“Knowledge comes, but wisdom lingers.” – Alfred Lord Tennyson

Now that you’ve decided on a certain amount of income you’d like to invest every month, where exactly should it go? While I will be talking about active investing and how to select winning stocks in a series of upcoming posts, I’d like to start off by looking at the other side.

Passive investing puts all the work into someone else’s hands. Basically, you can either go with mutual funds (unit trusts) or index funds:

Mutual Funds

By putting money behind a fund manager and the company he or she works for, you’re buying into a certain philosophy on investing and risk. You’re hoping that they know more about the market and can outperform everyone else.

A great way to chose fund managers is to look out for open communication, thorough research, good governance, low expenses, and a willingness to invest their own money alongside yours. Be thorough in checking out their past performance in order to determine whether or not it will be sustainable going forward. 

Index Funds

Instead of struggling to determine who to invest with, you effectively invest with everyone when you buy “the market” in the form of an index like the S&P 500 or ALSI. Because expenses charged for mutual funds are more than those charged for index funds, mutual funds must perform even better to achieve the same end return.

Index funds recognise that predicting the future is impossible, which means beating the market consistently is incredibly unlikely. Of course there are exceptions to the rule (like Warren Buffet or Peter Lynch) but finding these people in advance and hoping they prove just as prescient going forward is hard. As with most things in life, safety should be your first concern.

(To download your completely free copy of the South African or International edition of Work in Progress, right-click and save the relevant link. Then open, enjoy, and repeat as needed.)

“If thou wilt make a man happy, add not unto his riches but take away from his desires.” – Epicurus

I’m sure you’ve heard how important it is to pay yourself first. But do you? Are you making provision for the future in order to achieve your personal goals? If not, it’s probably time you started. Start investing immediately because the amount of time you spend in the market is more important than when you actually do so. In any case, now is the perfect time to find real bargains.

Paying yourself first means automatically having a certain amount deducted from your income. That needs to happen before you even see it so you’re not tempted to spend, ultimately risking not putting it aside at all. The beauty of compounding means that time will weather the ups and downs resulting in good returns over the long-term. Small steps forward become great strides in the end.

(To download your completely free copy of the South African or International edition of Work in Progress, right-click and save the relevant link. Then open, enjoy, and repeat as needed.)

“A bank is a place that will lend you money if you can prove that you don’t need it.” – Bob Hope

The problem

A lot of people seem to think credit is the reason the global economy is in such a mess and cash is king. While part of that might be true, I don’t think things are that clear-cut. Firstly, debt can be good as long as you know how to use it. That means paying off the full balance on your credit card every single month or else not having one at all.

Secondly, amassing as much money as possible won’t solve all your problems. It doesn’t make sense to have a stash of cash sitting in a savings account earning measly returns when you’ve got a mortgage (or two) on your house charging interest at twice that rate. A lot of people don’t make this connection. They don’t understand that increasing income (in a savings account) and decreasing expenses (on your house repayments) is exactly the same thing. They get stuck in what behavioural economists call “framing”, i.e. falling into the trap of viewing the same thing differently just because it happens to be phrased a little odd.

The solution

So, what should you do? One recommendation that might not go down well with a lot of people (like most new ideas do) is to forget about having an emergency account. Instead, set up a home-equity line of credit, which you can then use as an emergency reserve. Obviously that means whatever would have gone into your savings account should go into your house. Blowing it elsewhere defeats the point.

Another idea is to pay your instalments once a week instead of once a month, effectively resulting in an extra payment each year. For example, instead of paying $1,000 per month, you pay $250 dollars per week. This means that instead of paying $12,000 per year ($1,000 dollars x 12 months), you pay $13,000 per year ($250 dollars x 52 weeks). The extra $1,000 “amortised” to your mortgage means you pay it off sooner and save on interest. Now doesn’t that sound doable?

(To download your completely free copy of the South African or International edition of Work in Progress, right-click and save the relevant link. Then open, enjoy, and repeat as needed.)