Episode #3 - Setting your investment strategy

In the previous episodes of Jeune Investisseur, we discussed the prerequisites to getting started with investing. We covered budgeting as a prerequisite, to know how much you can invest periodically, and also understood that inflation should be kept in mind when considering the return of an investment.

In today’s episode, we focus on defining an investment strategy that matches your goals.

1. Everything personal finance ~ budgeting and interest rates
2. Inflation and what it means for your investment
3. Finding the investing strategy that matches your goals - you are here!
4. Getting real - tools & methods for Investing tools

Let’s get started!

⚠️ The content of our podcast and production is Not Financial Advice. Do your own research or contact your financial advisor before making a serious financial decision.

3 questions to ask yourself prior to investing

Before even investing one € / £ / $, try answering the following questions:

1. What are your financial goals?

Buying a house, preparing for retirement, setting money aside for your children’s tuition fees - these goals differ on the amount they require and when you’ll need to access these funds - they have different time horizons. For instance, retirement is often considered a long-term goal (~ 30 years or so for both of us). Knowing clearly why you are investing - and you can definitely have more than one goal simultaneously - is helpful, for a few reasons:

1. You can break down these goals into smaller milestones, which make it easier to track your progress and measure if you’re doing well.
2. Knowing why you invest helps you choose the financial products that best match your goals.
3. By setting your goals early, you can give yourself more flexibility. As an example, starting to set money aside for retirement early means you can choose riskier assets early on (e.g., tech stocks), which are associated with higher returns, and transition towards lower-risk assets when you get closer to your objective (e.g., US treasury bonds). What you choose to invest in will also depend on your risk tolerance 👇

2. What’s your risk tolerance ?

Your risk tolerance refers to how comfortable you are with your investments when going through periods of market volatility, during which your portfolio can endure losses. Your risk tolerance very much depends on your own circumstances. A few illustrating examples are as follows:

• A recent college graduate who started their first job may be okay with a more aggressive investment style, with potential higher returns at the risk of higher losses, than a person close to retirement, who might prefer low-risk investments to guarantee a stable retirement income.
• If you prefer capital appreciation over recurring income, this may guide you towards a more aggressive investment style.

It’s important to estimate your risk tolerance early in your investing journey and re-assess it when substantial life events happen (graduation, becoming a parent, getting closer to retirement). Questionnaires exist to help you gauge your risk tolerance, and many brokers will usually ask you when onboarding you as a new customer.

3. How much time are you ready to invest to handle your investments?

We often equate time with money, and this remains true when it comes to your financial journey. Making investment plans, reviewing them, adjusting your portfolio: all of this requires time and attention. Decide how much time you’re ready to dedicate to your investing journey, knowing it won’t be a one-time focus - it’ll be a recurring task over your lifetime. Tradeoffs exist and there are ways you can limit the time you dedicate to it. For instance, if investing in stocks, you can cherry-pick the stocks you buy, which typically require to study which are undervalued and knowing more about the company and the market it operates in - or you can choose investments such as index funds and ETFs (Exchange Traded Fund), which make it easy to invest in a diversified basket of stocks, thus lowering the risks.

Imagine spending 4 years and $150,000 to learn about the efficient market hypothesis and then the market does this: pic.twitter.com/p7YO8eYh6s

— Fintwit (@fintwit_news) January 26, 2021

Some investment requires less due diligence and thus are more beginner-friendly, index funds like ETF (Exchange Traded Fund) makes it easy to invest in a diversified basket of stocks, thus lowering the risks. ETFs are your best option when you have little time to make extensive market and company research before investing.

Now that you have answers to the above questions, let’s dive into common investing rules.

4 Golden rules of investment

1. Stick to your plan

As discussed above, there’s usually a main goal you’re working towards when thinking about investing.

Having a plan helps you navigate uncertainty, giving you a clear vision to keep in mind when times are tough. Though, having a plan isn’t enough - you’ll have to periodically adjust it whenever life gives you 🍋.

Perhaps you’re no longer able to set aside 200€ per month (because the rent went up); now, it’s only 150€. Adjust your plan with the new reality, but keep the same commitment. Your vision hasn’t changed and you’re still on track to achieve it. The path to it simply has changed a little.

Having a vision and a plan to lead you there will also help you avoid selling your assets during market downturns, and more generically be resilient in the face of market volatility the worst time and resist market ups and downs. Once you did the first allocation of your portfolio and where to invest (more about this in episode 4), you can set up a recurring transfer towards your investment account to ensure you commit to your goals.

ℹ️ Recurring automated transfers to your investment account every month is the easiest way to stay on track with your goal. The easier your investment habit is, the more likely you’ll stick to it. See the excellent book Atomic Habits: An Easy & Proven Way to Build Good Habits & Break Bad Ones from James Clear from more on this topic. Investing is a long-term game, being consistent requires developing a set of appropriate habits to achieve your goal.

On top of helping you commit to your vision, investing regularly helps smooth the market variation. It’s the concept of Dollar Cost Averaging, DCA for short.

2. Be patient

An important behavior trait for an investor is being patient and in control of their emotions when the markets act up. This stance will be regularly challenged - notably, humans are indeed subject to the Fear Of Missing Out (FOMO) when we see certain assets appreciating very quickly. Remember GameStop (tweet above)?

Let’s lay out the difference between investing and trading:

• Investing: For The Long Term
  • It’s money you’re setting aside and willing to not use before 5 years (ideally longer), to let it appreciate in value.
  • The longer you leave your money untouched, the better - as it will help smooth the market’s ups & downs.
  • Diversify your portfolio, to minimize risks.

• Trading: For The Short Term
  • Generally seen as trying to benefit from the market’s movements, i.e. buying and selling assets in a short time period (a few hours to a few days).
  • This demands to be more reactive, hence closer to your investments, and ultimately more exposed to the market’s risks.

Warren Buffet (sometimes considered as the world’s best investor) had issued a challenge to hedge funds, betting that actively managed portfolios would not beat the market’s return (i.e. active vs passive investment strategies). 10 years later, the hedge funds admitted they had lost.

3. Consider taxes & fees early on

Taxes & fees are sadly real, and could take a bite out of your investments if you do not keep them in mind. Let’s go over them:

• Fees: Generally costs linked to transactions (e.g. buying a stock), account fees, others (e.g. if some of the funds you’re buying are actively managed, you’re likely paying for that). We typically consider 2 types of fees:

  • Flat fee: e.g. making a transaction will cost me $1. Simple enough and transparent.

  • Percentage fee: Brokers tend to charge fees as a % of the amount you have invested with them. This means that the larger your investments - either contributing new money or market appreciation -, the more you will pay in fees. And just like interests compound, so do fees! Let’s take a hypothetical example of investing $10,000, leaving it appreciate for 20 years with a yearly market return of 5%. Now, let’s consider a scenario with no fee and a scenario with an annual 1% fee:

    • 10,000 * 1.05^20 = $26,532.97
    • 10,000 * 1.04^20 = $21,911.23

    i.e. a difference of 17%!

• Taxes: We wish they did not exist, but they do. We refer here to capital gains & dividends taxes, and more generally to income tax (tax you pay on money you earn). They can affect how you access your investments when you need them (i.e. selling them).

  • If you sell an asset and make a gain on it (e.g. you bought one $AAPL for $10 and sold it for $100, you have a gain of $90), that gain will be subject to capital gain tax.
  • If the assets you hold pay you dividends (e.g. Treasury bonds), this will be considered as income and will thus be taxed.

Taxes can be considerable depending on your situation, your portfolio distribution and your investing strategy. There are however ways you can lower the amount you pay. This is very much dependent on the country you live in, and we will thus give here generic examples:

• Some savings accounts can be tax exempt. Examples include the Plan Épargne Actions in France and the Individual Savings Account in the UK. How much you can contribute to these accounts is generally capped.
• Some pension accounts are also tax exempt. Examples include the Plan Épargne Retraite in France and the Personal Pension in the UK. Generally, you cannot access these funds until you reach retirement age.
• Finally, it can be that the country you live in allows allowances on certain taxes.

Taxes can quickly become overwhelming, which leads us to our final rule:

4. - Seek help when you need it

At the end of the day, this is about your money, so best is to avoid major mistakes with it. Be humble and seek help when you need it. You can find help online for the points mentioned above:

• There exist services which can help you fill in your tax return (e.g. TurboTax, TaxScouts)
• You can also consult a financial advisor. You’ll want to verify whether they are independent or attached to an investing firm. If the latter, they may be able to advise you only on the products their firm proposes. You’ll also want to verify how they get paid: is it a flat fee or a percentage of the amount you invest? Remember our point above about fees compounding!

Wrap up and key action items

Let’s wrap up by summarizing the 4 rules we established:

1. Stick to your plan - your plan will change throughout your investing journey, which is why you’ll need to adapt. But it’ll give you a reference point in periods of market volatility.
2. Be patient - resist FOMO and be resilient when the market fluctuates. Investing over a long term horizon will help smooth the ride.
3. Taxes & fees - keep them in mind.
4. Seek help - Do your research and reach out for help when you need. Finance is a complex topic, and we only hope to introduce you to it. An accredited financial advisor can be a good resource.

In Episode 4, we’ll cover the different types of investment you can make!

Bibliography

A non-exhaustive list of resources that helped us craft the content for this episode.

1. Time Horizon and time preference, Investopedia, last updated on July 30, 2021, retrieved on Mar. 14 2022. https://www.investopedia.com/terms/t/timehorizon.asp
2. Dollar Cost Averaging, Investopedia, published on Aug. 19 2021, retrieved on Oct. 21 2021 https://www.investopedia.com/terms/d/dollarcostaveraging.asp
3. GameStop gate, February 2021, retrieved on March 15 2022. https://fr.wikipedia.org/wiki/Affaire_GameStop
4. Investing 101, tips for beginner, retrieved on Oct. 24 2021, https://www.wealthsimple.com/en-ca/learn/investing-basics
5. “Prélèvement forfaitaire Unique (PFU) ou Flat Tax”, Service-public.fr, retrieved on Oct. 24 2021, https://www.service-public.fr/professionnels-entreprises/vosdroits/F32963
6. “Plan d’Epargne Retraite, service public,” retrieved on March 15 2022 https://www.service-public.fr/particuliers/vosdroits/F34982

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Cover photo by Anne Nygård on Unsplash