Your Money Should Work for You

We want to put our money to good use by investing it.

Generally, we want to invest in assets that are productive and valuable to society. E.g., good companies, real estate, etc.

Productive vs non-productive assets

Productive assets generate a return - they produce something. A company sells a product. A rental house provides shelter and collects rent. When you hold a productive asset you’ll generate returns on your money even if you never sell the asset again. You can buy a rental house and collect rent forever. Or a stock which will return dividends.

Non-productive assets don’t return anything. Instead, the investment thesis for non-productive assets is that someone else will buy it from you sometime in the future for a higher price. The classic example is gold - and the more modern version is bitcoin.

Non-productive asset are, by their nature, more speculative. You are betting on finding a buyer at a higher price later. Productive assets are still subject to speculation (see the stock market volatility) but you don’t need to sell to generate returns.

Indexing

Investing is hard. Knowing what to invest in incredibly difficult - and you are competing with a horde of professionals.

You could let the professionals do the investing for you. But time and time again the data shows that even the professionals are having a hard time picking the winners.

One example:

According to the widely followed S&P Indices Versus Active (SPIVA) scorecards, about 9 out of 10 actively managed funds didn’t match the returns of the S&P 500 benchmark in the past 15 years.

The S&P 500 is an index tracking the 500 largest public companies in the US.

… and 9 out of 10 actively managed funds did worse than this index over the last 15 years!

Luckily for you and I, we have the option of simply investing in these broad indexes. You can invest in an S&P 500 index which will automatically track the top 500 companies in the US. And even better news: passive index funds have very low fees - so you’ll get to keep more of your money than if you hired someone to do the investing for you (or invested in a actively managed fund).

Instead of picking individual companies - hoping they do well - we simply invest in all of them.

You can also invest in real estate indexes if you really don’t like investing in companies. Look into REITs if this is for you (but be aware that stocks have generally outperformed real estate).

Risk

Investing naturally carries a risk. But so does doing nothing.

We have just had a period of high inflation:

Which meant your money rapidly decreased in value. So keeping your net worth in dollars (or any other fiat money) is not without risk. And even investing in something low-risk for a few percentage points may not be enough if we experience high inflation again.

If you do nothing an keep your money in your bank account, inflation will eat it up. At just 2% inflation the value of your bank account will be cut in half (!!) in 36 years (using the rule of 72 (72 / 2 = 36) - we’ll learn more about this in just a moment).

This is just to say that risk is something we have to live with. Whether we like it or not. The best you can do is understand your risks and act based on this.

The stock market is often misunderstood in this regard. If you are looking to make quick money by actively trading then sure, the stock market is risky and more akin to gambling. But if you are investing in good companies and ignore daily volatility, the gambling aspect quickly fades.

The stock market is about investing in companies. You buy a share of a company and own it. Isn’t that amazing? That you can simply go online and buy a share of some of the best companies in the world?

Compounding and the rule of 72

Initially, a few percentage points may not look like much. Sure it would be nice to increase my net worth by 5%. But if my net worth isn’t that large to begin with, what is 5% really?

At first it may not be much. But 5% year after year starts to add up. And with compounding it can soon add up to a lot.

Compounding is an interesting force. It seems like humans have a hard time really grasping the power of exponential growth. Here is what it looks like: (source)

Another way to try to grasp compounding is with the Rule of 72. The rule (really just a simplified formula) can be used to calculate how long it takes for an investment to double in value:

Years to double: 72 / expected rate of return

So if our expected rate of return is 6% it takes 72 / 6 = 12 years for our initial investment to double.

The S&P 500 “has returned a historic annualized average return of around 10.26% since its 1957 inception through the end of 2023.”. Which means the S&P 500 has doubled roughly every 72 / 10 = 7.2 years.

If you now start to consider an investment horizon of 30 years or so, that is a lot of double ups!

How much your investment will compound depends on three factors:

1. How often does your investment compound (compounding frequency)
2. What is the rate of return
3. Time

Items 1 and 2 hard to change and somewhat out of your hands. Sure, you can (and should) do what you can to get a good rate of return. But a higher rate of return often means more risk. And with a large portion of your net worth, you don’t want too much risk.

Item 3 is in your control. The earlier you start investing (and the more you put in), the more time you have for your money to compound. So the best thing you can do is start right now.

Fun?

One of the aspects of investing that is rarely mention is fun. I my experience, investing is interesting, engaging, and I’d even go as far as to call it fun! (most of the time).

When you have a stake in something, it becomes more interesting. I enjoy reading and learning about the stock market as I take part in the upside (as well as the downside). I find it much easier to care about the economy now that it directly impacts my net worth.

I generally think all of this is a good thing. I want society to prosper. I want that anyway but now I also have a direct, selfish reason. And that just makes me care more.

I also enjoy playing around with a small portion of my portfolio. There are so many interesting investment opportunities and I love to learn about them. I know most of these bets won’t pay off (which is why I only do it with a small part of my net worth!) - but I enjoy thinking they may.

This is also a recommendation I’ve seen multiple times: if you find yourself wanting to invest in more risky things, feel free to do that. But make sure you allocate just a small part of your portfolio for this. That way you get to satisfy your urge for gambling with money you don’t need. It’s a better approach than trying to repress your urge and then suddenly FOMO-ing into something with too much money when you can no longer control your emotions. And again, it’s fun!

Getting started

If you have never invested money before it may feel quite risky and uncomfortable at first. Take your time getting used to the ups and downs with a small amount of money. Learn what happens when the stock price drops. Discover how you react to volatility.

When you start investing you will likely see som red numbers (meaning you have lost money). This can take some getting used to. But over time two things happen:

A) You will be in the green overall, even when the market is a bit down.

This makes it easier to take the negative periods as you know you are still up overall. E.g., you may lose money for a few months but in the big picture it won’t look as bad if you have had lots of good months previously.

B) Once you experience big red numbers and realize nothing bad really happens you will soon become numb to the experience.

It just isn’t that exciting after some time. If you do this right you will only look at your portfolio every once in a while and the rest of the time you’ll just enjoy living your life doing better things than staring at a number on a screen.

If you build up your investment portfolio over time, your capacity to tolerate volatility should grow along with it. I.e., losing $100 in a day may seem like much at first. But you’ll soon get used to losing $1000.

Okay, but what should I actually invest in?

The Vanguard Total Stock Market Index Exchange Traded Fund (VTI) tracks the entire US stock market. It’s a big, broad index with low fees.

Generally, Vanguard has low fees and good broad indexes - they also have something for the S&P 500, international stocks, bonds, real estate, and much more.

If you can, it’s a good place to start. But there are some things you may want to consider:

1. Tax - how does your country tax investments?

This in itself can be a quite complicated topic. What to do may depend on how much you invest, how much you make, what the tax is on different investment categories, etc. Over time you may want to optimize this but don’t worry too much about it at first - the important part is that you get started. Then you can start optimizing later.

2. Availability

Maybe you have some funds in a pension account with limited options. If so you can hopefully find some sort of index provider. Vanguard is just one of many. But remember to pay attention to their fees.

Really, that’s it?

So I just put my money in VTI? Really?

Yes. The most important things is that you get started. Your success mostly depends on:

1. Investing early
2. Saving a lot
3. Not risking ruin

VTI fits that profile well. If the overall US stock market goes to zero we have bigger problems than losing our portfolio.

I do recommend you continue learning though. You can start with VTI or an S&P 500 index. But as you learn you may want to change your strategy a bit. That’s up to you. Get started now and continue your journey with more learning and experiences.