article on this subject in the near future.

Set up a savings plan

This is the final step to complete the investment process. A savings plan is the process of putting the defined amount of money into the selected investments on a monthly basis. Ideally this will be automated fully. Most modern brokers offer options to do just this, but it might not be available to you or for the selected investment product.

The ideal flow of the plan:

  1. Beginning/ end of month triggers process.
  2. Automatic money transfer from bank account to broker account.
  3. Broker invests the money into the chosen funds.

Profit

With all the above steps completed, there is nothing more to do than the sit back and let the money flow into the savings plan each month. Remember to think long-term and try to not focus on the up and down movements in the markets. The stock market can have years of under performance, but historically, over a time horizon of 10+ years, a positive return is almost guaranteed. Even if you invested in the S&P500 at the peak of the dot-com bubble you still would have had a 300%+ return by 2022. Better than to worry too much about the returns, put your effort into accomplishing full automation of the process if not done so yet. Alternatively, just focus on your neglected hobbies that you can now pursue in the knowledge that your savings are taken care of.

…

You May Also Enjoy