How to own the world with index funds

Own the world?! Some mistake, surely? After all, we’re only here to reach Financial Independence! We’ve no business trying to own the world, right? Wrong! Two words for you: index funds. If you don’t know what I’m on about, this post is for you. Bear with me, and I promise all will be clear.

But first, let’s talk about the basics of investing in the stock market. When it comes to investing, a lot of people are scared. At best, stocks are often viewed as a socially acceptable cousin of gambling.

 

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That’s quite understandable. Just like putting it all on black in roulette, shares in a single company can leave you with double or nothing in a short space of time. Just ask anyone who bought Enron shares in the late 1990s. All of this makes the stock market seem a real emotional roller-coaster.

Let’s be honest. Investing is risky, and it will never feel 100% comfortable. But we’re about to learn a strategy to smooth out the roller-coaster. To do so, let’s go back to kindergarten. We were all taught this proverb as kids:

 

Don’t put all your eggs in one basket.

 

I’m sure most of us follow that advice without even thinking about it a lot of the time. When we look for work, most of us submit many applications rather than just putting in one and crossing our fingers. It turns out “don’t put all your eggs in one basket” is pretty sound investing advice too.

Whilst individual shares can be exceptionally volatile, big groups of shares across large numbers of companies tend to be less so. Why? Because when one company goes down, another will probably go up, balancing things out.

Here’s where “owning the world” comes in. If we could just own a bit of every company in the world, we’d be insulated from the fortunes of any single company, or even country. Instead, we’d just take a slice of the overall pie of global growth. Obviously there are times when the global economy as a whole takes a dip. On the other hand, if the whole global economy ever goes the way of Enron we’ll be too busy worrying about other stuff in the armageddon to even notice.

I hope we can agree that owning the world is a solid theory. But in practice it sounds like a lot of hard work, doesn’t it? Can you imagine how long it would take to buy shares across the whole world? Here’s the lucky bit: someone already did it for us. We can invest in a whole bunch of shares – getting the benefit of global diversification – through vehicles known as global index funds.

We’ve got options on specifics. The biggest game in town for index funds is Vanguard. Even Warren Buffett – the most famous stock investor in history – wants his wife to put their wealth in Vanguard funds when he dies. I’m not here to sell any particular option. If it’s good enough for Warren Buffett, though, it’s certainly good enough for me!

 

What are your main concerns about investing? Have you already started? Would you consider global index funds?

 

 

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The phenomenon that could 45x your investment

Disclaimer: This post is not investment advice – details are use merely to illustrate a general investment principle.

 

I don’t use the word miracle lightly, but tell me: does turning $10,000 into $452,593 without putting in a single extra dime not sound like a miracle? Well hang onto your hats, because one powerful phenomenon can make this miracle a reality: compound interest. Let’s do a bit of maths:

Year 1

Captain Thrifty starts with $10,000. He puts it into a fund which tracks the S&P 500 (don’t worry about it if you haven’t heard of this – it’s basically just a vehicle to invest in all of the biggest US companies at the same time). Captain Thrifty gets a 10% return (historical records show the average annual return for the S&P 500 since it began in 1928 is approximately 10%) = $1000. His $10,000 is now $11,000.

Year 2

Captain Thrifty gets another 10% return = $1100 (10% of $11,000 rather than the 10% of $10,000 he got in Year 2). His $11,000 is now $12,100.

 

So far, so pedestrian. Lets have a look what happens over the rest of a 40 year working lifetime, though, at that 10% return:

Year 10 $25,937

Year 20 $67,275

Year 30 $174,494

Year 40 $452,593

 

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Putting in no more money, that initial investment has grown more than 45x over. Sound exciting? Damn right it does. You’ll notice a few things:

  1. Time is the magic ingredient. Compound interest starts off slow and unsexy, but by Year 40 that original $10,000 generates over $41,000 in a single year!
  2. Winners start early. Because time is so important to harnessing the power of compound interest, the earlier you start, the more heavy lifting it can do for you.

 

Before we all get too excited, though, there are a few important things to be aware of:

  1. Inflation. The calculations above don’t take account of inflation. You may have 45x the nominal value of your starting sum, but that doesn’t mean it’s worth 45x that sum in today’s money. Generally speaking, we’d expect everything to be much more expensive in 40 years’ time, so your money won’t go as far. Accounting for inflation, the S&P 500 has returned around 7% per year. At 7%, $10,000 in todays money would become $149,745. Still not shabby!
  2. Returns. The 10% figure is based on historical returns. However, it’s very debateable whether or not similar returns are likely for the next 100 years. The return you get will affect¬† the final outcome massively.
  3. Volatility. Returns are not consistent in real life. This massively affects the final outcome. Take this example. Two annual returns of 10% each make for an average annual return of 10%. So does -10%/+30% or -20%/+40%. Should end up with the same result then…nope!:
    • $10,000 -> +10% = $11,000 -> +10% = $12,100
    • $10,000 -> -10% = $9,000 -> +30% = $11,700
    • $10,000 -> -20% = $8,000 -> +40% = $11,200

The long and short of it is that we can’t go too crazy with our figues, but still let’s be honest – compound interest is a powerful tool towards Financial Independence. If you’re a young reader, especially, time is on your side. Get that snowball rolling and it just might surprise you. And even if you’re a little older, don’t worry. This can still help you. After all:

 

The best time to plant a tree was 20 years ago. The second best time is now. – Chinese Proverb

 

What’s the most powerful financial concept you know? Do you like to crunch the numbers or play everything by ear?

 

 

Introduction: Meet the Captain

The secret to happiness is freedom, and the secret to freedom is courage – Thucydides

 

The Captain on Compass Background

Hi there. If we haven’t met yet, I’m the Captain. For as long as I can remember, I’ve always been a bit of a misfit. Not a rebel. Not someone who railed against social norms. Just someone a little quirky who didn’t always see the logic in everything “normal” people did.

One of the things I wondered from childhood is why high earners didn’t just save and retire early. It took me till I was 21 to find out I wasn’t the only one to wonder this. One sunny day in 2012, an idle internet search led me to Early Retirement Extreme, which opened my eyes to the possibility of saving hard for 5 years to generate enough passive income to retire.

I spent the next year or two saving hard and sailing the seven seas (the inspiration for the nautical theme to the blog). Although ERE inspired me to some pretty hardcore saving by most people’s standards, I realised I had fallen into a trap of chasing the destination with no real thought to the journey. I was still slave to a materialist dream*.

Fast forward a few years. Despite easing on the saving, I found myself aged 26 – a land-lubber once more – with a paid-off house and a modest investment pot. I also found I no longer had any burning desire to retire. I looked back and realised I’d sleepwalked into living the dream. The magic ingredient? Freedom.

I’m not saying this to brag. You may well be cleverer, wealthier and better-looking than me. Actually scratch the last one – nobody’s better-looking than the Captain. And if you’re already happily retired, or plan to work till you die, or love nothing more than buying flash cars, this blog probably isn’t for you. But if you want to hear more about what I’ve learnt so far and – hopefully – share what we’re learning too, step aboard. Financial freedom isn’t easy, but hey – few of the best things in life are.

What’s your experience? Where are you in your financial journey?

 

*This is totally not the message of ERE – it’s a great blog – just the way that I ended up taking it

 

 

 

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