The Evidence-Based Investor

Tag Archive: Plain English Finance

1. The advantage of owning the world

   December 15, 2019 6:30 am Comments Off on The advantage of owning the world

   The sixth in our series of articles serialising ANDREW CRAIG’s book How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely goes into the advantages awaiting investors who work to “own the world”.

   Andrew has worked in the City of London for over 20 years. In 2011, he founded plainenglishfinance.co.uk, a personal finance website that aims to help people to improve their finances.

    

   When I talk about “owning the world” I mean:

   You should own a wide variety of investment products or assets. In the long run you will want to have cash, shares, bonds, commodities and property, not just one or two of these.

   You should aim to own assets from all over the world, not just one geographical area such as the UK or the USA.

   You will recall from earlier in the book that the world economy as a whole continues to grow. You will also remember how important it is to be diversified. Owning the world means that you end up being diversified both geographically and by asset class.

   But what does this mean?

    

   Geographically diversified

   “Geographically diversified” simply means that if one part of the world is having a difficult time, perhaps Europe or the USA, you still have a good chance of making money because you have exposure to another part of the world that is going up a great deal, for example certain emerging markets or Japan. Every year, different parts of the world are stronger than others.

   Rather than trying to work out where the best place for your money will be next year, which is difficult and time-consuming, it is easiest just to be invested in every major part of the world. This means that you benefit from the consistent growth of the world economy as a whole. Bear in mind that the world has only really ever had ‘down’ years across the board in times of major war.

   One of the biggest mistakes people make with their investments is that they tend, in the main, to own assets from their own country. This means two things: firstly, that when that particular country or geographical area has a difficult time, their investments there will struggle. Secondly, that they miss out on the potential for explosive growth that comes with owning what some would deem to be more exotic parts of the world.

   It is worth noting that stock markets in many of the faster-growing areas of the world can double or even triple over quite short periods of time. With that sort of performance, you don’t need to have a large share of your money exposed to these markets in order to enjoy a material impact on growing your wealth and achieving the sorts of numbers we saw at the beginning of this book.

   There is no guarantee that this will continue. The trend might even reverse, and growth in the USA and the UK might one day again be better than in places like China, India and Brazil (at the time of writing this third edition of the book this is basically the case – underscoring the point).

   The key point here is that you may not want to spend too much time trying to work out what is going to happen. A simpler approach is just to ensure that you have exposure to the world as a whole. As the world keeps growing and developing, this approach will give you the best chance of benefiting from that growth.

   I would repeat that the only time the world as a whole has failed to grow has been in times of major wars. If we are unlucky enough for the “Third World War” to happen in our lifetimes, your investment performance might be the least of your concerns. Having said that, without wanting to sound horribly cynical, smart money has usually found that even wartime can be reasonably lucrative. Even in the case of another world war, there will be opportunities for the informed and enlightened to keep their money safe and possibly even to grow it.

   Leaving aside that rather depressing possibility, however, in the more normal run of things, “owning the world” simply means that you want to end up with exposure to everywhere: the UK, Europe, the USA, Japan and the rest of Asia, as well as various emerging markets. You will want to own assets in as many places as possible so that you catch those doubles and triples over the years, and benefit from the explosive growth of the global middle class. In an ideal world, you might also own a wide range of types of company – large and small – in all of these regions.

   One of the reasons relatively few people pursued this sort of strategy in the past is that it used to be very hard for a private individual to invest like this. It is also the case that relatively few financial advisers have a grasp of how to do it or even why it is a good idea for all the reasons we looked at earlier in the book. Not that long ago, this strategy realistically wasn’t possible for a private individual. Today you can get closer than ever before to this sort of asset allocation without paying crazy fees – even if you only have a small amount of money to start with.

    

   Diversified by asset class

   “Diversified by asset class” means that in those dreaded crash years when shares (equities/stock markets) fall off a cliff, as most of them did in 2000 and 2008, for example, you won’t lose a vast chunk of your money like everyone else. You’ll actually have a good chance of having a positive year (or at least a far less negative one than most people) because, even though your shares might have fallen in value, you will own other assets such as property, bonds, gold, silver, oil and other commodities. Many of these will have held up very well in a bad year for shares. The reason this happens is due to a phenomenon called “negative correlation”.

   It is often the case in investment that certain types of asset tend to go up when others go down; that is to say, they are negatively correlated. This relationship in real life is never exact, but if you own a wide variety of types of asset rather than, say, just shares or just property, you have a much better chance of seeing your money continue to grow if there is a stock market or property crash, for example.

   Gold went up in value every year from 2000 until 2011. What a shame that the vast majority of people in the world did not own any. Before that, shares had gone up virtually every year for a decade or so, whereas gold went sideways or down for a long time. In 2007–9, stock markets around the world crashed by more than half but oil hit an all-time high in 2008 and gold was up nearly 20 per cent in 2009.

   In the long run, it is much easier to own a mixture of assets so that you have a better chance of owning something that goes up when another type of asset crashes.

   To summarise: the holy grail here is your money being put to work with the minimum of effort but the maximum exposure to the world as a whole. Ultimately, you will want to be the proud owner of a wide variety of assets – shares from all over the world, cash, commodities, bonds and property – so that you will benefit from global growth, wherever it is, in the future.

    

   

    

   In case you missed the other articles in this series:

   Bitcoin and other crypto assets: what are they really?

   There is significant real inflation in the world

   Two amazing facts about finance

   Financial independence is entirely realistic

   It’s easier to make money from your money than from your work

    

2. There is significant real inflation in the world

   November 30, 2019 6:30 am Comments Off on There is significant real inflation in the world

    

   In the fourth of our articles serialising ANDREW CRAIG’s book How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely, Andrew covers what we all need to know about inflation.

   Andrew has worked in the City of London for over 20 years. In 2011, he founded plainenglishfinance.co.uk, a personal finance website that aims to help people to improve their finances.

    

   Since the early 1970s central banks all over the world have been printing money at a faster and faster rate. Or, to put it more accurately, they have been inventing money rather than printing it. They don’t physically print much of it these days but simply add some zeroes to accounts in a central computer. The sheer scale of the acceleration in recent years is extraordinary.

    

   “When I was a lad…”

   Stop and think for a moment about the prices of the most important things you need to buy, and compare them to what they cost ten years ago, or even when you were a child. If you really think about it, nearly everything you need to buy has gone up in price significantly.

   This is inflation at work. Many people think that they understand inflation. I would argue that the reality is that most people have only a vague idea of its existence, and they absolutely don’t ‘get’ its sheer magnitude and what it means for their long-term financial situation.

   This is extremely bad news for most people but relatively good news for the small minority who do understand. The value (purchasing power) of one pound or one dollar has fallen by around 90 per cent since 1971. Worse, this negative trend in the value of money is accelerating thanks to the actions of politicians and central banks all over the world as they continue to invent large amounts of new money out of thin air. In the UK and the USA, this is called quantitative easing (QE).

    

   But what is inflation?

   “But inflation is still really quite low – 2 per cent or something, isn’t it?” I hear you say.

   Yes, but what is ‘inflation’ as reported by governments? Here is a little story that may help explain why official government inflation numbers are of very little use to us. Understanding this is incredibly important for your financial future.

   In the 1980s, the British government changed the definition of “unemployment” on numerous occasions. Each time it changed, the unemployment number “fell”. It is not hard to argue that all that was going on here was that people we would most likely understand to be “unemployed”, such as adults who didn’t have a job and wanted one, were no longer defined that way and so dropped out of the numbers.

   Some were reclassified as “disabled” (those earning disability benefits) – now a huge number in the UK – while others were said to be on a “youth training scheme” or reclassified in any number of dubious ways to take them off the headline unemployment numbers discussed in the media.

   At the time that I wrote the first edition of this book, the UK had about 2.7 million “unemployed” (happily, this number has fallen a long way since then). But there continue to be another several million who do not have a job but are classified differently to keep them out of the headline unemployment numbers.

    

   Unemployment? I thought we were talking about inflation!

   ‘Why is this relevant to inflation?’ I hear you ask.

   The answer is that governments all over the world have been playing the same trick – or worse – with their inflation calculations. The US authorities made the biggest change to the calculation in 1996 when President Clinton implemented adjustments recommended by something called the Boskin Commission. If the pre-1996 method was still being used, US and UK inflation today would be closer to 10 per cent.

   I cannot stress enough how important it is to understand this reality. In my experience, almost no one does. Or, at the very least, they do not understand the scale of the problem. I have been constantly amazed by the complete ignorance of the facts among members of the general population and investment professionals alike. Few journalists seem to understand what is actually going on; nor do virtually any of the people I have worked with in the City, many of whom are analysts and economists at major investment firms. As a result, understanding why today’s inflation numbers are essentially a fiction may give you an investing advantage.

    

   Substitution, weighting, and hedonics

   ‘Trickery and treachery are the practices of fools that have not the wits enough to be honest.’
   – Benjamin Frankin

   There are three particularly dubious ways in which governments ensure that inflation numbers end up always being lower than the true increase in your cost of living (so you think you are wealthier than you actually are and they get to pay out less in social security, given that this is linked to the ‘official’ inflation numbers). These dubious mechanisms are called ‘substitution’, ‘geometric weighting’ and ‘hedonic adjustment’. Let’s look at each in turn:

   Substitution is very simply when the statisticians replace something that is going up in cost a great deal with something that isn’t. For example, they might replace cod that has doubled in price with farmed salmon that may even have become cheaper. The cod is still twice the price but the inflation number hasn’t budged. As you can imagine, this is an easy game to play. You might replace fillet steak with hamburgers or even, as one gnarly old economist has joked, dog food, in the fullness of time.

   Geometric weighting is where the authorities include something that has gone up in price a lot as an inappropriately low percentage of the calculation. For example, the healthcare sector represents just over 17 per cent of the US economy but it makes up only 6 per cent of the US inflation calculation. Healthcare inflation has been notoriously high in recent years given the ageing population’s demand for it (running in the double digits), but it hasn’t had anything like the impact on inflation numbers it arguably should have done, as the authorities have just made it an inappropriately small percentage of the calculation.
   

   Hedonic adjustment is, in my opinion, even more gratuitous than the last two. This is when an item is reduced in price for the purposes of the inflation calculation because the authorities argue (subjectively) that you’re getting more for your money and you are therefore effectively paying less. Let’s say that last year a 50-inch television from Sony or Samsung cost £1,000. This year there is a new 50-inch television that has a slightly better screen and improved functionality and still costs £1,000. The statisticians will then say that the TV is, say, 20 per cent better than last year’s TV and adjust its price in the inflation calculation from £1,000 down to £800. The TV actually still costs £1,000, but they have included it in the calculation at £800. This trick is used to adjust the price of nearly half of all the products that go into the inflation calculation.

   I am not making this up. This is not a conspiracy theory. This information is all widely available online if you “read the small print”, as it were – it’s just that a significant majority of our journalists and financial professionals don’t.

    

   In summary

   I want to note that the actions of many governments in recent years have led to a situation where we are in the throes of significant monetary inflation. And when there is significant inflation, the value of cash falls as the price of ‘things’ increases.

   The smart investor benefits from this by making sure he or she owns the very things that are going up in price. As a basic rule of thumb, this includes many financial assets, shares, precious (monetary) metals, commodities and property. We don’t need to understand in detail why stock markets, gold, oil, wheat, cotton, coffee, art, houses, jewellery and wine go up in price when there is inflation. It is enough just to be aware that this is the case, just as it has been for the last several years.

    

   

    

   NEXT TIME: What really are bitcoin and other “crypto” assets?

    

   Interested in reading more from Andrew Craig?

   Two amazing facts about finance

   Financial independence is entirely realistic

   It’s easier to make money from your money than from your work

    

3. Two amazing facts about finance

   November 27, 2019 6:30 am Comments Off on Two amazing facts about finance

   The third of our articles serialising ANDREW CRAIG’s book How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely covers the two simple, but amazing, facts about finance that we should all be aware of.

   Andrew has worked in the City of London for over 20 years. In 2011, he founded plainenglishfinance.co.uk, a personal finance website that aims to help people to improve their finances.

    

   I believe there are two amazing facts about finance to focus on immediately. Once you understand these, you should very quickly start to see the incredible possibility that effective investment offers you.

    

   Fact 1: Compound interest is “the eighth wonder of the world”

   One of the main objections I hear when I share with people my excitement about the wonderful world of investing is: “But that won’t work for me, I make too little to have enough left over to invest.”

   Wrong! Wrong! Wrong!

   Many people believe that they need a big lump sum or the ability to save a large amount of money every month to make investment worthwhile. People often believe that investment is “for the rich” and not for them. This is absolutely not true. With money, as with so many things in life, it is the tortoise who generally wins the race, not the hare.

   Those who understand money and end up with lots of it tend to be those who understand that little and often is the road to success.

   You are much more likely to save a small amount of money right now than you are to save a large amount of money at some time in the future. I’m sure you are familiar with this psychology – it is also true of going to the gym, revising for exams, doing housework, and so on. As you are about to see, time is one of your biggest allies in becoming wealthy, so you must take action now or as soon as possible. Start small but start now. If you do start small, no matter how small, you will enable yourself to benefit from the magic of compound interest immediately.

   So, what is compound interest and why is it so important?

   If you take nothing more away from this book than an understanding of the incredible power of compound interest, then you will have joined a lucky (and generally wealthy) few. None other than Albert Einstein described compound interest as ‘the eighth wonder of the world’. Compound interest is, quite literally, a form of free money … and it is free money that grows like a weed over time.

   But how can this be?

   Well, imagine that you invested £1,000 today. Imagine, too, that whatever you invested it in went up by 10 per cent this year. In this scenario, you would have £1,100 one year later: your original sum, plus £100 of interest, or return on a share or other investment. Simple so far. Now comes the ‘free money’ part. Assume you invested that £1,100 for another year and achieved 10 per cent again. The following year you would have £1,210. This time you have made £110 of interest (1.1 x £1,100 = £1,210), but £10 of that interest is essentially free money. It is the interest you have been paid on your interest – or, to put it another way, the return on your return. At first glance this may not seem particularly exciting, but over time the effect is incredibly powerful.

    

   Fact 2: You have access to financial products and information sources that are better than ever before

   One of the paradoxes of the last few years is that people have been so focused on the “global financial crisis” that they have generally missed some very interesting developments in the finance industry as a whole. It is only in the relatively recent past that the financial services industry has developed to the point that people from any background can invest in almost any asset class in almost any country and can do so easily, quickly, cheaply and, in the UK in particular, tax-efficiently too.

   Let’s say you thought that the price of oil was going to increase. (Don’t worry for now about how you might have come to form this opinion.) Today you can own some oil with the click of a mouse, and with far lower fees than in the past. You can even make money betting that the price of oil will fall if that is what you believe will happen. Or perhaps you think that Brazilian farmland is going to increase in value, as the world’s population grows from 7 to 9 billion and Brazilian crops enjoy increasing demand. You can benefit financially from this belief from the comfort of your home.

   Not that long ago, these sorts of investments were very difficult or even impossible to make. If you wanted to benefit from growth somewhere like India, China or Singapore or to make money from gold, oil or Brazilian farms, you needed a large amount of money, a relationship with a private banker somewhere like Switzerland, and a willingness to pay high fees and deal with lawyers. In the last few years, thanks to the Internet and intense innovation from financial services companies around the world, these hurdles have pretty much disappeared. As a result, investing is far simpler for us than it was for our parents or grandparents.

   These days, if you have a basic grasp of what you are doing, you can easily and cheaply become the owner of almost anything. You have never been in a better position to make money out of a good idea than you are today. Sadly, very few people have any idea how to do this.

   The reason for this is that the vast majority of people fall into one of three categories:

   Those who do not invest any money at all

   Those who do invest but use their high street bank for financial advice

   Those who do invest but go to a substandard financial adviser.

   There are now almost as many financial products available in the world as there are wine producers. Sadly, the main high street banks – and many IFAs – are like a wine merchant who sells a very limited range of mediocre wines at high prices.

   There is a wonderful world of investment opportunity available out there if you know where to go. The key is choosing the right things to own, knowing how and where to buy them, and paying the right price for them.

    

   

   NEXT TIME: There is significant real inflation in the world

   Missed the previous two articles in this series?

   Financial independence is entirely realistic

   It’s easier to make money from your money than from your work

    

4. It’s easier to make money from your money than your work

   November 23, 2019 12:30 pm Comments Off on It’s easier to make money from your money than your work

   In the second part of our serialisation of ANDREW CRAIG’s book How to Own the World: A Plain English Guide to Thinking Globally and Investing Wisely, Andrew explains that, although few people realise it, it has never been easier for ordinary people to invest and find success in the stock market.

   Andrew has worked in the City of London for over 20 years; and in 2011, he founded plainenglishfinance.co.uk, a personal finance website that aims to help people to improve their finances.

    

   Most people do not have confidence in their abilities, when it comes to investing their own money.

   Be honest, did you spend more time researching the purchase of your last car (or pizza delivery or pair of jeans for that matter) than you have ever spent learning the best way to look after your money or reading a solid “how to invest” book? Do your eyes glaze over when you hear words like bond, equity and commodity?

   If you answered “yes” to the above questions, don’t worry. You are in good company. In my experience, this is true of the vast majority of people. Crazy as it might sound, this includes many financial advisers and people who work in financial services, for reasons we will examine shortly.

   This is a huge shame given that the number-one secret of nearly all truly wealthy people throughout history is that they do understand money and how they can make more from it.

   Over time, it is actually far easier, quicker and less hassle to have your money (capital) make you money than it is to make money from your work (labour). Whether we like it or not, we live in a capitalist era. One of the fundamental truths of capitalism is that capital makes a great deal more money than labour; it should be pretty obvious to you that people who own businesses tend to make far more money than people who work for them. This is truer today than at any other time in history, primarily because capital is more mobile than ever before. recent figures show that capital’s share of the world’s overall wealth relative to labour is the highest it has ever been – something that was the subject of one of the most famous books on economics of the last few decades, Thomas Piketty’s Capital in the Twenty-First Century. This is one of the reasons why the rich who own businesses are richer than ever, relative to people who work for those businesses.

   The great news — and what so few people realise — is that the stock market and other forms of investment are fundamentally just fantastic innovations that enable anyone to become a business owner, almost no matter how little money they have to start with. In addition, it has never been easier to invest, thanks to inexpensive and powerful online tools that have emerged in the last decade or so.

   The fact that making money from money is ultimately easier than making money from work is entirely logical when you consider that you only have a limited number of hours in which to work. On the other hand, your money ‘never sleeps’, as the old saying is quite right in telling us. Money will also breed like rabbits if you know what you’re doing. Even multimillionaire actors, businesspeople and rock stars have often made vastly more money from their money than from their performance fees, salaries or record sales.

   It is not an exaggeration to say that virtually every very wealthy person in history has accrued far more money from their investments than from being paid for their work. It is also worth noting that they have invariably spent far less time making money from their money than they have pursuing their career or passion. Once your money starts making you money, you will find yourself with the freedom to do anything you want — whether you get paid for your time or not. To become rich, you need to get into this mindset.

   The fact that most people do not understand this is a tragedy and the main reason so many of the population struggle financially. Because they have never studied it, most people have unfortunate, incorrect and limiting beliefs about how money works: ‘the stock market is a casino’; ‘investment is risky’; ‘cash is safe’. All three of these statements are inherently untrue in one way or another, a fact that is often well understood by the rich. (I would add that the dictum ‘money is the root of all evil’ is a similarly unhelpful statement — and one which has caused a great deal of misery for people who believe it to be true, in my own view.)

   You might find it hard to believe, but “you can’t go wrong with bricks and mortar” is also a dangerous statement. Many people throughout history, including in the past few years, have gone horribly wrong with bricks and mortar, and many more will do so in the future. We will look at this in more detail in Chapter 5. It is also fair to say that cash is nowhere near as safe as you might think, given what is happening in terms of real inflation these days.

   The reason many people have come to believe the stock market is a casino is simply that most people know nothing at all or incredibly little about it. Amazingly, this includes many of the people investing in it.

   I have lost count of the number of people I have met over the years who buy and sell shares without understanding almost any of the things that you should know before investing in the stock market. This is why “average” investment performance numbers are of no use to you and you should ignore them. A top sprinter who can run the 100 metres in under ten seconds doesn’t care that the ‘average’ adult human can run it in tens of seconds. The fact that there are large numbers of slow people bringing down the mathematical average has no impact at all on the professional athlete’s ability to run at his or her speed. We forget this logic when we decide that investment is difficult because the “average” return is only x per cent. This number includes a vast number of people who have no clue what they are doing.

    

   

    

   NEXT TIME: Two amazing facts about finance

   And if you missed the first article in the series, give it a read here:

   Financial independence is entirely realistic