This article will discuss the following topics:
- How to make money from money. How can you invest productively?
- Your options for making money from money
- Why is it easier to make money from money, at least long-term, than only relying on your job/work? I look at the long-term mathematic reality later on in the article.
The sections will also speak about some misconceptions people have about wealth and investing more generally.
Two of those misconceptions is that investing is risky and only people who are rich to begin with can do it.
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Your options for making money from money
In this section I will speak about some of the assets you can invest in, how to invest in them and the pros and cons of each.
Later in the article I will speak about why assets are likely to eventually make you more money than your primary income.
The stock market
The Dow Jones was trading at 66 in 1900, 2,000 thirty years ago and about 31,000 today.
The S&P500 has done similarly well, whilst the Nasdaq has outperformed both in recent decades.
MSCI World has performed relatively well too, despite seeing slightly lower returns than US Stock Markets over the last half century.
You would think with this stellar performance, which represents over 7% above inflation since 1945 (if dividends are reinvested) according to this calculator, that everybody would want to invest in the stock market.
There are three main reasons why people don’t want to invest in stocks.
First, there are those who know that stocks have risen long-term but wrongly assume that property has outperformed. More on that later.
Then there are those who understand that stocks go up long-term but are terrified by the huge falls that can happen, despite the fact that stocks have always recovered from these crashes.
Finally, there are people who either don’t understand that stocks have risen, or are scared off by the media.
The last point is an interesting one. I have been advising clients for long enough to see the same trends.
People worried about the 2016 US election and the stock market crashing.
The same people worried about 2020, and will probably worry about 2024.
The same people also tend to worry after any event – be that a government shutdown, virus and pandemic, lockdowns and potential wars.
What probably doesn’t help is that the media screams “this time is different” every time something happens..
John Templeton called these the four most dangerous words in investing as per the quote below:
It is also common for people to confuse investing in individual stocks versus something more diversified.
It is true that an individual stock can be very risky. Countless have gone to zero as shown by Lehman Brothers in 2008, and many others have never recovered.
Even individual sectors have never recovered. The banks certainly haven’t recovered to their post-2008 stock prices, or even came close.
Yet the general market, which can be accessed through ETFs, has always recovered as these statistics show:
If you add 40% government bonds for diversification and 60% in stocks, the results are even more astounding:
Even a broadly diversified Japanese investor has done well, despite the Japanese stock market being one of the worst performing in the world:
Added to that, there is countless academic data out there which suggests that nobody can time the stock market.
Only liars manage to time the perfect time to enter, and exit, stock markets.
The evidence is therefore clear – it is far better to put in money when you have it and also increase your exposure at regular intervals through a monthly or yearly investment.
Doing it this way will ensure you have excellent, good, ok and terrible years, but your average return will be good.
The bottom line then is the stock market isn’t risky unless you make it.
Now sure, it can be risky, but only if you decide to be short-term, speculate, try to time the market, panic and sell when stocks are down instead of holding and engage in other destructive behaviours.
So, why doesn’t everybody who invests in stocks make money, if the overall market is going up?
A big part of it is emotional and destructive behaviours. Vanguard, one of the biggest firms in the world, have done some research on do it yourself (DIY) investing versus using an advisor or company.
This is fascinating as they offer DIY facilities and also work with advisors.
They found that clients who go through advisors get better net returns than those who DIY, despite being in the same kinds of investments and adding an advisory fee.
The reasons are simple. Advisors can help clients with emotions. You can read the full finding’s here.
That doesn’t mean everybody needs an advisor. Some people can control their emotions, and not everybody has the kind of complex problems most of my clients have as either expats or high-net-worth individuals. Yet advice can be invaluable.
Whichever option is suitable for you, the process of getting started is simple.
You need to either find an advisory company or DIY platform which will accept you based on your country of residence.
It is then part of the usual process where you will need to complete an online application form and submit anti-money laundering documents like your proof of ID and address.
Many people assume that “you can’t lose with property”, but is it true?
Long-term, direct real estate doesn’t do as well as the S&P500 and most major stock markets, even though it can outperform during some time periods.
What is true, however, is that property investments offer some advantages.
Firstly, you can use leverage (debt) to increase your gains. Somebody else can pay for your mortgage, and buy-to-let properties, without you needing to put down loads of cash.
It is very tax-efficient as well in some countries like the United States.
Yet from looking at the research and my own associates, very few people beat the stock market (at least long-term) through property investments unless they are a professional in real estate.
In addition to that, property is more like running your own business than a pure investment, because you have to manage cashflow and several moving parts.
It is therefore unsurprising that plenty of tax authorities out there, such as the UK’s HMRC, require employed workers who have a property to file for self-employed status for the houses, but don’t require stock and ETF investors to do the same.
There is an alternative to this and that is to invest in real estate investment trusts (REITS).
REITS are companies that own, and usually manage, cashflow generating properties.
The benefits of this is broad diversification because you can gain access to residential and commercial (hotels, shopping malls etc) properties globally in one ETF or fund.
You also face less costs, with many REITS costing just 0.1% per year. In addition to that, a portfolio with 10% REITS has been found to slightly outperform a pure stock and bond market portfolio.
Having a mixed portfolio of stocks, bonds and REITS can therefore be a winning combination.
Starting your own business
Starting your own business can be a great decision and it is something I did.
Yet every business owner should have private investments because a private business usually relies on the owner’s health, time and sometimes the economy.
In other word’s it is riskier than investing in ETFs long-term, and relies on time as well.
That isn’t to mention that most private businesses fail.
One of the reasons for this high failure rate is that many people try to start businesses in areas they have little experience in.
The data is clear. The biggest indication of business success isn’t the passion of the founder, the economy or even the strength of the product.
The amount of experience the owner has is key because it allows him/her to execute better with more connections, experiences and sometimes money.
In addition to the stock market, property and a business, there are alternative assets such as private equity which can offer excellent returns.
Yet the average investors should stay away from alternative assets unless they are already wealthy or are using an advisor.
The best investments, then, will depend on your skills and experiences.
Yet if the goal is to make money from money rather than time, the stock, bond and REITS market offers a distinct advantage over time-intensive activities like real estate and a business.
I believe that is the biggest reason why most successful business owners have private investments in the stock market.
Investing in the stock market, combined with other assets, is also a great risk-adjusted investment compared to ultra adventurous assets.
Why it is easier to make money from money than only relying on your job?
After looking at some of the assets you can invest in, it is worth contemplating why assets tend to outpace wages.
Firstly, whether you like it or not, we live in a capitalistic system. The key word here is capital.
We need to learn how to make capital work for us, and not against us.
It was one of the fundamental themes of Thomas Piketty’s book, Capital, that the biggest reason why inequality increases over time is that capital earns more than labour.
If wages are, on average, seeing increase of 2% above the rate of inflation, and the stock market is doing 4% or even 6.5%-7% in the case of some of the best markets like the S&P500, those rates compound over time.
Now sure, there is volatility in those numbers. Sometimes the stock market will perform above 7% per year after inflation as has happened since 2008.
On occasion, markets will be stagnant, fall or crash, and there will be occasions when labour sees bigger returns than capital.
Yet for somebody who holds for the long-term, capital will almost for sure beat labour.
In addition to that, there are less risks and hassles associated with capital if you are long-term orientated
You can lose your job instantly and be given one months’ notice almost anywhere in the world.
Even if you are lucky enough to always have a job, working involves a lot of hassle.
Everybody needs an income, and it doesn’t make sense for many people to quit their jobs and focus on being an investor full-time.
Yet the point I am making is that it is a mathematical reality that the aforementioned returns will make earning money from a second source of income (your portfolio) easier in the long-term.
Let’s look at a simple example to illustrate my point
Luck is a graduate and is earning 30,000 Pounds a year in the UK – which is about the average wage in the country.
He has worked for three or four years. If his wage increases by 3% every year, which is 1% above inflation, he will be earning 97,861.13 in forty years before he retires.
Yet if we factor in inflation, that is 45,000-50,000 pounds in today’s money.
In comparison, if he invests on average just 250 pounds a month + a one-off 25,000 pound investment from inheritance, his nest egg will be worth 1.9million in forty years.
That is assuming a rate of return (9%) which is 1%-2% below the historical rates of return of the S&P500, Dow Jones and Nasdaq.
Even adjusted to inflation that is over 1million Pounds. Now let’s change the figures slightly.
Imagine he invests 100,000 pounds in the early years, due to an inheritance, bonus and/or other unexpected money, in addition to the 250 Pounds a month.
He would now have over 4.2million in forty years. The extra money wasn’t acquired by working harder.
He only made one difference – to reinvest the complete 100,000 he received rather than 25,000.
You can only imagine how much money Luke would have if he also increased the 250 monthly figure.
He is also taking few risks as he is just investing long-term. By investing and keeping his main job, his risks are spread out compared to relying one income.
When I look at all the people I know who are in their 50s and 60s, the one commonality all the broke people seem to have is relying on just one income – their primary one from a job.
Whilst this is theoretical figure, they are based on assumptions which are conservative by historical, and recent, standards.
In addition to that, if Luke starts early he doesn’t need to worry about markets having a bad period.
Let’s us the aforementioned 100,000 and 250 a month figures. This time, however, let’s assume Luke gets 0% in the first 10 years, 7% from years 11 until 22 and 16% from years 22 until 40.
He would have 5 million at retirement, so 800,000 more than the previous example, despite the fact that the returns for the first 22 years are below historical averages.
The reason is simple. He received his best returns from years 22 until 40, when his account was worth more, and managed to buy cheap for years.
I give this example to illustrate why younger investors shouldn’t worry about stocks stagnating.
To put it in a crude way, you will make money if stocks usually go up, but even more money if they fall/stagnant before rising to new heights again.
Is this only for “the rich”?
The good news is that most wealthy people didn’t start out wealthy. One of the most definitive guides to this was the book the Millionaire Next Door.
The author, Doctor Thomas Stanley, was clear. Most millionaires are middle-class and middle-income.
Teachers, accountants, managers. There are even millionaires who are low income.
This cleaner in Canada, Ronald Read, amassed a millionaire fortune:
You might think these stories are exceptions to the rule, and they just got lucky.
In fact, 14% of the world’s millionaires are estimated to be teachers, and over 50% are doing other middle-income jobs.
These people simply invested in a consistent and long-term fashion. This compounding helped them get wealthy over time.
None of this means that we shouldn’t focus on our primary incomes, jobs and careers.
Not everybody can start their own business successful and many people get great joy in their jobs.
Merely, we all have a lazy bone in our bodies. That even applies to the most hardworking of us.
Even for people with strong work ethics, working smart makes just as much sense as working hard, as does minimising risk.
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