As a person looking to become financially independent and fire my boss, I’m always investing my money. As soon as it enters my bank account, I assign every euro a job, and a lot of it goes to my investments. This is my investment strategy to become financially independent in Europe.
My Basic Investment Principles
My investment strategy is based on a few basic principles that I also tried to cover in The Introduction To Investing. You can read all of the details over there. Just make sure to pour yourself a nice cup of tea before you start reading ;-).
In short, my portfolio consists of stocks (I temporarily removed bonds) and cash (to save up for an investment in real estate). I do so through low cost index tracking ETFs and mainly follow a buy-and-hold investment strategy.
Low Cost Index ETFs
When you start investing in stocks and bonds, you might be tempted to manually pick stocks to buy and sell. This is a losing strategy over time! By far the only thing that seems to work long term is following the market. That means that you don’t buy individual stocks, you just buy all of them.
Luckily, we can invest in products called index funds and exchange-traded funds (ETFs). These are simple funds design to invest all the money they manage into a pool of stocks or bonds, that make up an index. So instead of having to buy, manage, rebalance more than 5.000 individual shares, I simply buy VWRL and IUSN and be done with it. For a price of about 0.22% – 0.35% management fee per year Vanguard and iShares are investing my money in the world economy so I don’t have to worry about it.
Total Expense Ratio
Now some of you might say, wait B, isn’t 0.22% a bit expensive for an index tracker? Yes, it is. You can get index funds and ETFs that are cheaper than that. However, here in The Netherlands we got one of the most stupid laws that prevents citizens from investing in funds that don’t provide documentation in Dutch. So the ultra-low fee funds like VTI and VXUS that offer worldwide equity investments for <0.10% are not available anymore. That’s unfortunate, as most financial independence people would want these funds in their investment strategy.
Low costs are something to strive for. A lot of investment fund and wealth managers that you see in ads, are super expensive. Most of them are in the 1% TER (total expense ratio) per year, while some can be up to an incredible 2%! That means that when you investments return 5% that year, you receive only 3! The difference goes to the fund manager… Now compare that to the 0.22% I’m paying, or the less that 0.1% some others are paying. Instant profit! Not to mention that most actively managed funds under perform the index over the long run, even before fees.
The Importance of Low Cost Funds
I’m a young guy at only 25 years of age (as of the moment I’m writing this). That means my investment horizon is really long. Although I plan to be financially independent by age 40, that doesn’t mean I’m completely out of the market by then. So my investments will probably be there for the next 50+ years. However, it is very difficult to calculate the part where I start drawing from my investments, so let’s just calculate the first 20 years of my career, my accumulation phase.
Let’s say I can invest 18,000 euro on average every year (1,500 per month) from age 20 until age 40. These are my working years. Of course, in the beginning I invest way less, in the end it might be more due to an increasing salary. But let’s go with 18,000 for the sake of this example. We know that equities have yielded about 7% on average, after inflation. When we invest 18,000 per year, for 20 years, yielding 7% we end up with a portfolio worth almost 790,000 euro. However, I do not get a 7% return. Due to the costs of my ETFs, I only get a 6,78% return on average. When we plug in those numbers, we end up with a balance of 766,000 euro. A difference of 24,000 or almost a year and a half of savings.
How Actively Managed Funds Can Cost You Serious Money
What do you think that happens with a cost of 1 or 2%? You will end up with a balance of 702,000 euro at 1% cost, or 625,000 at 2%… So even though 2% doesn’t sound like a lot, it actually is a difference of 18%, or 141,000 euro! Yes, that is the amount of money you just gave to your fund manager!
Remember, this is only for the first 20 years. Due to the power of compounding interest, if we extend the calculations to 30, 40, 50 years these numbers will grow to enormous differences. See the table below:
As you see, that 141,000 difference quickly grows to almost half a million euros in the next 10 years, and will continue to grow to a difference of almost 6 million by year 60 if we keep compounding. This is why we, the financial independence bloggers, keep stressing the fact that you need to invest in low cost funds!
Buy and Hold Investment Strategy
Another part of my investment strategy is that I don’t trade, meaning I don’t buy and sell all the time. I do buy, and then I wait and buy more. That is called buy and hold.
The reason behind this is that I’m in it for the long term. I don’t chase the game today, tomorrow, even this year. I want to be free in 15 years. That means I have to make a consistent return on my money over the next 15 years and then the 40 years after that. If I constantly buy and sell, not only do I incur high trading fees every time I buy or sell, I’m also likely to under perform the market.
It is difficult for me though, to just buy and hold. I am very sensitive to the numbers, looking at them every day. Just stop doing that. Even delete your broker’s app from your phone. If you don’t see your balance going up and down every day, you’ll not be tempted to trade and time the market that much.
Investments Over Mortgage Payments
The last bit on my investment strategy is that I consider investing more important than becoming debt free. Heck, I even took out more mortgage debt to invest!
The reason for that is that I expect my investments to grow much quicker than my mortgage interest. When I first bought my apartment I paid 1,90% in interest, before tax deductions. Now after refinancing, I pay only 1,40%. So given tax deductions the net interest rate will be somewhere around 1,1% and due to inflation I pay a negative interest rate in real terms.
So why should I pay off that debt so quickly, when I can just invest in my ETFs and real estate and be done with it? One reason to pay off the mortgage debt would be to lower your monthly payments. Yes, if you can barely survive the payments on your debt definitely prioritise to pay them off early. But when you have enough liquidity, I wouldn’t bother, not with these interest rates.
Of course, for others there might be a valid reason to prioritise paying off debt instead of investing. If you do, the Debt Snowball vs Debt Avalanche is a nice post that goes into more details regarding debt strategies.
The Details of My Investment Strategy
So in the first part of this post I detailed out the big lines of my investment strategy. Now I would like to dive a little deeper in the specifics. There’s not that much to it, but I want to share with you the funds that I use.
Just remember that I’m not an investment professional, and while these funds work for me, they might not necessarily work for you. Do your own research.
Overall Investment Allocations
So overall, I want to allocate 50% of my investments towards “the market”, that is, investments in stocks and bonds. The other 50% I would like to have in rental real estate. I also invest money in my pillar two retirement accounts, but can probably optimise a bit there.
The part that goes into stocks and bonds, I decided to split up according to my age. Every year, I want to allocate a little bit more money towards bonds and less towards stocks. The formula I use is age – 10 as your percentage of bonds. I’m 25 years old when writing this, that means I would allocate 15% of my money in the market to bonds and the remaining 85% to stocks.
So that accounts for 50% of my investments. The other 50% I want to have in real estate. However I cannot seem to find any good investment property these days. The market in The Netherlands is crazy hot right now, and there are almost no deals to be found. Because everything is so expensive, the rent on a property doesn’t justify the mortgage payments and costs anymore.
This 50% of my investments I’m saving up in cash. I realise that is an enormous drag on my portfolio. However, if I spot a deal in the market I want to be able to quickly move and purchase property. If the market is down, and my stocks are at a big loss, I don’t want to sell them. That’s why I save up for real estate in cash.
Temporarily No Bonds
Because I’m holding on to quite some cash as opposed to investing everything, I sold all my bonds recently. The reasons for that warrant a post on their own, but mostly I’m interested in bonds because of their rebalancing buffer. If stocks go down, and bonds stay flat or go up, you can sell some bonds and purchase stocks. This is essentially a way to buy low and sell high without timing the market.
At the moment, the real estate cash works as a buffer to rebalance. If stocks fall, so my cash reserves go over 50%, I will just purchase more stocks to keep the 50/50 in place. The other way around, when stocks rally and become really expensive, I need to allocate more of my monthly savings to cash to keep that at 50%.
Specific Funds I Invest In
Please note that this is not actual investment advice. I made these investments after hours and hours of research. Do you own research! Of course, use my experiences to guide you, but always make your own decisions based on your situation, not mine.
The funds I would like to invest in are VTI and VXUS, two index tracking ETFs from Vanguard that give investors a very low cost option to purchase the entire world economy. Together, they include the US and non-US equities, in both developed and emerging markets, and through a range of large to small cap companies.
However, here we can can’t buy them. I hear that in a lot of other European countries we have the same problem. Since this year, a new law is in place to force fund managers to come up with documentation in Dutch, which they simply will not do for most funds.
So we’re stuck with the next best alternative, which is the slightly more expensive VWRL, a world tracker from Vanguard. It tracks an index of the entire world’s equity markets in the large and mid cap segment. To account for small cap companies, I buy IUSN, a world wide small cap tracker from Blackrock / iShares.
The specific allocation I try to keep between the two ETFs is 90/10, because about 10% of the global stock market weight is small caps.
What is your investment strategy? Do you also invest in index funds, or do you incorporate more exotic investments? Let me know in the comment section below.