Investing Basics: FIRE in your eyes? Invest in your financial education
The FIRE (Financial Independence, Retire Early) movement is the latest to sweep through personal finance in the States (more) and is gathering momentum on this side of the Pond (more) as an increasing number of people recognise that financial self-reliance will necessarily replace state provision – writes Christian Leeming
The first element of the acronym that underpins the movement is ‘FI’ – Financial Independence; achieving the liberation that it brings is a powerful motive force for those that decide to actively take control of their money.
Achieve financial independence, and then the second element – Retire Early – is just one of the very many options that you will have, along with that trip of a lifetime or the shiny convertible that may have captured your imagination in the first place.
‘a powerful motive force for those that decide to actively take control of their money’
However, one of the biggest challenges for anyone seeking financial freedom is to break the cycle of living from month to month; let’s not pretend it’s easy, for many young adults, student debt, squeezed wages and the high cost of accommodation combine to deliver a pretty stiff headwind to those embarking on this particular odyssey.
For Mrs May’s ‘just about managing’, budgeting from month to month could be seen as an achievement in itself; to take the next step by establishing a rainy day fund and embarking upon a regular savings and investment strategy might seem a bridge too far.
However, the only way to break the cycle is to do just that, and those that manage to do so are rewarded with the benefits that accrue from being invested for a long time; ‘time in the market’ is considered one of the most important elements of investment success, but with any investment, being ‘in the market’ inevitably comes with risk.
The fear of failure and the role of financial education
For all of the brick bats about avocado toast and seeking a life of experiences that ‘boomers might hurl in their direction, by and large millennials and young adults are pretty, small ‘c’, conservative and eminently sensible; however, this can work against those seeking to put their money to work, as risk aversion can see some choosing to save rather than to invest, in many cases losing the value of their money in real terms due to the enduring low interest rate environment and the corrosive effect of inflation.
Research by Mankiw and Taylor in 2014 showed that as human beings, losing something makes us twice as miserable as gaining something makes us happy; those opting to save may be motivated to do so by a fear of losing their hard-earned.
‘you may be in a prime position to enter the world of investing’
However, cautious they may be, but daft they’re not, and that is why financial education has such an important role to play; understanding the risks associated with a particular investment and then working out how to balance them and mitigate them where possible, is a precursor to a journey to financial freedom, and the key to uninterrupted nights’ sleep along the way.
Financially educated people know that stowing money in a sock simply isn’t the way towards financial freedom; their challenge is to look beyond the here and now, and seek to ensure their long term financial wellbeing.
Investing requires focus and discipline and to some may simply seem too much of a challenge, resulting in them vowing to revisit it when their financial situation has at least stabilised; however, the fact is that as a twenty-something, you may be in a prime position to enter the world of investing, even with student debt and a poor salary.
So, what’s stopping you?
If quizzed, most young adults would acknowledge the virtues of investing, so why do so many hesitate in getting started?
One obstacle to overcome could be the fundamental conservatism of millennials and their proclivity to save rather than invest; the financial crisis appears to have created a deep mistrust in many surrounding the stock market and a fear of what might go wrong.
This fear causes many young adults to be risk adverse, and in truth there is a lot of sense in clearing expensive debt before embarking upon an investment strategy; however, sound financial education and a grounding in the basics of budgeting and cash flow can lay solid foundations for when the ‘time is right’.
In fact, the time may never feel right, but once an individual recognises that the long term objectives are worthy of the short term privation, then that is time for the first steps; little and often is rarely worse than nothing and never.
‘the key to overcoming that fear is financial education’
Those that may feel unprepared to make such a commitment to themselves should take some time to understand the range of potential outcomes they could achieve/may face and then decide if they are prepared to invest the time and effort it takes to become financially literate and enjoy the benefits of financial freedom down the line.
In investing as in so many disciplines, knowledge is power and those investing according to carefully considered criteria and with sound judgment, seeking to minimise risk and maximise gain, give themselves every chance; fear of failure may see young adults shy away from easily attainable opportunities, and the key to overcoming that fear is financial education.
The number of investment tools and sources of information online is huge; inexperience should not be your excuse not to invest – via social media there will be many thousands of people in circumstances just like you, with objectives just like you.
The power of the crowd is phenomenal and the ability to interact with so many kindred spirits should serve to allay many fears, although some may still miss out because of deep rooted psychological barriers to investing.
‘Do it Yourself, Do it With me, Do it For me – just don’t do nothing!’
However, there are now a range of options available that mean there should be something appropriate to your level of knowledge and experience, how hands-on you want to be with your investments and where you are on your journey; as we say – Do it Yourself, Do it With me, Do it For me – just don’t do nothing!
A key milestone in arriving at the decision to ‘not do nothing’ is the realisation that things in the future are unlikely to resemble those in the past; in the way that social housing has been removed as an option for the majority, so financial self-reliance will necessarily replace state provision when it comes to later life care and income in retirement.
Auto enrolment may be a first, faltering step along that path, but until or unless the ‘401k/fifty nine-and-a-half’ conversation becomes as ubiquitous here as it is on the other side of the Pond, FIRE will remain the preserve of a fortunate minority.
Get in early
As a young adult your most valuable resource in pursuit of financial independence is time; as explored on Muckle (S=P(1+ J/N)NT….but no chicks for free!) compound interest, Einstein’s ‘eighth wonder of the world) is a more powerful force the longer the period of your investment.
The benefit of earning interest on interest means that the longer your money is put to work, the more wealth it can generate; start investing early and each unit of currency becomes more potent by the time you retire.
The process of investing consistently works to the advantage of a young investor as interest is earned and compounded, dividends are received and share values appreciate; however, if you are reading this in your forties or fifties and now rue the fact that twenty years of compounding value may have passed you by, remember, you can only start from where you are.
So what can you invest in?
Having made the commitment to strive for financial independence, this is the exciting bit and there is no right or wrong way to achieve it.
We all know that the tortoise wins in the end, right? But what if the hare unearths that ten-bagger that just keeps on going?
Again, financial education is the key; once you have got to grips with the investment options that exist and how they might be expected to perform, use one of the many ‘attitude to risk’ calculators that are available and decide which combination of investments could help you achieve your objectives without keeping you awake at night.
Then decide how hands on you want to be – do you want to do your own research and make individual investment decisions, would you prefer collective investments that either track an index or have an active investment manager, would you like to be able to select a ready-made, risk adjusted portfolio, or would you prefer to hand over responsibility to an advisor – IFA or robo advisor; there will be a solution that fits your level of knowledge, desire to get stuck in and fee tolerance.
And remember, this isn’t a race; it is a journey toward the achievement of a carefully constructed set of objectives.
By adopting a long term strategy young investors can spread risks associated with stock market volatility although there is not a ‘no risk’ option; the value of even the safest havens of cash savings or investing in bonds can be eroded by inflation meaning that at the end of any given term, the buying power of each unit of currency is reduced.
‘young investors can spread risks associated with stock market volatility’
When considered in terms of buying power, investing in shares has been shown to deliver the best returns over a long-term investment strategy, delivering strong long term real returns in the region of 8% over two centuries.
Whether it is something you decide yourself, take advice or trust the algorithms of a robo advisor, getting the right balance of risk and reward is key; finding investments that have the potential to deliver the outcomes you want, but without keeping you awake, and without the danger of wiping out your capital in a worst case scenario.
There are also varying levels of risk associated with individual investments within a particular asset class; on average shares may have delivered 8% over that time frame, but when riskier stocks are considered the spread was from a gain of 48% to a loss of 32%.
By contrast, a government bond is a government bond; there is no standard deviation in terms of the returns that can be achieved from a ‘gilt-edged’ investment, although the purchasing power of the result may be eroded by inflation during the period of the loan you make, and there will inevitably be attendant fees and taxes to consider.
Psychologically, if they are able to look beyond short term risk, young investors can take comfort in the fact that shares have always been the safest long term asset.
The message from the movement is that young adults should make the lifestyle changes and life choices to allow them to start investing now; however tough in the first instance, even small regular investments can deliver massive long term benefit as the stock market has proven to be a very productive long term builder of wealth.
‘even small regular investments can deliver massive long term benefit’
Financial education is the key to understanding the trade off between different investments types, and also to understanding the dynamic of an investment that may appear to be delivering indifferent returns, or indeed have slipped into reverse; what may be considered safe today, may be risky tomorrow, and vice versa.
So, despite the huge financial pressures faced by young adults, those that do take the plunge and become young investors have an awful lot of positives on their side; with the ability to withstand more financial risk, a well diversified portfolio skewed towards equities can even out volatility between the best and poorest performing stocks, whilst taking full advantage of what has been an incredibly productive source of wealth over a long time horizon.
There are now more ways than ever to achieve such a diverse portfolio, with generally low fees, and sophisticated monitoring and rebalancing tools to allow you to monitor your investments to ensure that you remain on track, or indeed make any adjustments required in response to changing circumstances or objectives.
Taking a short-term view of the market can be terrifying; young adults have the ability to take a much more pragmatic long term view and by investing sufficient time in their own financial education, will have the ability to understand the forces that are at work, and to make informed and rational investment decisions.
Self-directed, sometimes ‘retail’ investors, are often mocked for ‘buying high and selling low’ – allowing emotional responses to events such as the recent dip in the market to cause them to make poor short term decisions; those with a good level of financial education can avoid making a knee-jerk decision to follow the herd, whichever way it is heading.
It’s been sixty years since Harold Macmillan declared that ‘most of our people have never had it so good’; since then there has been an ebb and flow generally fuelled by allegations that one generation is unable to empathise with the financial challenges faced by another – not to mention the obsessive clamour to pigeonhole people which has thrown up labels such as iGeneration and ‘screenagers’.
‘none of us is stronger than all of us’
It could be that history records that today’s pensioners will be the wealthiest generation ever, benefiting hugely from an increase in house prices and often living very comfortably on final salary scheme pensions and reaping the benefits of having ‘told Sid’; however, when challenged, this claims to be a generation that has dragged itself up by the bootstraps having ‘had nothing’ as a child – scoffing at the idea that to not have the latest smart phone is an indication of poverty when they were used to receiving a satsuma and a lump of coal at Christmas.
One thing for sure is that millennials, post-millenials, Generation Y or generation Z – you pays your money and takes your choice – will have to take much greater personal control of their finances if they want to achieve financial freedom, and that is at the heart of the FIRE movement.
This is a topic we will return to as momentum and awareness grows, and social media will have a vital role as the movement grows apace – remember, none of us is stronger than all of us.