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 – PRELUDE
I dedicate this to my daughter Carla Lodewijks/Davie, who expressed a desire to better understand “Investment”, so that she could better manage, preserve and grow her wealth.
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.
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 many 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. Regardless, handing over the responsibility for preserving your wealth is counterintuitive, since
“you can delegate a task, but you can “NEVER” delegate a 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 pay him and so you should be able to trust him to do “everything in his power” to preserve your wealth.
Accordingly, the purpose of this book is not to make you an expert, but to give you an overview of the investment arena, which is remarkably simple, 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 interactions in the marketplace form a complex matrix of 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. I do have one problem in that we are faced with a bit of a chicken and egg situation. If I introduce countless basic concepts first, I may lose you to boredom, whereas if I start with the bigger picture first, I will confuse you because you will not understand the terminology and basic concepts. Therefore, I have chosen to go with basic concepts first and hope I do not lose you, as these concepts lay a foundation that will help you better understand the bigger picture. Having said all that, I appeal to you to stick with the overall picture and not get too side-tracked by the plethora of market complexities. 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 if you so wish.
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 the economy. In fact, it is human interference that introduces much of the complexity and uncertainty. Similarly, it is always good to understand the degree of manipulation of official statistics as this distorted picture can mask huge risks, or present opportunities. Finally, it is important to understand that it is human 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. What I mean by this is that you also need to have a sense of what is going on in the world, as that also has a bearing on “safe” investing. For example: The rate of change of technology can make products or companies (like Kodak and Nokia) obsolete within a year, or birth emerging technologies where the truly great returns can be made. Therefore, every company is now at risk of being usurped or made obsolete by a new technology. 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 all this is to preserve and grow your wealth, to ensure that you have enough so that you are not eating dog or cat food in your latter years. Therefore, you and your broker should strive to adopt strategies that will reliably achieve this 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. In the process, small, short term losses cannot be avoided, but big and longer-term losses should be avoided at all cost.
It is important to understand the investment markets are dominated by two 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. Contrarily, when markets are falling significantly and rapidly, they are frequently being driven lower by “Fear” as people are fearful of losing more. 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”.
After a crash, there is usually widespread fear, as people have lost money and are reluctant to get back into the markets, even when 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’s blood in the streets“, when people are slitting their wrists.
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 market is approaching a top, which is actually 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 the hairdressers, bellhops and waiters are telling you what shares to buy, it is time to get out”.
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”.
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.
I have kept most of the chapters short, mostly between 1-3 pages, so you can read one a day for a month.
The chapters that follow progressively explain the most important aspects and considerations of investing. 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 time. I tried to keep it all short and simple. Have fun.
CHAPTER 2 – FINANCIAL PLANNING
WHY ENGAGE IN FINANCIAL PLANNING?
Financial Planning is the process of securing your future financial freedom 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 more wealthy than those who do have high incomes, because the latter lived beyond their means. Therefore, accruing wealth is mostly more about self-discipline and your spending habits, than it is about your income. While it is mostly about money, it is more about broader risk management so that you ensure that you will always have a great life, “no matter what”. It is about ensuring you can maintain and/or improve your lifestyle from today onward into your retirement in the distant future, no matter what!!!
MOST IMPORTANT: 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 you are able to maintain your lifestyle, even in the event of a life changing event, which means you are going to strategically consider, and properly address the following:
- Death – which means insurance, preferably taken out at a 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.
- 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 un/self-employed people, saving becomes more essential, but that requires great discipline. 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.
- 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.
- Economic, Stock Market and/or other crises – ensure you adopt defensive strategies and hedge against crises. 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 eventuality. Again, I elaborated on this in the 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. More importantly, while these sacrifices may prevent you from living an opulent lifestyle, they do not have to rob you of a wonderful life. NB! Those friends who only associate with you because you live the high live are, inevitably, not your friends.
Here are some tips:
- Decide how much you 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.
- Set aside some money for holidays.
- 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. This book is broader than that.
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 advocated that we should aim to become Antifragile. To become Antifragile, you must continually look to the future, identify all possible crises, anticipate and prepare for these, 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. I think you get the idea.
CHAPTER 3 – Introduction to the BASIC INVESTMENT 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 the selection of the optimal strategy. Ideally you should arrive at their offices with a broad strategy that you refine with them. If you’re able to shuffle your own investments without a broker, understanding all this becomes 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 quote 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 and Bonds until after the 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 reward, and, the lower the risk, the lower the reward. i.e. Having most of your money invested in Cash and Bonds, reflects a “Risk Off” bias, whereas being overweight Equity and Property reflects a “Risk On” bias.
I MODIFY THIS MATIX IN A LATER CHAPTER – to embrace other asset classes
Typically, your investment portfolio will have money in both aggressive and defensive assets, with most of your money shifting between Equities and Bonds, because this will partly protect your total investments in the event of losses in one asset class. I elaborate on this in subsequent chapters.
I explain and elaborate 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 bearing on 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 needed to enable us to compare these 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”. I have tried to sequence the chapters in such a way that these dilemmas are minimised.