I guess that many of you dream about retiring as full-time private investors.
To have enough capital to live a comfortable and fulfilling life by just deploying your money
into various stocks of your own choosing.
Following the 4%-rule, perhaps $1 million would be enough to retire from the daily grind?
For those of you not familiar with the 4%-rule, here’s a quick story that will serve as an introduction.
This is Tom.
Tom is a 43-year-old dad and husband.
Tom has invested in the stock market for 20 years, while working full-time as an engineer.
Tom's yearly living expenses amounts to $37,000.
Tom has saved and invested his money continuously,
so that he is now the proud owner of a $1 million stock market portfolio – great job Tom!
Say that Tom can net 4% from his investments per year, an assumption which isn’t too wild.
That would provide him with $40,000, which would cover his living expenses by some margin.
Knowing this, on his 44th birthday, Tom retires from his engineering 9-5.
He will now spend more time doing what truly makes him happy: investing in the stock market,
going on hikes, playing tennis, and especially spending more time with his family and friends
and being an even better dad!
This video is based on 12 successful private investors that, just like Tom, retired from employment
somewhere mid-life, to spend more time on the things that really matters to them
while also continuing to accumulate their wealth through stock market investing.
What I find especially inspiring about these individuals is that they don´t seem
like super humans – and if they made it, so can we!
This is a top 5 takeaways summary of Free Capital:
How 12 Private Investors Made Millions in the Stock Market, by Guy Thomas.
And this is the Swedish Investor, bringing you the best tips and tools
for reaching financial freedom, through stock market investing.
Takeaway number 1: Don’t Dig too Deep
Let´s return to Tom from the intro.
Being somewhat experienced, Tom has developed a knack for identifying the key metrics of certain investments.
Let´s say Tom is intrigued by a company that produces and sells plant-based
beef directly to restaurants – let´s call the company DeBeef.
When analysing DeBeef, Tom doesn´t waste too much time looking behind every little rock.
Once he has determined that the company has an attractive valuation compared to last year’s
earnings and cashflow, he buys the shares, and then focuses on keeping
tab on the key drivers of DeBeef.
Those that will make it or break it for the company in the long run.
In this case, he decides that the pricing power of DeBeef will tell him a good deal
about the competitiveness of the product.
The average price is something he finds and can follow in the annual reports.
Secondly, his investment thesis expects that DeBeef
will be able to keep up its historically high growth of earnings.
In addition to the pricing, he will therefore monitor how many restaurants that the company
is able to add to its customer base, in connection with its highest expense
– which happens to be its cost of sales & advertising.
If it is getting costlier to grow, Tom wants to be the first one to know.
Even Warren Buffett applies this strategy.
In the 1998 Berkshire Hathaway annual shareholder meeting he mentioned that figuring out
how Coke will do in the future is essentially figuring out two variables
– number of cases sold and earnings per case.
Buffett said that the same holds true for GEICO.
It’s just insurance policies in force and underwriting experience per policy.
A common denominator among the investors in the book Free Capital, is that they often
skip details to focus on the few trends and figures that they believe are the ones that really matter.
If you try to keep tab of everything that is going on, chances are that you start giving
equal weight to the different parameters, even though only a few of them are crucial.
Also, additional knowledge always comes with an opportunity cost so one must continuously
question if it’s worth it to keep digging.
The devil is rarely in the details!
Takeaway number 2: Enjoy the Hardship
It is very common that even investors who are now experienced and wealthy
had some major setbacks early on in their investing careers,
which is also true for the investors in this book.
Investing is hard.
After all, it’s a game with extraordinary rewards if you become good at it,
so it makes sense that there’s some competition.
Our world is complex and to try to foresee how companies will do in the future,
and then decide if their shares are priced on the low-end or high-end based on that,
well, let’s just say that there are easier job descriptions out there.
If you haven’t realized how difficult this can be, you might be in the early stages of
the Dunning-Kruger curve.
The Dunning-Kruger effect is a cognitive bias which makes you overestimate your ability initially
when you take up a new interest.
Only after facing some hardship, you start to realize your inability.
The Dunning-Kruger effect is common among stock market investors, as you can be lucky
for a while and make a lot of money, even with an investment strategy that is filled
with as many holes as a Swiss cheese.
You know what they say: “Don’t confuse brains with a bull market”.
And do you know what Charlie Munger says?
“It's not supposed to be easy.
Anyone who finds it easy is stupid.”
The talk when they should listen.
The investor should focus on learning as much as possible early on, not chasing or expecting great returns.
Before you are at least decent investor, you cannot achieve a good risk-adjusted return
– which is what it is all about.
This is true simply because at the early stages of your Dunning-Kruger journey,
you won’t even be able to perceive the risk part, due to a lack of experience and knowledge.
However, this is a period which should be embraced and welcomed.
To experience some major mistakes is good for the learning process
– and it is much nicer to make the mistakes early on, when your portfolio most likely still is quite small
than a few years later, when mistakes have become much, much more expensive.
Are you having a hard time on the market, or recently had?
Remember that it is normal and expected.
This hardship is what will make you try evenmore.
And if it wasn´t hard, well, everyone could do it, and the opportunity would be gone.
Takeaway number 3: Reach for Freedom
The first step to becoming a wealthy investor is to understand that consumption shouldn't be your main goal.
Freedom should.
One of the major things that can postpone your plan to live of your portfolio, is to interrupt the compounding
by making large withdrawals for consumption before you have reached your goal.
Munger again: ”The first rule of compounding is to never interrupt it unnecessarily".
Even though consumption can grant some instant gratification, and satisfy some vanity-trait,
remember that it will delay your ultimate goal to retire from your portfolio.
When you see someone who drives around in their Lamborghini, realize that you are
also witnessing someone who is a Lamborghini poorer.
So … is it worth it?
Perhaps counterintuitively, focusing on freedom initially will increase your chances to be able
to spend more on consumption down the road anyways.
So yes, it’s a way of having your cake and eating it too,
if you have the perseverance to stay a little hungry for a while.
Takeaway number 4: Focus Matters
People who built their fortunes from stock market investments often run fairly concentrated portfolios.
This is also true for the individuals in this book.
The median person had less than 10 companies in his or her portfolio.
Why do you think that is?
Warren Buffett has his own theory: "If you have a harem of 40 women, you never get to know any of them very well."
Constructing an investment portfolio really is a game of piling stocks
which are likely to overperform the general market.
Once you’ve added your 10 best ideas to that portfolio,
what do you think the effect will be of adding an additional 30?
That’s right. If your investment strategy really has an edge, this will reduce your expected returns.
Critiques of the concentrated portfolio approach will often argue that you put yourself in too much risk
if you only invest in just a few companies, that your portfolio will fluctuate too much.
Even though I wouldn’t agree that volatility is a measure of risk,
even the volatility of a stock portfolio will be greatly reduced once you’ve added like 7 different companies to it
so this argument is just totally invalid.
A word of caution though; even if an expert investor can concentrate even more than that
– Warren Buffett has had 40% + of his capital in a single stock on a few separate occasions
- a more concentrated portfolio can be harmful for the inexperienced investor.
It is oftentimes more psychological stressful to handle, as volatility increases.
The beginner should invest in a way that ensures that he says in the game, rather than shooting for the moon.
Takeaway number 5: What Makes You Tick?
Who are you, and what do you know?
Depending on, for example, your skills, your personality, your profession, and your interest,
you should construct an investing strategy that suits you.
There are tons of strategies and methods to make money in the stock market.
In order to maximize portfolio returns and minimize sleepless nights;
you need to have a strategy that suits you.
Yes you, not somebody else.
If you have an engineering background like me, for example,
perhaps more of a quantitative approach would suit you best.
But if you, on the other hand, have a background from art or service jobs,
perhaps a qualitative approach with a tilt towards the storytelling surrounding a company
should be the focus in your process.
Kind of following the mantra of Peter Lynch:
“If you like the store, chances are you’ll love the stock.”
If you are an extroverted person, attending a lot of annual shareholder meetings can potentially
create a lot of value for you, and can contribute with a lot of insights.
But on the other hand, if you are an introvert, that might just be discouraging and stressful.
Or maybe you work 80-hour weeks at a prestigious job?
Then skip attempts at stock-picking altogether, for now, and set up a fully automated index investing plan.
No matter what, also spend some time thinking about what interests you.
Don´t develop a strategy which you know from the get-go relies upon methods that bore you to death,
because then you will never have the endurance to stick to it for the long run.
To find out what suit you, you’ll probably have to explore a few different paths.
Even though I certainly do not consider myself a trader these days, at one point in time
I may have called myself an IPO-arbitrager.
Or no, I take that back, an IPO loss-generator would have been more accurate.
Anyways, chances are high that the method you start out with will not be the one that builds your future wealth.
• All metrics are NOT created equal
• We’re all beginners at some point – enjoy the learning process
• Don´t sacrifice long-term happiness for short-term vanity
• Be picky with your investments
• Testing leads to failure, and failure leads to progress.
Develop an investment strategy that suits you!
Check out this video next if you want to see how Warren Buffett made his first $1,000,000 in the stock market.
A huge thanks to my friend Richard Dykes who made this video possible.
Cheers guys!