This blog post is part 1 of a bigger series called “How to Invest”.
What is the goal of this blog series?
Over the last couple of years friends and family repeatedly approached me with the question of how to invest. It usually sounds like this:
- “I inherited 100k from my parents. Do you have any advice on what to do with it?”
- “I’ve been working for 5 years and I saved some money. The stock market has been going up like crazy. Should I invest ..and if so, how does it work?”
- “I saved some money and I think I should do something with this money rather than having it lay around on my bank savings account. There’s practically no interest on the bank and then there’s the risk of inflation. So do you think I should invest this money?”
- “I saved some money and I want to invest. But I also have plans of buying a house or founding a business in 2 years. What should I do?
The goal of this blog series is to answer these questions.
Is Investing Complicated?
Studies show that over a 15 year time frame you can outperform 95% of active money managers with the simplest of all strategies. In the words of John Bogle: “Investing is not nearly as difficult as it looks. Successful investing involves doing a few things right and avoiding serious mistakes.”
So, what are these few things that you have to get right? And which mistakes should you avoid? This is exactly what this blog series is about.
You don’t want to invest?
What if you don’t want to invest? As you certainly know there are risks involved in investing and your portfolio can experience sizeable drawdowns. What if you want to stay in cash?
The tough news is, cash is also an investment, and it even is the worst one. This has even been true if you come from a country with a relatively strong currency, such as the US Dollar or the Swiss Franc. Studies show that due to inflation the real return of cash is -0.8% every year. In fact, since 1913 the dollar lost over 96% of its purchasing power.
This doesn’t mean you should own zero cash. You should probably follow Warren Buffett’s example: “We always keep enough cash around so I feel very comfortable and don’t worry about sleeping at night. But it’s not because I like cash as an investment. Cash is a bad investment over time.”
In contrast to cash, if you do investing the right way, it allows you to grow your money over time thanks to the magic of compound returns. Chances are that you have heard a story of an old lady living a average life, but still leaving a huge fortune after her death? What these stories usually have in common is an early investment in an asset that compounded returns and grew over time.
How much should I invest?
Ok, at this point, hopefully we have established 2 things: Firstly, Investing is supposed to be super easy and secondly, whether you like or not, you have to do it. You are doing it already. Even if 100% of your wealth is on the bank, cash is also an investment, and it is the worst one of all.
Having established these two points, we can move to the first step of the process and the main topic of this blogpost: How much should you invest?
Well, I have no idea. So I asked a friend who does this for a living. Here’s what he told me:
Let’s unpack this. You have to read this pyramid from the bottom up.
Firstly, you probably have cash savings. Unless you are paid in Bitcoin or something like that, you have income and expenses in cash. Whatever is left at the end of the day/week/month is your cash saving. Just like Warren Buffet said in the quote above, you’ll want to have a bit of a cushion here in order to sleep at night.
On the second level are tax-incentivized investments. Chances are that you live in a country that has a tax-incentivized retirement plan (e.g. “401k” in the US or “3-Säulen” in Switzerland). Contributions to this plan are usually tax-deferred and sometimes matched by your employer. Distributions are taxed in the year they are taken. Why do countries offer an incentivized retirement plan? Well, because if they don’t, they might have to take care of you when you’re old – and that sucks.
Finally, we get to the third level and to the question “how much should I invest to compound returns or to buy a house?”. The answer is “Whatever is left from the two levels below”.
Going further up the pyramid, people often use the remaining cash or the proceeds from their investments to build a company and have fun. In this context “fun” also refers to buying a yacht or speculation (i.e. buying individual stocks and cryptocurrencies).
So there you have it. This is how much you should invest. Naturally, the actual number varies from person to person and depends on your individual circumstances. However, I like the framework above, because it provides an overview and sets the priorities. So you probably shouldn’t invest if you’re unable to save money, are in debt, or if you haven’t maxed out your tax-incentivized retirement plan. Additionally, when you think about investing, you might want to consider any plans to buy a house, build a company or have fun.
Favorite sources discovered while researching for this post:
- 7 Easy Ways To Start Investing With Little Money
- Why Investing Is Simple But Not Easy
- Warren Buffett’s Super-Simple Retirement Advice
- How To Invest Money: The Smart Way To Make Your Money Grow
I am no financial advisor and this is not financial advice. So don’t sue me when your portfolio blows up. Do your own due diligence.
Before making any investment decision, you should seek financial, legal, tax and accounting advice, taking into account your individual financial needs and circumstances and carefully considering the risks associated with such investment decisions.