A LAYMAN’s GUIDE TO
UNDERSTANDING INVESTMENT AND WEALTH MANAGEMENT,
PROTECTING AND PRESERVING YOUR WEALTH
By: Eelco Lodewijks
I, Eelco Lodewijks, am not a qualified Investment Advisor.
The aim of this book is to educate. To teach you how to think about investment. To help you understand investment considerations and strategies.
As trading and investing in any financial markets may involve serious risk of loss, I recommend that you also consult with a qualified investment advisor.
The content of this report represents my opinions. I am a retired Civil Engineer with diverse interests. Where applicable, the content should be deemed informative guidance to get the reader thinking and not specific advice.
Aside: My book Technology Tsunami Alert will be published mid-2020. It reveals the breadth and depth of technological disruption in the near future, so that they become aware of the risks and opportunities and are able to choose a better future. See website at
CHAPTER 1 – INTRODUCTION/PREFACE
I dedicate this to my daughter, and anyone, who expressed a desire to better understand “Investment”, so that they could better manage, preserve and grow their wealth. Since she lives abroad, I was unable to share my knowledge with her, except by way of this book. The advantage is that I now have a “book” that I can share with anyone who wishes to understand this space. I hope you enjoy it. If you do, let me know on https://eelcogold.com/
Most people are very good at spending, but not good at saving for a rainy day, which is not wise!! Worse still, for those who are savers, it has always been my contention that:
“We spend a lifetime accruing wealth and no time learning how to look after it”,
which is illogical as it is a very important component of our future happiness and welfare.
When it comes to their investments, most people say: “I find it all confusing” and/or “I am not interested in all this”, so they can hardly wait to hand the entire responsibility over to some investment broker. However, that is risky, because some brokers are outright charlatans, few “truly” understand their role and/or know what they are doing, and very few are “truly” and “honestly” trying to serve your “very best” interests. The majority merely abide by the tried and tested rules and watch the commissions rolling in, which they try to maximise. Very few “actively” try to consistently maximise your return on investment and continually preserve your wealth. Regardless, “totally and entirely” handing over the responsibility for preserving and growing your wealth is counterintuitive, since,
“You can delegate a task, but you can “NEVER” delegate such responsibility”.
Therefore, when your portfolio loses money, you cannot entirely blame your fund manager, as it is “arguably” your fault for not understanding the big picture and participating in the decision-making process. Contrarily, you both “need” and “pay” your broker, and so you should be able to trust him/her to do “everything in his power” to maximise your investments and preserve your wealth. Therefore, make sure you choose your broker wisely. More about this in a later chapter.
Accordingly, the purpose of this book is not to make you an expert, but to give you an overview of the “remarkably” easily understandable investment arena, so that you can intelligently engage with your broker. However, while each of the individual concepts and the overall picture are simple and easily understood, their “subtle” interactions in the marketplace form a complex web of interconnected interdependent influences and links, which “nobody” fully understands. It is important to ignore this complexity and stick with the simple concepts conveyed in this writ, as these will be sufficient to provide you with a fairly visual reference map. Bottom line, this book aims to reveal the art of investment in general, and how to think about your investment strategies in particular. For perspective:
Above, I said understanding investment is remarkably simple. Warren Buffet calls investing a “simple game” that financial advisors have convinced the public is harder than it really is. My response is that it is not that simple because then anyone could succeed. However, it is certainly not as complex as most think it is. Buffet also said that “in most cases, “monkeys” could provide better investment returns simply by throwing money at American companies” (I say in a bull market), and, “You can have monkeys throwing darts at a page, and, you know, take away the management fees and everything, I’ll bet on the monkeys (over the advisors)”.
Does he conclude this based on the fact that most funds to not beat the markets over time?
I do have one problem in that we are faced with a bit of a chicken and egg situation. I need to introduce some important basic concepts first, because I will confuse you if I deal with the bigger picture before you understand the terminology and basic concepts. Therefore, I have chosen to go with basic concepts first, as these lay a foundation that will help you better understand the bigger picture. To assist you, I have named most individual chapters after each of these concepts, and tried to keep these short, so that you can refer to them whenever you so wish. You may end up having to read all this all twice if you struggled the first time.
I have kept most of the chapters short, mostly between 1-3 pages, so you can read one a day for a month. I really recommend you browse through the table of contents, to get a sense of the range of the topics, because many of the later chapters are even more important than the earlier chapters. Please note! Keeping it short and simple means I oversimplify some things, so do not hold it against me if you understand some things better than I have outlined.
NB! This is first and foremost a book for lay people. Therefore, I will precede some chapters with a brief “KEY CONCEPT TO GRASP” summary. Understanding this Key Concept will hopefully make it easier for you to understand the remainder of the chapter.
It is also important to remember that each of us has his/her own biases and preferences. Therefore, the purpose of this “book” is to give you insights, not answers, to make you “think”, whether, or not, you agree with everything I say. Once you truly understand the basic concepts properly, do not dwell on any single aspect. Rather allow your intuition to assimilate the big picture and guide you. In my opinion, this is really important.
- After the two introductory chapters, Chapter 3 explains the “basic four pillar” investment matrix that is every investor’s essential tool for understanding prudent diversification.
- These are followed by three “less financial” chapters that have a critically important bearing on investment “in this modern era”.
- Next, we have two key concepts that you need to understand, comprising a) the role of interest rates on asset pricing, and b) a useful graphic depiction of Bull vs Bear markets.
- I then explain the role and importance of each of the asset classes referred to in chapter 3, and other less traditional ones, with considerations that have a bearing on each of these.
- Thereafter, we get into the real meat of risk management, broker selection, performance measurement, wealth building and really important wealth measurement considerations.
Bear with me as you preferably need to grasp the essence of every concept, before we can progress to the bigger picture. That said, if you do not, hopefully it will all become clearer as you progress though the chapters or when you read it all for the second, or even a third time. It will almost certainly be worthwhile reading it all a second time.
Have fun, because, in my opinion, learning new stuff is always fun.
ASIDE: For the most part, the information outlined in this is a book does not date.
However, I periodically make “current” market comments, for perspective, which may be useful if it is all being read in the early 2020s. I also make many references to Gold and Silver, merely because these are currently offering interesting opportunities for greater investment diversification, as at 2021/22. NB! There is a time to own these and a time not to own these, so they are not an inevitable part of your portfolio. However, they should be in 2022-2026.
Some key insights:
It is important to understand that Economics is all about humans, because it is merely a reflection of human activity, decisions and behaviour in the marketplace and business arena.
That is, without humans, there is no economy, so it is important to understand how human behaviour in government, corporate and commercial space is impacting on both the markets and the economy. In fact, it is human interference that introduces much of the complexity and uncertainty. It is the shifts in the psychology of the masses between Greed and Fear that accounts for market and price fluctuations. It is greed and the human desire for power that corrupts, which results in anticompetitive practices. Similarly, it is always good to understand the degree of manipulation of official statistics, at the behest of government, as this distorts the market picture. All this distorts free markets and market signals, which can mask huge risks, or present opportunities. Therefore, it is important to understand that it is human interference and emotion that causes most of the fluctuations in the Equity and other markets.
Unfortunately, our world is also becoming increasingly complex as new technologies are facilitating new ways of doing business. These are upsetting conventional economic models and business practices. This makes a clear understanding of “diversification” to reduce risk, more important than ever. What I mean by this is that you also need to have a broad sense of what is going on in the world, as that has a bearing on “safe” investing, particularly if you are buying individual shares. For example: The rate of change of technology can make products or companies (like Kodak and Nokia) obsolete within a year, or it can birth emerging technology companies like Amazon and Tesla, where the truly great returns can be made. Therefore, every company, even the newest company, is now perpetually at risk of being usurped or made obsolete by a new technology or competitors with a better offering. This is particularly true of platform-based companies like Facebook and Netflix. That said, the basics of good business remain the same. For example: Every business must provide good value at the right price. Your revenue should exceed your costs. Good strategic and financial management are essential. Good service is critical, etc.
Remember, the primary objective of prudent investing is to “preserve” and “grow” your wealth, “in real terms” after “adjusting for inflation”, to ensure that you are not eating dog or cat food in your latter years. Preserving your wealth “in real terms” is hard enough, whereas actually, growing your wealth is a real challenge. Therefore, you and your broker should strive to adopt strategies that will reliably achieve the preservation and sustainable growth of your “real” wealth in the long term. Sometimes, this requires a willingness to accept a slightly smaller return on your investments for a short time, such as when you are adopting conservative/defensive strategies when markets are overvalued. Remember, small, short-term losses cannot be avoided, but big and longer-term losses should be avoided at all cost!
It is important to remember that investments are broadly split into two groups. The most important group are those investments that have value by virtue of their “income stream”, which translates into the return on investment, that they produce. Then there are those investments, that have value by virtue of their “perceived value/ desirability/rarity”, such as rarities, which are riskier and more difficult to value. I will focus on the four key asset groups, where you are buying an income stream and how that income stream is valued.
It is also important to remember, understand and be constantly aware that investment markets are dominated by the two aforementioned emotions, namely Fear and Greed. Broadly, when markets are rising significantly and rapidly, they are frequently being driven higher by “Greed” as people are fearful of missing out. This causes markets to overshoot “fair value” to the upside, which means you are paying more for Equities than you should. Contrarily, when markets are falling significantly and rapidly, they are frequently being driven lower by “Fear” as people are fearful of losing more. This causes markets to overshoot “fair value” to the downside, which means there are serious bargains to be had. Therefore, when greed or fear are the dominant drivers of market sentiment, the markets are, by definition, no longer rational. Because of this, the basic investment strategy known as “Buy Low and Sell High”, is easier said than done, because the right time to get in is mostly when everyone says “stay out” and the right time to get out is when everyone says “buy, buy, buy”.
The buy low and sell high strategy is illustrated in the USA’s S&P500 Equity market chart below, with opportune “Sell” times marked just before the peaks in 2000, 2007 and probably 2022??, and opportune “Buy” times marked just before the dips in 2003 and 2009.
After a crash, there is usually widespread fear, as people have lost money and are reluctant to get back into the markets, even after they have been rising for a considerable time, because they fear there is more downside to come. This is why Baron Rothschild said: “the time to buy is when there is blood in the streets“. i.e. When people are slitting their wrists.
Warren Buffet said it more diplomatically – “The time to invest is when others are fearful”.
After the markets have gone up significantly and for a long time, and when everyone is talking about the money to be made, most people experience FOMO and get back into the market. Unfortunately, this usually happens when the markets are approaching a top, which is mostly too late and nearing “the time to get out”. Such markets typically boom to the point where investors experience “irrational exuberance”, which means the markets are feeding off greed, which has driven them higher than is justified by rational valuations. This is why they say of any big generational bull market that “when the financially ignorant, especially lay people like hairdressers and waitresses are telling you what shares to buy, it is time to get out”. Such situations, where the markets are irrationally high, are now referred to as Bubbles. George Soros’ definition of a bubble is when: “Assets are artificially expensive, based on a belief that is false”. i.e. The markets have no business being up there, or, “the emperor has no clothes”.
This is also why the truly clever investors are often referred to as contrarians as their philosophy is “When everyone is getting out, they get in and when everyone is getting in, they get out”. In this modern digital era, there are many reports calling tops before they happen, so one can mostly anticipate when a peak is near, within a year or so.
CHAPTER 2 – FINANCIAL PLANNING – Managing your life’s “financial” risks
WHY ENGAGE IN FINANCIAL PLANNING?
Financial Planning is the process of securing your “Future Financial Freedom”, and that should start with immediate effect. One tends to think one needs a high income to build wealth, but people who do not have high incomes often end up being wealthier than those who do have high incomes, because the latter lived beyond their means. Many apparently “rich” people constantly feel the need to spend money to show how rich they are, whereas truly “wealthy” people are those who feel frugally free not to “spend and/or spend unnecessarily”. There are as many stories of ostentatious people who ended up being paupers, as there are of ordinary frugal people who put away a bit every month and ended up being Dollar multi-millionaires upon their retirement. Therefore, accruing wealth is mostly more about attitude, self-discipline, and your spending habits, than it is about your income. While wealth is clearly about money, it is also about inner peace, job satisfaction, a balanced lifestyle, family and “real” friends. i.e. It is about a balanced perspective, broader risk management and building wealth gradually into your future retirement, to ensure that you will always have a great life, “no matter what”.
MOST IMPORTANTLY!!: I think it should be something you really want to do willingly!!!
I say this because it should be a positive process with an optimistic purpose, like that you are expecting to live long and are investing now so that you can enjoy a good lifestyle in later life. It should not be a grudge obligation you do now out of fear, because you are scared you will end up eating dog food in your old day. If you do it willingly, you enjoy the process and look forward to putting away “enough”, whereas if you do it reluctantly, you never put away enough.
Financial planning means you are taking the necessary precautions to ensure that you and your family are able to maintain your lifestyle, even in the event of a life changing crisis, which means you are going to strategically consider, and properly address the following risks:
- Death – which means insurance, preferably taken out at a very young age, because the younger you are, the cheaper it is. Preferably take out one that “inflates” every year. This is particularly important once you are married with kids, to help the remaining spouse cover kids, “education”, “sport”, “au pair” and other related costs in the event of your death.
- Disability – which means income protection and/or lump sum disability insurance in the event you are struck down with some incurable condition or disabled in an accident. Remember, this does not have to be done by way of an insurance policy if you choose instead to develop some, or many, supplementary skills and sources of passive income.
- Retrenchment – which suggests it is prudent to operate with minimum debt and maximum savings reserves. The best insurance against this is broader experience and education, as these make you more employable!!! The second-best insurance is for you to have alternative sources of income, sources of passive income, or income producing hobbies.
- Un/Self-Employed – The technologies of the future suggest you are more likely to be self-employed in the future. For self-employed people, disciplined saving becomes essential, because your income may fluctuate dramatically, which means you need greater reserves to cover you during lulls. Once again, experience and education are your best assets. Regardless, one should always foster the skills needed to secure your future in the self-employed space, although not everyone has the right aptitudes and/or attitudes. e. Strive to have some IT, bookkeeping/financial, marketing, admin and leadership skills.
- Loss of your house or car – which suggests the prudent approach is insurance. I devote a short chapter to this. NB! There are many ways to make it both affordable and effective.
- Wars, Hurricanes, Floods, Economic, Stock Market and/or other crises – ensure you are always hedged against crises and adopt defensive strategies when needed. A book called Antifragile, by Nicholas Nassim Taleb, helps put this into perspective. I provide a brief overview of this “key” concept at the end of this chapter.
- Marriage and Divorce – this starts with a good antenuptial contract but is more about planning that both parties will be well provided for, in the unlikely eventuality. A good ANC provides insurance for both. Again, I elaborated on this in a later chapter on insurance.
- Retirement – this is the costly elephant in the room, presuming none of the others come to pass. The ultimate goal is to be in a position to, at least, be able to sustain the lifestyle you had, or better. The earlier you start putting money away, the more disciplined you are and the better you manage this process, the more likely you are to achieve this goal.
How much should you be putting away. At least 15% of your after-tax income, including that which your employer is contributing, but preferably between 20%-25%. This is easier to do before you have children and after they have left the house. More about all this later.
It is not clever to live beyond your means on the financial edge, like most people, and hope you will have enough money later, because you will later regret it with 100% certainty. You may think you do not have enough money to put away, but then you have to figure out how to “MAKE DO WITH LESS”. Once you have made that decision, it is amazing how many ways there are to save a bit here and a bit there. However, it is important to keep track of each of these savings and then increase the amount you put away into your savings account or home mortgage account. More importantly, while these sacrifices may prevent you from living an opulent ostentatious lifestyle, they don’t have to rob you of a wonderful life. NB! Those friends who only associate with you because you live the high life are, inevitably, not your friends.
Here are some tips:
- Decide how much you can and need to save for your retirement, presuming you will live to the ripe old age of at least 100, which is increasingly likely as medical technological advances favour longevity. Put that away first and adjust your lifestyle to live off the rest.
- Set aside some money for emergencies and holidays. This is what saving is about.
- Where possible, take out insurance to protect yourself in the event of crises.
There are many books that deal with this sort of thing. One of the best, although it is a bit Australia centric, is “The Barefoot Investor”. Done with considerable humour, it is the perfect book for those who are struggling to keep their heads above water, as it provides a step-by-step guide on how to recover, find your feet and then prosper. My e-book is far broader and deals with the more complex insights relating to the “prosper” aspect, not the recovery aspect.
Antifragile – Duplicated in a later chapter. If you do all the above right, you become Antifragile, which is a concept pioneered by Nicholas Nassim Taleb. He suggests that if something is fragile, it breaks when things go wrong. Contrarily, in nature, the survival of the fittest is not just about survival, it is about adapting and evolving in such a way that the species emerges “both stronger and better able to survive” the next crisis. Accordingly, Nicholas Taleb coined the word Antifragile and advocates that we should all aim to become Antifragile. To become Antifragile, you must continually look to the future, identify all possible crises, anticipate and prepare for these, including self-defence, so that you not only survive the next crisis, whatever it may be, but emerge stronger. All the above-mentioned tools help you achieve this goal.
Becoming Antifragile, includes broader concepts, like continually improving your education and experience, as these are assets that secure you in the event of sudden unemployment. Similarly, having a second citizenship and some of your wealth in another country is important, so that you are free to move to another country if the country you are in adopts increasingly oppressive policies, or the security situation in the country deteriorates.
CHAPTER 3 – Introduction to the BASIC INVESTMENT MATRIX/FRAMEWORK
This chapter reveals the basic matrix/framework within which all investment strategies fall.
As with all things in life, true success ultimately lies in the art of getting the basics right. The basics are not rocket science, so you do not need to be an investment expert to grasp them adequately. While you mostly need to use brokers, because the public cannot deal directly with the big investment funds, it is important that you understand the gist of what your broker is saying and participate in his/her/your selection of the optimal strategy. Ideally you should arrive at their offices with a broad strategy vision, that you refine with them. If you are able to manage your own investments without a broker, understanding all this becomes ultra-critical.
The first important thing to understand is the broad risk reward concept, that “higher returns/rewards usually come with higher risk” and vice versa. The slide below perfectly illustrates the conventional, albeit simplistic investment strategy matrix. There are times when it is justified to pursue far more aggressive “Risk On” strategies, such as when you are young, equity markets are undervalued and/or equity markets are growing strongly. Contrarily, there are times when it is better to adopt more conservative/defensive “Risk Off” strategies, such as when you are older, or when the markets are very overvalued and/or toppish and/or falling.
The essence of an extremely defensive “Risk Off” strategy is best encapsulated by this saying that is frequently used when markets are very overvalued, namely, “This is a time to be concerned about the return “OF”, and not the return “ON”, your capital”. What this means is that you could lose 20%, 30%, 40%, 50%, or even 90% of your money if you are “Risk On” when highly overvalued markets crash, whereas you will lose little or nothing if you temporarily adopt a “Risk Off” strategy by staying in Cash, Bonds and Gold until after the correction/crash.
This slide by Chris Hart, a South African economist tells the story
The conventional investment strategy matrix below, illustrates that you are continually trading off Risk and the Reward. The higher the risk, the higher the return and, the lower the risk, the lower the return. i.e. Having most of your money invested in Cash and Bonds, mostly reflects a “Risk Off” bias, whereas being overweight Equities and Property reflects a “Risk On” bias.
RISK/REWARD TRADEOFF MATRIX
I MODIFY THIS MATIX IN A LATER CHAPTER – to embrace other asset classes.
The above matrix provides your first glimpse into “basic” diversification, which is important, because you never want to put all your eggs in one basket. However, diversification is much broader than the above 4 asset classes and I elaborate on that separately in a later chapter.
It is worth noting that each of the above assets provides a “profit share/income stream/return on investment”, and your goal is to maximise that income stream for your “combined” investment portfolio. i.e. It is important to remember that you are not investing in these assets for the sake of investing in those assets, in the “hope” that their price will rise. Instead, for each of those assets, you are buying an expected future income stream that you anticipate will give you an inflation beating return on investment after tax. It is that income stream that provides the basis used by professional market investors to determine the price they are prepared to pay for that asset, which I explain in a later chapter. However, the attractiveness of the income stream from each of those assets keeps changing, which means you need to constantly re-evaluate the merits of each asset class and move your investments between these asset classes as your perceptions of risk change. Therefore, the question at any moment in time is how reliable your expected future income stream from each asset class will be, and what your return on investment will be, after tax. The time to get in is when the return from any asset class promises to be both attractive and secure, and the time to get out is when the probability of that income stream becomes less attractive and certain.
Typically, your investment portfolio will have money in both aggressive and defensive assets, with most of your money shifting between Equities (risk on) and Bonds (risk off). This is because it will partly/best protect your total investments in the event of losses in either one of these two asset classes, because they are mostly contracyclical (more about this later). i.e. With luck, what you lose on the swings, when say equities go down, you will regain on the roundabouts, when say bonds go up, or at least partially, – and vice-versa. i.e. You are hedging your bets to reduce your losses in the event the markets turn against you. (This is how it mostly works, however, due to super and artificially low interest rates in the early 2020s, it may be less effective this time around. I elaborate on this in a later chapter).
I explain and elaborate on this concept, and on each of these asset classes, in subsequent chapters. However, before I do, I highlight some matters in the next few chapters, that have a significant bearing on your/our evaluation of each of these asset classes. This is because they illustrate that government intervention and greed have skewed the investment playing field. Thereafter, I highlight the role of interest rates in pricing these asset classes, which is necessary as it enables one to compare these assets when selecting our optimal portfolio.
Bear with me as we will encounter a few minor chicken and egg situations henceforth, in that I cannot explain say concept “A”, before explaining concept “B”, which requires an understanding of “A”. This gives rise to an element of duplication, which is not a bad thing, because it helps you better remember the concepts. I have tried to sequence the chapters in such a way that these chicken and egg dilemmas are minimised. This is also why I suggested earlier that you may, and probably should, want to read this book a second time.
Remember too, not to get too bogged down remembering all the detail. Rather let your mind get an overall sense of what investment and the major considerations are about. i.e. You will have subconsciously/intuitively assimilated a picture, which will be worth thousands of words and details. You can always go back to review concepts that are niggling in your mind.