There is a common thread in most financial planning advice and it goes like this:
Work hard, save 10%, invest in mutual funds (or if you are smart, low cost ETFs) and over time everything will work out (or something like this.....)
In principle, working hard is a good thing. Laziness should never be rewarded. And working hard is a great human trait. We get more out of life if we commit ourselves to something.
Saving 10% is where I start to question the advice. In todays environment I don't believe that 10% is enough. We are living in a low return world and compounding a low % year on year until retirement might not get us to where we need to be financially.
Depending where you live you may be experiencing hidden inflation. This is when you know from your own receipts of expenses that things are just more expensive however the media keeps telling you that its not. Deflation stories are just as popular as inflation stories and it all leads to a narrative that the powers that be want us to believe in. One way (albeit slightly complex) is to look at how much money is actually being printed by the Central Banks as inflation is a monetary phenomenon (something that requires a lot more detail...probably for another post). Anyway, the point is we are living in a high inflation / cost of living world together with low investment returns. So in my humble opinion, 10% of your earnings may not be sufficient (unless you are 12....).
Mutual Funds as a vehicle for long term investment? This is where I start to have major concerns. Mutual funds are often sold as a "simple way to gain exposure to the market without having to be an investment expert". I am not convinced these are the right tools for the following reasons:
-High costs - you pay on the way in, you pay on the way out and you pay regardless of your return. In some cases you may be giving away up to 40% of your annual return for someone to give you a return no better than the market. In 1940 Fred Schwed wrote a book called "Where are the customers yachts?". Next time you want to use a financial adviser, read this first.
-Its hard to pick a good one - Managers have track records but none of them can see the future (they are only human!) so past performance does not mean a thing really.
-They are inflexible - as they can be quite large they cannot move in and out of the market at will
You have no control on what they buy - this is my major issue. I don't believe that a fund manager knows any better than you. -For an interesting article on the topic of mutual fund manager competence see
http://www.forbes.com/sites/rickferri/2012/12/20/any-monkey-can-beat-the-market/#71fb7bfe6e8b
Low cost ETFs are a better option however you won't get a return better than the market. Most advisors who advocate the use of an asset allocation model with ETFs were shocked when 2008 happened as the theory of correlation started to unwind. Financial houses are now coming out with catchy titles like "Smart Beta" ETF which will, in my opinion, underperform the market because of the embedded costs associated with these products.
Compounding is most definitely your friend and the earlier you start a financial plan or strategy the better you will be on condition you don't have any huge negative drawdowns over your life.
So whats the point?
I believe that control of the return outcome is more important than any of these points. There are only a few products and strategies in the financial markets that give you, the investor, absolute certainty of the return you will generate.
My strategy and my coaching is based on the following principles (more on each of these in future posts):
1.Control as much as you can - profit %, cost of transaction and duration of risk
2.Compound as frequently as possible - weekly compounding is better than annual compounding
3.Reinvest profits in secure dividend stocks
4.Focus more on cash flow than asset value
5.Avoid any product thats says "savings" or "investment" or structured products - its usually a fee monster and performance handicapped
6.Understand the value of life insurance and how it can be used to build a secure base for financial security
By keeping this in mind you will be able to gain a greater degree of certainty on your financial strategy and your outcome.
Happy investing!