I often write answers on Quora, where I am the most viewed writer for investing and personal finance, with over 220 million views.
On this article, I will use my answers from Quora to answer the following questions:
- What advice would I give to a high flyer who seems destined for success and wealth? Would my advice be different to anybody else?
- Can you lose more money than you put in investing in ETFs or does it depend on which ETFs we are speaking about?
- Is it a good idea to invest in index funds when some track “overvalued” as well as undervalued stocks?
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ETFs, like mutual funds, can be linked to many types of sectors, countries and financial instruments.
They are just cheaper to own in general and quicker to sell, but there isn’t one type of ETF.
The following ETFs exist:
Index-linked ETFs – This could be MSCI World, the FTSE100, the US S&P500 or something very niche like a Vietnam or Hungary ETF. Bond ETFs track bond markets.
Commodity-linked ETFs – These ETFs track the price of oil, gold, silver and other commodity.
Inverse and leveraged ETFs – These types of ETFs are based on debt and try to either magnify your upside or bet against an index. So an inverse S&P500 ETF will bet that the S&P500 will be down.
Niche ETFs – such as cannabis ETFs, sustainable energy etc. There are literally thousands like this.
There are many other but let’s just focus on these to begin with.
The riskiest ETFs tend to be leveraged or inverse ETFs because it is a kind of speculation.
The S&P500 and other major stock markets tend to go up long-term, so inverse ETFs will only work if you time the right moment to short the index.
Leveraged ETFs, moreover, can magnify the downside as well as the upside.
Commodity-linked ETFs are also risky. That is because commodities, long-term, tend to match inflation at best. Look at oil and gold.
Both hit real terms highs in the 1970s or 1980s when Oil was trading at about $200 a barrel in today’s money and gold was at close to 3k adjusted for inflation.
Niche area ETFs can perform very well. Right now sustainable energy, as an example, is doing incredible well.
They are clearly riskier than something more diversified but don’t do harm if they are kept to maybe 10% of a portfolio.
Index-linked ETFs are the least risky of them all if:
- You avoid niche countries
- You don’t panic when markets are down. Being down, and losing money, isn’t the same thing if you wait it out.
- You focus on broadly diversified ones like the S&P500, MSCI World and any other index which is weighted towards many sectors and countries. Yes the S&P500 is an American index, but really it is global. Most US firms less as much, if not more, overseas, than in the US.
- You reinvest dividends. Even markets which haven’t performed as well as the S&P500 have been up adjusted for this. In some of my previous answers I pointed out how the Japanese Nikkei hasn’t been down adjusted for dividend reinvestment.
- You also hold a bond market index ETF
- The focus is long-term.
The graphs below illustrate the point:
For most investors the biggest risk isn’t the market, it is themselves.
Panic selling when the market is down or focusing on niches which seem hot.
So many people bought oil ETFs near the top of the oil prices, or switched to emerging market ETFs when they were outperforming US Markets.
Likewise, every time there is a crash (2000, 2008, 2020 as three recent examples) plenty of people panic sell.
The bottom line to your question, then, is that nobody has historically lost money by buying and holding 2 or 3 index-linked ETFs, provided they reinvested the dividends and didn’t panic sold.
That doesn’t mean it couldn’t happen in the future, but it has never occurred in the past.
Many have lost money by panic selling or speculating in niche areas.
If somebody was truly destined to become a multi-millionaire, meaning it seems highly likely that they would achieve that number, I would first speak about the importance of a lack of complexity.
I know, personally, countless people who fit into the following categories:
- They peaked too soon in their teens, 20s or 30s.
- They became millionaires and multi-millionaires but then lost it due to divorce, complacency or any number of events. 2020 was a great example. Plenty of new millionaires were created due to the rise and rise of the internet and rising stock markets yet…….there were also plenty of ex-millionaires that were created too. Typically, they were either old-fashioned companies that didn’t adapt, or business owners who didn’t see the need to diversify until it was too late. Bar and restaurant owners who were doing well before the crisis, and never planned for the worst case and black swan events.
So, I partly agree with this quote below. I think the key is a healthy degree of paranoia – one that avoids a high degree but keeps you on your toes:
In addition to that, I would get them to focus on the process of planning money and managing money.
Most highly talented people, be they business people, sports and entertainment stars or whoever else, know how to make money.
Sometimes they know how to make a lot of money. What is much less frequently found is somebody who knows how to manage money long-term.
Studies have shown that between 20% and 60% of lottery winners go bust and up to 78% of former NBA and NFL stars are broke within five years of retirement.
The reason is simple. Salaries go down after retirement. If you can’t adjust your spending habits and live within your new means, you will soon be eating into your wealth.
For somebody who is used to living off tens of millions, this can be a hard pill to shallow, which is why the likes of Mike Tyson and Michael Jackson went into financial difficulties despite earning $500m+.
So, my biggest tips would be to focus on expenditure and investing the surplus well as much as income.
It is pointless to earn $1m, if you spend $1.1m! It is far better, for wealth, to earn 90k and invest 20k a year over many decades.
People make the same mistakes in business. Saying “I have a business which has a turnover of $10m, and I employ 100 people across five continents” sounds sexy, but it is pointless and an ego measure if the costs are also $10m.
Having ran businesses myself, I can say that it gets harder to stay as profitable once you add infrastructure like staffing and rental costs.
In some cases having a business with $30,000 a month after tax revenues and only $5,000 costs because it is a one-man business ran from your home, is a far better model, as it is net $25,000 a month vs net $0.
Too many people are focused on the top line and not the bottom line. Now sure, running a business is different to personal finances.
In some cases if you manage the top line, the bottom line will eventually follow, and you can sometimes sell out a non-profitable business which has big revenues.
But I am more alluding to the obsession some people have with status and something sounding good.
That is one reason why online, stay-at-home, businesses didn’t take off as quickly as they could have done from 2000 until 2015 or 2018.
Too many business owners thought it doesn’t sound as sexy as some alternatives.
What’s more, highly talented and intelligent people, are more likely to get bored and think something is working too well.
That is another mistake to avoid.
It isn’t the index fund itself that is forced to sell Tesla. Most index funds and ETFs are market capitalization.
That means it will naturally happen that the indexes need to be more tilted towards the Amazon’s and now Tesla’s of this world…..at least for a period of time.
A less common strategy is for ETFs and index funds to weigh each stock equally.
The bottom line is, regardless of whether you buy market-capitalization or non market cap indexes and ETFs, they do work long-term if:
- You are diversified in 2–3 indexes. If you have a world index + the S&P500 + a bond market index then any individual name won’t comprise a huge percentage of your portfolio.
- You reinvest the dividends
- You don’t panic sell at the bottom
- You are truly long-term.
What isn’t recommended is trying to be “too cute” about things like valuations and p/e ratios and so on.
In the last 5–7 years, I have lost count of the number of people who dumped their US indexes in the 2014-present period, because quote “UK, Japanese and Eurozone indexes looked undervalued”.
They do look undervalued. Yet nobody can time which markets will do better.
If it was so easy to look at a bunch of ratios like p.e ratios and pick which ETFs to buy, everybody would do it.
Instead, people who are too analytical and overthink often get worse results than those that don’t.
In my network many highly educated finance professions have received worse returns than the markets for this very reason.
The less risky way is to invest monthly regardless of valuation, be diversified and forget about it for decades.
The debate about different types of indexes and ETFs reminds me of the Vanguard vs Dimensional Fund Advisors (DFA) debate.
DFA claim to have an advantage by investing into smaller views – “smart beta” to give the technical term.
Essential though, the returns are very correlated long-term. Those far, anybody who has tried to make indexes more “smart” hasn’t increased the performance by that much.
In the answers below I focused on:
- Most people, at least in developed countries, assume that getting rich is more difficult than before. But is that really true? I speak about how our perspective influences our approach to this question.
- What do people understand in their 30s that they don’t in their 20s?
- What should people know about investing in stocks? What are the opportunities, risks and what is the bottom line?
Below is a preview of one of the answers
The biggest things we shouldn’t forget are:
- Stocks as an asset class do go up long-term. The Dow was at 66 in 1900, 2,000 about 30–32 years ago and 31,000 today.
- Yet individual stocks don’t always go up. Individual industries don’t always go up either. The banks have never recovered from 2008 even though the general market has.
- Despite the fact that the market goes up long-term, there can be long periods of stagnation. 2000–2011 and 1965–1982 saw many markets stay still. The long-term investor shouldn’t be afraid of such periods. It allows you to buy lower for longer! When markets come up, you will make more money than if they had been rising however.
- Dividends are key. Over 35% of many stock market returns have been from reinvesting dividends. What’s more, reinvesting dividends protects you in stagnant or falling markets as well. The UK FTSE100 hasn’t done as well as the FTSE250 or S&P500 in recent decades. Yet look at the graph if you had reinvested the dividends:
As you can see, it all compounds. Over a 30 year period, the person who reinvested the dividends has about 5x more.
Likewise, many people know the Japanese Nikkei market is the only major market which is down on its height.
It is now 28,850. It’s height was briefly 38,916. Even if we ignore the fact that it is highly unlikely that you would have invested 100% at the very peak, you could still be up slightly in 2020 if you bought only once at the peak and reinvested dividends.
5. It doesn’t make sense to be 100% in stocks forever. At a young age that can work and if you are willing to see big volatility. Having a bond market index works long-term, because bonds tend to rise during periods when stocks fall. At least that is the case with short-term Treasuries.
6. US Stocks have beaten most International ones long-term, including emerging markets. Yet every dog has its day. There have been numerous periods where international has beaten US Stocks. It makes sense to own at least 2–3 indexes for this reason.
7. Nobody can consistently time markets. The only safe way to invest is long-term. Time is one of the only free lunches in investing because it lowers your risk and compounds your gains.
8. You should never speculate or panic.
9. Don’t blindly follow trends which are pushed by the media and others.
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