Merry Christmas 2018! Thoughts about Socialising, Conformity and the Recent Market Turmoil

This post will go over some of my thoughts that have been on my mind over the Christmas holiday. In true minimalist style, I have not purchased a Christmas tree nor have I purchased any gifts for anyone, and I will not be attending any Christmas parties. I have caught up with some friends and family over the holiday period but little else. Although it is cliche to say this, Christmas is highly commercialised these days, and personally I don’t celebrate Christmas too heavily, but many other people do, and I think my lack of engagement in Christmas activities puts a distance between me and others.

Ultimately the main issue is that often the cost of human connection and intimacy is conformity, but conformity is often costly.

Socialising and conformity

As I have discussed, an idea that has been on my mind recently is the cost of socialising. Many of us like to think that we are independent, that we do what we want regardless of what others think, but going against the grain and being very different is harder than you may think. It is natural and normal to conform. In fact, I would argue that we are hard-wired to conform. It is something that we evolved to do. There is a famous psychology experiment (the Asch conformity experiments) that shows just how powerful conformity is and how susceptible we all are.

Even though I like to think of myself as independent, I do conform to a degree, and conformity is sometimes important because it allows you to fit in to a certain culture with which others are familiar. Taking the example of Christmas, if you do not give gifts or engage in any Christmas activities, this will clearly put a barrier between you and others.

There have been moments in my life when I have been too independent, too much of a freethinker, and this has isolated me from society, which leads to misanthropic feelings, and this can have very negative mental health outcomes and can lead to depression. It is important to find the right balance between independence and conformity. As a man who enjoys independence and freedom as well as systematically minimising all forms of obligations (debt, social norms, customs, tradition, etc) this has been one of the realisations I have come to this year, that there is some value in conforming, but it needs to be controlled and I need to practice conformity in a way that still allows me to be myself and to be authentic. Most importantly, conformity needs to be practiced from a position of independence and freedom. This reminds me of the concept of exit, voice and loyalty. You can be loyal i.e. you can conform to something or someone’s values, but you need to have the freedom to be able to voice your own views or values, and if your values or views conflict too much with those with whom you are loyal, then you need the ability to exit. This is where having huge passive income and minimal obligations helps. For example, if you have a huge mortgage and three children to support, and you work a job you hate, you are trapped in this job. You are forced to conform or be loyal in this arrangement without the freedom to voice or exit. However, if you suddenly hate your job but you live off passive income, have no debt, no children, no mortgage, and no obligation or commitments, then there is nothing stopping you from voicing your displeasure or exiting entirely.

Although I do believe there is some value in conformity, I should say that everyone is different and that I do believe there are many who value nonconformity. We are typically more comfortable when we are in environments that are familiar, that fit in with our own culture. When someone is noncomformist, e.g. to take an extreme example, if someone comes to work wearing clothes that are inappropriate (e.g. wearing underwear), then this creates discomfort. Something just doesn’t seem right. However, conformity can go too far. Too much conformity creates a fakeness that many find unappealing. Although familiarity can put people at ease and build human connection, you can go too far to the point where you are fake and this also creates unease. There is value therefore in conforming in moderation but it is also important to have the courage to be yourself, to reveal your true thoughts, and to be authentic. Usually the ability to be your true self and to be authentic comes when you are financially secure and when you have few obligations.

I should also add that conformity is not just about whether you give gifts or wear certain clothes to work. Most of us conform but aren’t really aware that we conform simply because we feel that what we do is what we are supposed to do. For example, most people drive cars, get married and have children without even thinking about it because this is seen as normal. If you’re a cycling, if you’re single, and if you’re childfree, this is seen as unusual, but I think society nowadays tolerates individual freedom, so even if you are a single childfree cyclist, you will be considered different but you will not necessarily be socially ostricised. In my opinion, it is very important to be aware of how much culture affects you because when individuals conform to most cultures, they usually impose upon themselves large obligations. Among most cultures there is an expectation that a person’s youth is a period of freedom. However, the expectation is that once someone has enjoyed his or her youthful freedom, they need to become adults, they need to accept adult responsibilities, and they need to “settle down.” I argue that you don’t need to ever settle down, that you don’t need to accept large obligations. You can be free forever.

The recent market turmoil

I will change topics now and talk about the markets. The markets have done very poorly over the last few months. In my opinion, we have gone through an eight-year-old bull market without a major correction, which is the longest in history, so we are due for a crash soon. This recent turmoil in stocks may be the start of the next financial crisis but there are many credible institutions (e.g. JP Morgan) predicting the next financial crisis will occur in 2020.

Donald Trump’s policies do not help, especially the tariffs between the US and China. Importers will need to pay the tariff and pass it on to customers, which creates inflation as the cost of living rises. Furthermore, corporate tax cuts and higher government spending increases money supply in the economy. All these factors increase inflation, which necessitates the central bank increasing interest rates. Higher interest rates means corporate profits fall as companies need to pay higher interest to service their debt. Furthermore, tariffs don’t just mean importing products into America become more expensive. Once tariffs are applied to Chinese goods coming into America, the Chinese will apply retailiatory tariffs, which block American exports going to China, which in turn hurt sales. Because Chinese companies cannot export to the US as much, this impacts on Australia as we export a significant amount of raw material to Chinese companies who then transform these raw materials into consumer goods to be exported to the US. History has shown that protectionism benefits no one. Both parties lose out.

In my opinion, throughout a market collapse it is important to stick with your investment plan rather than sell in a panic. In an earlier post I spoke about “age in bonds” or owning your age in government bonds e.g. if you are 30, own 30% bonds. This rule is a guide and can be modified to fit your risk appetite e.g. if you can tolerate more risk then consider putting 50% of your age in bonds (e.g. if you are 30, you own 15% bonds).

The problem most people have is they cannot predict their risk appetite. When markets are going up, they think they can tolerate high levels of risk, but once markets actually collapse and they are confronted with large and sudden declines in wealth, they realise that they cannot stomach volatility, and they panic sell and crystallise their losses. Therefore, in my opinion, if the recent bull market has lulled you into complacency and now you are feeling nervous, it is a good idea to reflect on what your true risk appetite is, and in the future you can buy more (or less) defensive safe-haven assets (such as bonds, gold or cash) in order to align the asset allocation in your investment portfolio to your actual risk appetite. Over time, as you live through more market crashes, you start to get a feel for what your actual risk appetite is. It is not something that is easy to predict. It is something you need to adjust as you experience it in real life. One of the biggest mistakes in financial planning is when the financial planner hands you a form and you fill how much risk you are willing to take. In my opinion, no one really knows how much volatility they are able to withstand until they actually expereince it in person. Until someone feels $100k of their wealth being wiped out in one day can they truly appreciate how much volatility they can stomach.

It is also important to keep in mind why you are investing. For me, investing in stocks is mostly about generating dividends, passive income, and thereby providing freedom. Therefore capital gains do not matter much because my intention is to hold these stocks or ETFs forever. The recent market correction therefore can be seen as an opportunity to load up on more high-dividend ETFs. For example, with the market collapse, the iShares S&P/ASX Dividend Opportunities ETF (ASX: IHD) currently has a dividend yield of 13% according to Bloomberg. Of course, even if you are a dividend investor, there are benefits in diversifying into bond or hybrid ETFs. Although high-dividend ETFs such as IHD currently have a yield of 13% whereas government bond ETFs such as BOND have yield of 2.3% and HBRD, a bank hybrid ETF, has yield of 3.7% it is important to remember that although dividend yields are higher than bond yields, dividends can be cut.

If the market correction we are currently experiencing gets really bad, I will not be surprised if companies start announcing dividend cuts. It happened after the GFC, and it can happen again. This is where bonds can be useful because bonds are more likely to be paid to investors. If a company faces distress, bondholders by law are paid before stockholders. Bonds or hybrids then can be useful for income investors seeking passive income because they provide not only stability in price but also stability in income. Even though yields are lower for bonds or hybrids, this reflects the lower risk, the fact that these payments are less likely to be cut in the event of economic distress.

Disclosure: I own IHD and HBRD.

How to Prepare for Upcoming Stagflation

Recently markets have been shook by rising interest rates in the US. Interest rates around the world are somewhat correlated because of globalization. Australian banks often borrow from overseas (even from the US), so if interest rates rise overseas, this affects the cost that Australian banks pay to borrow money. The ASX200 chart below shows the correction in recent weeks.

the beginning of an xjo crash september 2018
Source: Bloomberg

How may the stock market crash?

Even though it is not wise to try to predict markets, my hunch is that a very large correction is near, but it may be delayed until around 2020. During the 2009 GFC, the threat was deflation i.e. prices going down, which means prices of e.g. property and shares went down as well. The solution to this was unprecedented money printing around the world. The printed money was used to purchase government bonds (in the US) or even stocks or ETFs directly (in Japan). When there is deflation, money printing is an easy fix because money printing puts more money into the economy, generating inflation, which cancels out deflation.

However, this time the fear is that when the market crashes, it is not a deflationary crash. Rather, we have a downturn while there is inflation at the same time. Why would there be inflation at the same time as a downturn? For example, take the US-China trade war. If US companies and consumers cannot import cheap goods from overseas, consumers and US businesses face higher costs. Higher costs cut into margins, which reduce profits, which reduce stock prices. If the trade wars heat up, US equities should decline futher as inflation increases. Usually when there is inflation, the central bank can combat inflation by raising interest rates. However, US businesses are already highly indebted. If the US central bank (the Federal Reserve) increases interest rates to combat inflation, businesses face higher interest expenses, which cuts into their profit margins and reduces stock price.

This dilemma that the Fed faces, in my opinion, will present a problem in the future and may usher in a 1970s-style stagflationary recession.

What can be done to protect against a downturn?

In a previous post, I spoke about the importance of the “age in bonds” rule. The “age in bonds” rule is just a guide. It doesn’t literally mean you must hold your age in bonds (e.g. if you are 30 then you hold 30% bonds).  “Age in bonds” is a rule of thumb. The complication comes from the fact that some bonds are risky (e.g. emerging market bonds, corporate bonds, etc) whereas some shares are arguably safe (e.g. utilities, gold mining stocks, etc). The basic principle behind “age in bonds” is to reduce risk or volatility in your portfolio as you are nearing retirement so that you are not exposed to e.g. a 50% decline in your wealth just before you retire.

“My personal, non-retirement accounts are about 80 percent bonds and 20 percent stocks, reflecting my old rule of thumb that your bond allocation should roughly equal your age. It’s spread across different bond funds, like the Vanguard Intermediate-Term Tax-Exempt (VWITX). I’m a pretty conservative guy.”

~Jack Bogle, Vanguard Group Founder

Given that I live off dividends, consider myself somewhat semi-retired, and don’t really have a fixed retirement date, I feel it is wise for me to reduce risk in my portfolio much moreso than the average person. For the average person in their 20s or 30s, they may feel that they don’t need to worry about a huge market correction because they can simply make up for the lost wealth by working longer. However, I don’t like the idea of being forced to work when I don’t need to.

Furthermore, even though many people feel as if they can withstand a huge market crash, if a 70% decline eventually does occurs and the reality hits that they have lost hundreds of thousands of dollars without any guarantee that the market will recover in the long run (remember that in the recovery may be many decades away and may be in the next century), I feel that many people would succumb to panic.

Which ETFs perform best in a bear market?

During the recent market correction, I was observing the reaction of different ETFs. What I found interesting is that MNRS, a gold mining ETF, shot up as the XJO went down. See the Bloomberg chart below, which shows MNRS (in yellow) shooting up as the XJO (in black) heads down.

xjo MNRS HBRD QAU and BOND during september 2018 correction
Source: Bloomberg

The large increase in gold mining stocks contrasts with the price of gold, which is represented above by the QAU ETF (in red), which holds physical gold. This makes sense since holding pure gold only provides you with access to gold whereas gold miners usually hold debt, which means they are leveraged to gold. The blue and aqua above show hybrid and bond ETFs, which both remain very stable.

Looking at the last six months, we can see how these ETFs perform not only during a bear market but also during a bull market. We can see that as the XJO goes up, the gold mining ETF and physical gold ETFs go down, which is not ideal. The bond and hybrid ETFs are stable as expected.

Gold miners and bonds vs stocks
Source: Bloomberg

What does this tell us? If you were shaken up by the recent market correction and feel that more risk is coming, a quick way to reduce risk in your portfolio is to buy physical gold and gold mining ETFs. This can be ideal if you don’t want sell shares and trigger capital gains tax. Gold miners are also legitimate companies in their own right. However, the problem with physical gold is that it pays zero passive income, and gold miners historically pay little in dividends. In contrast, the government bond ETF (BOND) pays about 2% in yield whereas the bank hybrid ETF (HBRD) pays about 3% to 4% in monthly distributions, so if you feel you have far too much risk in your portfolio, you can correct it fast by buying gold, but once you have derisked your portfolio sufficiently but still want to tread cautiously, you can take advantage of passive income with bond and hybrids, as well as some high dividend ETFs as well (e.g. IHD, VHY, EINC, etc).

The Simplicity of Living off Dividends

Some people have made comments that many of my posts on this blog are not finance related, so I will make an effort to post more about ETFs and other financial topics in the future. Perhaps the reason why there are few finance topics on this blog is because living off dividends is such a simple technique that I rarely think too much about finance. The whole point of making money is so you do not need to think about money. You do not need to stress about making ends meet when you have few obligations and multiple streams of dividends flowing into your bank account.

Budgeting, tracking net worth, trading, and rebalancing are not worth it

While most people maintain spreadsheets to track expenses and net worth, living off dividends only requires you to invest all your work salary and spend your dividends. If you end up spending more than dividend income, simply “borrow from yourself” by maintaining a few thousand dollars in cash in a separate savings account that you borrow from but pay back with dividend income. Either use a spreadsheet to keep track of how much you own to yourself or ensure that this savings account has a fixed amount e.g. you have $2000 in it, run out of dividends to spend, so you “borrow” $500 to have a balance of $1500 and then when your next dividend payment comes in, put $500 into this savings account to top it back up to $2000.

I don’t recommend tracking your expenses or tracking your net worth because it is time consuming and because the information you get out of it is not valuable. If you track expenses, you can see where all your spending goes, but what matters is not what you spend your money on but how much you spend. If you spend such that your expenses are equal to dividend income, this ensures you don’t spend too much, and one of the benefits of living off dividends is that dividends increase over time as you invest more and as companies become more profitable, so there is a gradual increase in standard of living, which I think helps overcome the feeling of deprivation many feel when they are frugal. If you only spend e.g. $10,000 per year for the rest of your life, you are stuck on that level and do not feel as if you are growing or making progress, but if you live off dividends and your dividends grow, you feel a sense of personal growth. As for tracking net worth, when you diversify across multiple areas (e.g. retirement accounts, managed funds, ETFs, cryptocurrency, etc) then it becomes a huge burden to log in to each of these accounts to check the balance. What matters to financial independence is not net worth per se but passive income. You live off passive income, not net worth, and if you live off passive income then you’ll be able to assess automatically whether you have enough based on whether you are satisfied or not with your standard of living.

Because living off dividends is simple, there are only two things you need to consider: how to spend your dividends and what to invest your work salary in. Most people have no issue with figuring out how to spend their money (e.g. holidays, books, smartphones, and coffee). What to invest in is more complicated, and generally I recommend buying broad and diversified ETFs with a slightly heavier allocation towards high dividend paying ETFs (or LICs). However, more important than what you invest in, in my opinion, is the “buy and hold” mentality. You should buy with the intention of holding these investments for a long time, if not forever. I also do not bother with rebalancing. For example, in recent years the Australian stock market has underperformed whereas foreign stocks (particularly US stocks) have done very well. There are those who rebalance by selling off US stocks to buy Australia stocks to maintain a certain amount to certain countries. This is far more effort than necessary, adds administrative burden by triggering capital gains tax, and does not add much value because if you feel you have too little Australian stock, rather than sell US stock, you can simply buy more Australian stocks. For example, in recent years, as US equities has gone up, I have purchased more high-dividend paying Australian stocks and ETFs e.g. CBA and IHD.

Age in VDCO

For most people who ask, I recommend Vanguard’s diversified ETFs. You cannot beat the simplicity of these ETFs. Whatever your age is, hold that amount in VDCO and the rest you hold in VDHG. For example, if you’re 30 then hold 30% VDCO and 70% VDHG. These Vanguard diversified ETFs diversify across just about all asset classes (e.g. Australian shares, international shares, emerging markets, small caps, property, bonds, etc) so you don’t need to worry about mixing and matching. The reason why you hold your age in VDCO is to broadly follow the “age in bonds” rule, which is insurance against retiring just after a huge market crash. There are many people who are anti-bond and claim that they are a drag on performance, that stocks always go up on the long run, etc, but this is not true. In fact, this is dangerous advice. There is no guarantee that stocks go up in the long run as the value of stocks merely represent company profits and there is no guarantee that company profits will go up in the long run. Even if stocks do go up in the long run, there are huge market crash (e.g. 50% decline) that emerge, not just normal business cycles but debt supercycles that can take centuries to materialize. You do not want to be in the position of being in 100% equities and then losing 50% just before you retire as this can really set you back and impact on the quality of your retirement. Broadly following “age in bonds” (government bonds, specifically) is insurance against such a scenario. In fact, of all the rules of personal finance, “age in bonds” is, in my opinion, the most important. You can pretty much invest in any exotic high-risk asset class (e.g. emerging markets, tech stocks, robotics ETFs, cryptocurrency, etc) but if you own your age in government bonds, you are safe.

When markets go up, it is very easy to rationalize why defensive asset classes are poor quality. It is when markets go up that people easily covert to the cult of equity, but when there is a market crash or when there is a prolonged economic depression that lasts many decades or centures, many will understand and appreciate the wisdom of “age in bonds.” The reality is that when markets are booming, it’s easy to convince yourself why 100% equities or high leverage is a good idea, and the opposite is true when there is a market crash. It goes back to Warren Buffet’s quote about being fearful when others are greedy but also thinking about Ray Dalio’s idea that you must stress test your ideas because you are never be too sure in yourself  because it is easy to be moved by your emotions as well as other psychological biases.

 

 

Vanguard Australia Diversified ETFs – The Only Investments You’ll Need?

Vanguard has always had diversified managed fund. I remember using these many years ago, but I stopped adding money into these funds as I was distracted by other new investments. However, when I look back the performance of my investments, I am blown away by the returns from these Vanguard diversified managed funds, and they pay regular quarterly distributions into my bank account.

Furthermore, at the end of the financial year, Vanguard provides a full tax summary that you can simply give to your accountant (I use H&R Block). For simplicity and effectiveness, investing in Vanguard and getting H&R Block to manage your taxes is, in my opinion, a foolproof strategy.

One of the main issues with Vanguard’s diversified managed fund was that its fees were quite high. However, recently Vanguard has released their suite of four diversified ETFs:

  • Vanguard Conservative Index ETF (VDCO)
  • Vanguard Balanced Index ETF (VDBA)
  • Vanguard Growth Index ETF (VDGR)
  • Vanguard High Growth Index ETF (VDHG).

Investors now only need to determine how much risk they are willing to tolerate and then allocate money appropriately, e.g. if you are willing to take on more risk then invest in VDHG whereas if you want to take less risk you pick VDCO. Everything else is handled by Vanguard, which makes investing simple and easy.

These ETFs can be purchased off the ASX, which can be done with an online broker such as CommSec. I try to purchase ETFs in $25,000 increments on CommSec as the fee is $30, which is the most bang for your buck.

Most financial advice follows the “age in bonds” principle whereby you own your age in government bonds, e.g. if you’re 30 then 30% of your wealth is in government bonds. Whether you strictly follow “age in bonds” or not, the main principle is that as you are nearing retirement you reduce risk in your portfolio. With Vanguard diversified ETFs, you can simply carry this out by buying VDHG when you’re young but as you get older you start to buy more VDCO to reduce risk. Although not exactly conforming to “age in bonds”, “age in VDCO” is a simple alternative rule-of-thumb. For example, if you’re 30, own 30% VDCO and 70% VDHG. As you buy, simply buy whichever ETF you’re underweight in.

I love to dabble in new exotic investments such as ROBO and cryptocurrencies, but I try to follow the core-satellite approach, which states that you limit exotic investments (the “satellite”) to a small portion of your portfolio (e.g. only 30%) while the bulk of your investments (the “core”) are in low-cost passive index funds. Vanguard’s diversified ETFs are perfect investments to take the role of “core” investments.

More information can be found at Vanguard Australia’s official website on its diversified ETFs.

https://www.vanguardinvestments.com.au/diversifiedETFs/

For those who prefer managed funds rather than ETFs, see below Vanguard Australia’s page on its diversified managed funds.

https://www.vanguardinvestments.com.au/diversified

Why You Don’t Need Debt

I do have debt, but it’s a small amount. For example, I have credit cards, but I always pay it off before there is interest. I also have a margin loan, but I have this so I can buy easily when the opportunity presents itself, and I try to pay off any debt quickly.

Many people talk about how debt is a tool for making money, and theoretically this can be true. For example, if you borrow at 4% from the bank and invest in something an asset, e.g. an investment property that makes 8% then you make a profit. However, if you borrow money from the bank to invest, you need to ask yourself why the bank didn’t invest in that investment itself. The answer is that it is risky.

Banks have a certain level of risk they are willing to take. The property could have gone up 8% but there is no guarantee that it will. If there were a guarantee that the property would go up 8% then the bank would simply invest in it rather than let you borrow money to invest in it. By letting someone else borrow money to invest in the house, the bank effectively transfers risk. If the bank vets the borrower to make sure they e.g. have high enough income, etc and if there were clauses in the contract enabling the bank to seize assets in the event of default, then that 4% the bank makes is almost risk free.

But don’t you need to take on more risk to make more return?

Risk appetite is a very personal topic because everyone has different risk appetite. Generally speaking, it is recommended that young people take on more risk because they have greater ability (and time) to recover should something go wrong. This is the main principle behind the “age in bonds” rule, which states that you own your age in risk-free investments, i.e. government bonds. For example, if you are 25 you should own 25% of your wealth in government bonds.

However, if you’re a 25-year-old who has higher risk appetite, the “age in bonds” rule can be modified to e.g. (age – 25)% in bonds. This slightly more complex rule states that the 25-year-old would have zero in government bonds, which would increases to 1% when he or she is 26 and so forth.

A 25-year-old who has no government bonds and puts all his or her wealth into, say, the stock market, has a high risk appetite, but more risk can be taken if he borrows to invest.

You don’t need to borrow to take on more risk

However, even if someone does no borrow, he can still take on more risk. This can be achieved by investing in internally leveraged ETFs (e.g. GEAR and GGUS) as well as investing in more risky investments, such as emerging markets (e.g. VGE), small caps (e.g. ISO), tech stocks (e.g. TECH and ROBO), and cryptocurrency (e.g. bitcoin, ether, or litecoin).

Right now bitcoin and cryptocurrencies in general are making headlines because of spectacular growth. Had you purchased $10k worth of bitcoin in 2013, you’d be a millionaire today. However, everyone knows that bitcoin and cryptocurrencies in general are risky, and when you hear stories about people borrowing money from their homes and putting it all into cryptocurrencies, most people think this is stupid. It is not that it is stupid but rather than their risk appetite is very high.

However, the example of leveraging into cryptocurrencies shows that you don’t need to borrow in order to gain access to high risk and potentially higher returns. If you simply invest in a riskier asset class, e.g. cryptocurrencies, you already increase risk and the potential for higher returns.

Debt is slavery – the psychological benefits of having no debt

I would argue that there is no need to borrow to increase risk and return because you can simply reallocate your money to risker assets (unless you believe that leveraging into bitcoin is not enough risk).

The benefits of having no debt goes far beyond the lower risk you’re exposed to. Debt is slavery. Happiness is an elusive goal. It is almost impossible for you to know what will make you happy in the future. You may think a particular job, relationship, car, holiday, or house will make you happy, but once you actually have it, you may not be happy. Trying to predict what will make you happy is hard, which is why the best way we humans can be happy to experiment and try out different things. In order to be able to try or experiment with different things that will make us happy, we must have the freedom to do so, and you don’t have that freedom if you’re forced to work in order to pay debt.

Even though freedom does not guarantee happiness, freedom is the best assurance we have of being happy.

Freedom comes from reducing your obligations. Obligations are mostly financial obligations (debt) but can be non-financial as well.

Ultimately it depends on your risk appetite

As I mentioned earlier, everyone has a different risk appetite. I have a fairly high risk appetite myself, but there are limits. For example, I’m happy to put 5% of my net worth into cryptocurrencies. I invest in certain sector ETFs because I estimate that they will outperform in the future (e.g. I am bullish on the tech sector).

Market fluctuations can result in the value of my ETFs and shares to go down by tens of thousands of dollars and I would sleep fine at night. However, there have been many times in my life when I have gotten carried away with buying too using my margin loan account and regretting it. You know you’re taken on too much risk when you worry about it.

Results don’t matter

The outcomes from investing are probabalistic, not deterministic, so results don’t matter. This is a common investing fallacy. Some guy would claim that he is worth $100 million due to borrowing money to generate wealth and that this is proof that you must use debt in order to become rich. However, this is misleading.

The outcomes from investing are probabalistic, not deterministic.

A person may borrow money to invest and be very successful, but another person may replicate the process, borrow to invest, and lose everything. What happens for one person may not necessarily happen for another person. For example, in 2013, there were many people who stripped money from their homes using home equity lines of credit and invested all that money into bitcoin. Just about everyone called these people stupid, but now they are multimillionaires. Does this mean you should borrow to invest in bitcoin right now? No. Just because bitcoin went up from 2013 to 2017 it doesn’t mean the same thing will happen e.g. from 2018 to 2020. Investing is not deterministic. Luck plays a major role.

Do you need debt?

Suppose you put 100% of your investments into risky areas such as cryptocurrencies, frontier market ETFs, mining stocks, etc. If you feel that this is not enough risk, borrowing to invest may be the answer, but I believe that most people do not want to take on this level of risk.

Where debt may be appropriate is if you having little savings and need to borrow money to invest in something that you are fairly certain is greater than the cost of borrowing, e.g. borrowing money for education and training can in most circumstances be a good idea. Even though borrowing money will cost you in interest, you boost your job prospects and your income. If you have savings (or if your parents have savings) then it is better to use those savings to educate or train yourself, but if you don’t have this, you need to go into debt as a necessary evil.

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