So far we have looked at diversifying between defensive and growth assets in order to set an appropriate level of risk.
To further spread that risk, it is essential to diversify within each category, as well. For example, it would be madness to hold only one share. The company might go bankrupt. It is much safer to invest across many shares.
In this section we’ll go through each class of investments and show how to diversify within it in order to manage risk.
Past performance is no guarantee of future performance
Here’s a common rookie investing error: you see that Acme Corp. goes up 14% in 2018. Then it goes up another 16% in 2019. You think, I must buy Acme shares, and quickly! You buy . . . and then in 2020 the share price falls by 22%. : (
The trouble with cryptocurrencies is that few are actually being used as currency. Instead they’re being used for speculation. Transactions that are made, are often transferred immediately back into fiat.
The original inspiration for bitcoin is yet to be realized – unimpeded trade across borders using a stable currency subject to no government control or manipulation.
Perhaps we could get things moving by making a gentlemen’s agreement to use a particular coin or token for trade within the dissident sphere.
Growth Assets 3: Alternatives to Shares and Real Estate
Most people trying to build wealth content themselves with simply investing in shares, or in shares plus their own home. A few purchase an investment property. Such conventional options are fine.
However, there are alternatives. Here I list a few for the more adventurous or unconventional investor. Like enlightenment, there are different paths to financial freedom. If the Roman Catholicism of shares and real estate is not for you, perhaps these Hare Krishna options might be of interest.
There is a way to invest only a small portion of your capital in property instead of buying a whole house. This is through a fund that pools investor money and uses it to invest in many properties. Such a fund is usually called a real estate investment trust (REIT, pronounced ‘reet’). Through this vehicle, you can put exactly as much or as little of your wealth into property as you want, with plenty left over for investing in shares and bonds in order to better diversify your holdings.
In addition, these REITs can invest in a variety of types of properties, i.e. mortgages, commercial office space, or retail, and they can invest across many locations, thus significantly reducing the risk should any one investment go bad. For some investors, this can be a good way of getting into property without having all the hassle of owning an actual house.
You might want to buy a property in order to charge others rent to live there rather than live in it yourself. In addition to the rent, which will perhaps increase over time, you’ll hopefully profit from capital gain when you eventually sell the property for a higher price. This is called an investment property.
In many countries it offers generous tax concessions. However, you should not be buying an investment property just for the tax advantage – it must be a sound asset to begin with.
Jessica Irvine is a Senior Economics Writer at the Sydney Morning Herald, one of Australia’s premier legacy media outlets. She’s kind of a big deal.
I’ve been following her with bemusement for a while, mostly because of her far-fetched stances on some issues. For example, she’s one of those jaded feminists who proclaim true equality will be reached when child-care is provided free by taxpayers (men) so that strong, independent single mothers like her don’t need to depend on any particular man.
Her reasoning powers are also on display in this TV appearance where she claims that a federal minister accused of rape (via a letter from a dead woman, not a police complaint) should not be given a ‘platform’ (press conference) to defend himself. On the grounds that the accuser can no longer speak for herself. Jessica’s not saying he’s guilty of course, just that men in parliament need to be ‘held to a higher standard’ and that ‘the Prime Minister should take a stronger stance’ (sack him without evidence).
Yikes, I only just found that one when searching for her qualifications. This was going to be a gentle piece but now the gloves are off. After all, such a prominent person with a national platform should be held to a higher standard.
Back to finance. Some time ago, Jessica gregariously wrote posts listing her exact superannuation savings, the cost of her house, and hinted at what deposit she’d put down and how’d she’d managed the financing – a bit of help from Australia’s most trusted institution, the Bank of Mum and Dad. No shame there. The median house price in Sydney and Melbourne is around $1M so purchasing a home is an intergeneration project.
Jargon: The terms ‘real estate’ and ‘property’ can include houses, apartments, office space, retail space, or even farmland.
Risk: Like shares, it is possible for the value of real estate to fall as well as rise. More about this below.
Return: If you go online you can enjoy reading never-ending arguments about which is the better growth investment in the long term, shares or real estate. These threads usually end in vicious personal insults and accusations that the other contributor is merely a shill for the rival investment vehicle, and an idiot. I’ll not get into it.
Let’s leave it at this: over a long investing horizon, returns on real estate in general are comparable to those of the stock market, i.e. pretty high. That’s what makes it a growth asset.
Some investments are recommended for, or restricted to, ‘sophisticated investors’, also called ‘accredited investors’. This is because the investment requires a high level of capital or expertise to manage properly. Such products are sometimes called ‘wholesale’, rather than ‘retail’, which means that they are mostly marketed to institutions rather than to individuals and often the minimum investment amount is half a million dollars or more.
Sometimes companies new to the stock market will have a ‘float’ – there will be an initial public offering of shares. This might be when a private company goes public in order to raise money for expansion. It might also happen when a formerly government-owned company is listed on the stock market. Readers might remember when Facebook first went public and floated on the stock market in 2012.
These tend to be risky investments as the value of the as-yet untraded shares is still uncertain. When we get to the part on how to invest in shares, I will not recommend specifically buying newly-floated shares.
Jargon: Shares can also be called ‘stocks’ or ‘equities’. Together with bonds, they can be called ‘securities’ because they can be sold on to third parties. Purchasing shares means to own a part-share of a company, as opposed to lending a company money as with bonds. If you bought 100% of all Toyota shares, you would own Toyota. I expect that my readers will only own tiny little slivers of many different companies.
Growth assets, as the name suggests, are the ones that will actually grow your wealth over time according to the magic of compounding returns, which we’ll explain in detail soon.
This is the sharp end of investing. In order to reach Financial Freedom Levels 3 (could work part time) or 4 (could cease working altogether), even if just for retirement in old age without depending on a precarious government pension, you will need to hold plenty of growth assets over a long period of time.
This chapter will explain how shares work and how best to invest in them. We will also examine alternative growth assets such as real estate, peer-to-peer lending, laundromats and royalties.
A cryptocurrency is a digital or virtual currency that is secured by cryptography, which makes it nearly impossible to counterfeit or double-spend. Many cryptocurrencies are decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. A defining feature of cryptocurrencies is that they are generally not issued by any central authority, rendering them theoretically immune to government interference or manipulation.[i]
I couldn’t be any clearer than Investopedia. Remember to refer to that site whenever you get confused. See how good it is?
There are many different cryptocurrencies on the market and many more will arrive in the future. The biggest, of course, is bitcoin. The second largest is Ethereum. Each is based on a different algorithm and works in a different way.
There are different investment categories. Some, like cash and bonds, are better for short-term investment because they are more stable but they generally have a lower rate of return. These are called ‘defensive investments’, i.e. they defend your wealth against the vagaries of fortune. Shares and equivalents are better for long-term investment because, while volatile, they offer higher potential (not guaranteed!) returns and you will have time to recover from losses. These are called ‘growth investments’ because they can increase, and not just preserve, your wealth. You will probably need a mix of both defensive and growth investments.
As an adult, you need to understand investing, just as you need to know how to drive a car, eat and exercise properly, wipe your bottom, or be able to independently support yourself through paid employment. No one is exempt.
If you want to do the math yourself, it works like this: In general, if you can live off four percent of your savings then that nest egg should last you a very long time, probably until death. We will get to the important provisos in a moment. First, let’s look at an example. Say you want to retire today on $50,000 per annum. Nice, hey? Let’s calculate:
A successful man is one who can lay a firm foundation with the bricks others have thrown at him.
– David Brinkley
It is not essential to have a high income in order to reach financial freedom. I promised a ‘poor man’s guide’, and this you shall have. However, if you can find a way to increase your income a bit, you’ll achieve financial freedom more quickly, and/or reach a higher level of financial freedom. As we will keep repeating, it is all about what you do with the money once you have it. Plenty of high-income people are floundering in debt and have no control over their finances at all.