In her last article Mrs Money Hacker discussed how to fine tune your spending and build up your savings from her experiences. Below she discusses her tips on how to invest this new found bounty.
1. Figure out your high level plan
Ask yourself, where do you want to be in 5-10-15 years? The answer to these questions will help determine what best to invest in. For example:
If you aim to be financially free (where your investments give off enough passive income to cover your expenses) in 15 years and then want to travel the world, then maybe investing in property and being a landlord might not fit well with this goal.
If you aim to be financially free in 10 years and you cannot access a pension for another 10 years, then maybe a pension should not make up a large part of your portfolio.
Knowing your high level plan will help you decide on which investment products best suit your future goals.
2. Figure out your risk tolerance
When trying to decide what to invest in, you’ll need to choose products and allocations, which align with your risk tolerance.
There are online quizzes you can take to help figure this out as well as general rules of thumb based on your age, though you may not actually know your risk tolerance until you experience your first crash or major loss.
Try to think about how you’d feel if you had money invested and experienced a 30-40% loss like many did earlier this year as a good gauge to your tolerance. Would you have the stomach to leave it invested and trust that with time you would be more likely to recover your losses than if you cashed out?
3. Tips on how to stomach market crashes
A good way to stomach big hits to your portfolio is to only invest money that you do not need.
Look at any money invested, the same way you would look at maxing out your pension, that money is locked away for many years and you have time to recover if you do not touch it.
Trust in the stats, that there have been 12 bear markets (where the market experiences prolonged price declines -typically where asset prices fall 20% or more from recent highs) since World War II with an average decline of 32.5% as measured on a close-to-close basis.
The last crash took 4 years to recover but on average bear markets have lasted 14.5 months and have taken two years to recover on average.
If you sell when the market tanks you definitely make a loss, if you hold on for long enough, you will more than likely recover.
Even better, if you keep investing and euro cost average your investments, you will stand to make even bigger gains if and when the market does recover.
4. Understand the pros and cons of each investment vehicle before you invest including average real rates of return after fees, taxes and inflation
To do a true comparison of an investment vehicle you must weigh up the pros and cons of each as well as looking at the realistic gains after taxes and fees are taken out.
I have a decent article on the main investment vehicles in Ireland, which does just this here.
If you still aren’t convinced on which investment vehicle is right for you I also provide consultations to analyse and compare 20-30 year plans of 3-4 scenarios with multiple investment vehicles to demonstrate the impact of each and help you decide on a plan.
You can read more about these services on the blog here.
5. Don’t assume that the “experts” managing your pension or other investments have your best interests at heart
I took for granted that people twice my age and in financial occupations would surely be in a better position to handle my money than me.
In most cases, they aren’t and actually understand very little about the underlying products they are selling.
Worse still, they continue to get a percentage of your total investments every year regardless of whether they make or lose you money.
In many banks, they will try to sell you the product, which gives them the highest commission, or interest rate, not the product that is best suited to you.
6. Question your pension
If you invest in a pension, company scheme or otherwise, ask the questions:
What are the annual management charges?
Are there any other fees?
What is the allocation rate (anything less than 100% is an additional fee). If your allocation rate is 98%, you are essentially paying another 2% on every contribution.
What has been the historical annual performance since inception
Be wary of a recent inception date – funds with long track records offer more history which investors can use to assess overall fund performance.
Another reason for a recent inception date could be a change in fund manager, potentially indicating their lack of experience or tenure with the fund.
Often a change in fund performance can indicate a change in management. Funds with longer histories have longer track records and can thereby provide investors with a more long-standing picture of their performance.
Many new funds have very little history by which an investor can hope to gauge their possible performance in various market climates.
Figure out your real rate of return to better compare investment products.
To find your real rate of return you take:
the average annual performance (I like to use overall performance since inception divided by the number of years since inception)
minus the annual fees
minus any percentage points of allocation rate under 100 (while your allocation rate is not charged annually, this is a rough guide to show you your real rate of return. To figure out your actual projections, a more complicated analysis model would need to be used)
minus the average 30 year historical inflation of 1.9%.
Your average pension performance over 20 years is 9%
Your annual management charge is 1.75%
Your allocation rate is 98%
Your real rate of return after inflation will be: 9– (100-98) – 1.75 – 1.9 = 3.35%
My analysis has shown that your pension needs to be making a real rate of return of 5.95% or more in order to outweigh the performance of a simple post-tax ETF portfolio.
Know the true impact of fees on your pension:
Most financial products I have bought over the years had hidden fees, which I didn’t fully understand the true impact of until recently. A good rule of thumb is that for every 0.25% your portfolio will have 5% less in the long term.
So if a pension is charging 2%, you will have 40% less in your final portfolio than if you could manage to negotiate lower fees. That’s €400,000 less in a portfolio of 1 million!
Most pensions I have seen are in default funds, prone to underperformance and high fees. Which leads to my next tip.
7. Know that you can negotiate your pension fees and allocation rates
No matter if you’re in a company pension or Personal Retirement Savings Account (PRSA), know that your rates can be negotiated.
I have had numerous clients come back to me to say they managed to get a better allocation rate or lower annual management charges simply by asking.
You won’t get it if you don’t ask.
8. Take action and get started if even with one baby step
Try not to overanalyze every investment option and suffer from analysis paralysis (like I did). The best thing you can do, once you have done some basic due diligence is to make a start.
open a savings account for a down payment for that investment property
open a brokerage account and buy 1 stock, ETF or investment trust
setup automatic over-payments of your mortgage by 50€ a month and increase as you can
get in touch with your contact for your workplace pension and ask about the pension they have on offer, the historical performance, fees, allocation rate and access age
Just make 1 baby step and the rest will follow.
Mrs. Money Hacker is a Canadian living in Ireland who struggled to find Irish specific content on investing and working towards financial independence following the popular passive investing approach through exchange-traded funds (ETFs).
Her blog was started to share her research in plain English as well as her journey to financial independence and ultimately help others look at money differently and live a simple, more purposeful life.
Her most popular articles include:
As always the above should not be considered financial advice or recommendations and please do your own independent research and speak to an independent financial advisor before making any investments.