This is the third part in my Minimalist Guide to Money and Investing. Here is Part I and Part II. You can also read about my Minimalist Meditations on Wealth and Money. It takes me a long time to write these posts, if you find them helpful, let me know in the comments below or on Twitter or Facebook.
Reminder: I am not a financial adviser. What I talk about below may not be best for you or your situation, please seek professional advice or do your own research before you put real money on the line. Short of writing an entire book,I can only give you the basics and tell you what I’ve done and what has worked for me.
4—Investing and Income
So you’ve paid off your expensive debt, and have a small nest egg saved for emergencies, what do you do next?
You put your money to work. Think of each dollar or pound as a little worker bee—you can let it stay in the bank and do nothing, or you can send it off to go recruiting for more dollars.
The best thing about making your money work for you, is that you don’t have to do it yourself. The more you make your money work, the more passive income you have, which means the more time and freedom you have for important things.
The aim is to achieve financial independence—this means earning enough money passively to cover your essential living expenses. Once you do that, you no longer have to work if you don’t want to. What your income has bought you is the freedom to choose. You can simply retire, or do whatever you want (painter? teacher? glassblower?). You can choose to work freelance, or part time, or even volunteer to do it for free because you no longer need the money.
When it comes to investing, the two most important things to know are:
- how to compare yields across different types of investments
- how to calculate risk and reward
It is quite difficult to get precise figures, because you can’t always have perfect information and you can’t predict the future, but you can make very educated guesses which will inform you on which investments to choose.
Yield means how much money you can get back for the amount of money you put in. If you can work out the yield for any investment, firstly you can see if it’s above inflation (which is 2-5% in most countries) so that you know that you would be at least making the amount of value your money is losing just sitting in the bank (I highly recommend reading up about how inflation works against you and your savings) and secondly you can compare it to other types of investments to see if it’s worth the risk…
Risk is the chance that you will lose or make money. Risk and reward tend to be inverse, in other words, if something is easy and safe to do, you’ll get a small (but safe) amount of return, but if something is riskier or requires more research and knowledge, you’ll be rewarded with higher returns if it turns out that you were correct.
A few important points:
- Investing is not gambling—even though risk is involved, if you choose your investments wisely, the risks should still be very low. The riskiest investments you should be willing to consider are ones that you can either make nothing or at most only lose a small part of your capital. You should not consider investments that are not backed up by anything of value, or where you can lose everything—that is gambling.
- Diversifying—having many different types of investments is how you can balance risk and reward. The bulk of your investments should be safe, even if they give low returns, with a few medium and higher risk investments in the mix to add to the returns. How you balance the ratio of low/medium/high risks depends on your own risk appetite, how much money you have, what your financial goals are, and how close you are to retirement age (when you can no longer work even if you wanted to).
- Getting yields of 5-10% is very respectable. A lot of people might think that getting £10 for every £100 invested is a very small amount (“But it’ll take 10 years to make back my money!”) but the point of investing isn’t to make back all of your money as soon as possible, that’s what owning a business is for (breaking even on what you’ve spent and then making a profit for all the time and effort you are putting into it). Investing for a passive income, on the other hand, is about getting the money that would have otherwise earned nothing as savings working for you. £10 might not seem a lot, but if you invested £10,000 with a 10% return per year, you would be earning £1,000 basically for free without doing any work.
- Compounding is the 8th wonder of the world. Furthermore, if you reinvest what you earn, you can earn interest on your interest and it wouldn’t take you 10 years to get your money back. In the example above, you may earn £1,000 in the first year, but if you add it to your initial investment of £10,000, making £11,000, 10% of that is £1,100, and if you add that on you’ll have £12,100 invested which will yield £1,210 etc. So you’ll be making money on your money that made money. Compounding is such a powerful force that if you achieve 10% returns per year, it would only take you 7 years to double your initial investment (£10,000 becomes £20,000).
So you can see that the more and the earlier you can invest, the more quickly you’ll achieve financial independence. The step after that is financial freedom—when you earn enough to cover both your essential and non-essential (i.e. ‘luxury’) living costs.
One of the easiest and safest ways to start to put your money in a low risk, low cost fund, such as an Exchange Traded Fund which now, thanks to the internet, you can find an abundance of low-cost platforms for online (Google ‘ETF’ to find out more about what they are). You can start with just a few dollars and earn anything form 3-5% return on your money. Considering inflation is about 2-3%, you’ll not only be preserving the value of your savings, which would otherwise be worth less and less over time, but you’ll also earn a tidy amount of profit on top.
There are hundreds of different ways to invest your money, and I won’t be able to go over all of them, but I can tell you what I do. Through all of my research, I have found that for me and my situation, property is the best investment for several reasons:
- Location—I live in an area where rental demand is high, but supply of housing is relatively low (this means with the rental income I can achieve yields of of 7-10%).
- Economics—there is a very healthy employment level and growth prospects for this area, and the other areas that I am investing in.
- Leverage—I can leverage my investment by applying for a mortgage (ie. instead of having to save up £100,000 which would take a long time, I only have to save £25,000 which is much less, and borrow the rest, yet still receive 100% of the rental income). Property is one of the only investments that banks will lend you money for.
To give you a concrete example and show you it can really be done, I own a two bedroom apartment that costed £125,000. I supplied the 25% deposit of £31,250, and got a mortgage for the other 75% of the value at £93,750. The market rent is £850 per month/£10,200 per year (£10,200/£125,000 = an 8% yield). Maintenance and other expenses amount to about £120 per month, and the mortgage costs £310 per month. This leaves a profit of £420 per month, which is £5,040 per year—a 16% return on investment of £31,250. Best of all, after doing the initial paperwork, it’s all passive income.
On top of that, at the time of writing, the value of the property has gone up to about £160,000 so I have also gained £35,000 in value in just two years, and in the future I can refinance it to get these funds out to reinvest. And this is only one of the properties in my portfolio. At the moment, I have achieve financial independence, which is why I was able to quit my job, but I intend to reinvest 80%+ of all my passive income over the next 5-10 years to increase my passive income until I’m able to achieve financial freedom.
I’m not telling you all this to show off, and I’m not necessarily advocating property as an investment for everyone. It’s just an example to show that with a minimalist lifestyle and a bit of hustle, I was able to go from nothing to something like this. If you set yourself an income goal that depends on how much you can live on a year, even if you were to have more than a few luxuries, say £30,000 per year, you can see how just by owning a couple of investments like the one earning £5,000 per year can realistically get you there.
Don’t wait to win the lottery. There are opportunities to make passive income everywhere. You’ll never be free if you slave away at a job you hate, trading hours of your life for cash, and you’ll never make it just by wishing for good luck. You have to take control of your finances, because it’s not about the money, it’s about freedom.
The magic formula for success is: Education + Action. This post only briefly covers things that took me months to learn, and then more months to implement. If there’s anything you didn’t know about or didn’t understand—feel free to ask me in the comments, but most importantly, do your own research. Here are some resources that I’ve found extremely helpful:
This book was life-changing for me when I discovered it when I was twenty years old. It introduced to me to the art of setting up a passive income business so that I wouldn’t have to work for money. Not only is it possible to earn money while you sleep, but it is perfectly achievable if you want to and believe you can do it. It also introduced to me the concept of taking retirement breaks now (doing things like travelling, volunteering, spending time with family etc.) without having to wait until I’m 65. I also reread this book every year to remind me not to let my business become another job.
A lot of investing books contain too much jargon and formulae that I don’t want to get into as someone who doesn’t want to be investing full time. This book is the most approachable one I’ve found for beginners, and I recommend it to people who are getting started. It explains in more detail the things I’ve mentioned in these posts about the basics of investing—why you should do it and how best to choose your investments wisely. It teaches you how you can compare different types of investment and how you can decrease risk by basically buying a bit of everything (i.e. ‘owning the world’).
This book is a great introduction on how to assess businesses to see if they’re worth investing in. Before this book, I stuck to ETFs because I didn’t think I would be capable of analysing company’s accounts and putting it all into complicated ratios and so on, but after reading this I realised that I can rule out a lot of the work by comparing some fundamentals to narrow down the number of companies I’m looking at. I genuinely believe the advice I got from this book will make me a lot of money in the future.
Blogs: Rockstar Finance links to all blogs worth reading in personal finance. I recommend signing up to their newsletter which I receive and read every day. In fact, if you liked this article, please submit it to share with others!
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