One of the most important goals of this blog is to bring information and new perspectives in terms of savings, investment and strategies to a safe (and eventually) early retirement. This is not meant to be financial advice. In a way, is more like bringing important topics to discuss for information and education purposes.
Recently I came across an article from Bloomberg, where California Governor Jerry Brown, talks about the possibility of cuts on the public pension benefits “which would go against long-standing assumptions and potentially provide financial relief to the state and its local governments.”
Apparently, the California Public Employees’ Retirement System (CalPERS), has just about 68 percent of assets needed to cover its liabilities. Keep in mind that this is the largest public pension fund of the entire US.
Across the US, governments have $1.7 trillion less than what they need to cover retirement benefits. This is the end result of:
- Investment losses;
- Failure by governments to make adequate contributions;
- Huge benefits granted in boom times.
We all know that there are retirement funds in better shape and others where the future is uncertain. Regardless of what the future holds, one good strategy is to think about our own savings, and how to invest them. We should never rely solely on one future income source. Diversify. Build and grow new sources of income. Prepare your early retirement. (Tweet this!)
Passive investing is a strategy that aims to maximize returns by reducing fees through ETFs (with low management fees), and avoid costly active funds.
What is an ETF? ETF is an Exchange Traded Fund. Basically is a fund, that doesn’t have anyone making active decisions where to invest. It follows policy and invests according to that policy. No more, no less. Thus the name “Passive” investing.
So, in this case, you don’t have anyone “timing” the market, and “guessing” who or what will be the next best thing. It seems like a drawback rather than a positive thing, but on the other hand, you won’t have active managers making bad decisions with your money. Hence making you lose money.
With an ETF you will get what Mr. Market gives you. If you invest in an ETF that follows the S&P500, you will have the return of S&P500 minus the small fees from that ETF and some tracking error.
If the S&P 500 returns 10% in any given year. An ETF that follows the S&P500 with 0.10% of management fees and 0.05% of tracking error, would return 9.85%.
This example is supposed to be simple, in future posts I will write with more detail. But roughly speaking, this is it.
An ETF that invests by market capitalization basically looks to the S&P500 and invests your money according to the % of each company has inside the index.
So if Apple represents 3.8% of the S&P500, from all the money inside the ETF, 3.8% will go to invest in Apple Shares. Also, if this % increases the ETF will buy more (and sell from those who decreased).
The fund will not try to “guess” where the index is going, rather it will follow the index and its components (the companies).
Keep Your Costs to the Minimum
Another key principle of passive investment is that it is supposed to keep your costs down by keeping the amount of buying and selling to a minimum.
If you have an asset allocation strategy where you will invest in 2 ETF, one from stocks (50% of your money) and the other safe government bonds (the other 50% of your money), one good option is to rebalance once a year to keep the 50%/50% allocation.
This way you will only buy (or sell) once a year, and only to keep your asset allocation. Therefore minimizing your costs.
It has an additional advantage: if you keep rebalancing, you will be forced to sell the winners and buy the losers.
This way if you start 50/50, and let the bull market increase your ETF stocks to a value where your asset allocation goes to 90/10, if a bear market comes your portfolio will be hit very hard. On the other hand if you keep the balance by selling stocks (ETF) to buy bonds (ETF) (or reinforce bonds with saved money through the year), if a bear market comes you will be much more prepared.
The hit will be much less painful, and you will have money in bonds to buy stocks with a much lower price.
If you have the discipline, you will buy low and sell high.
Passive investing is aimed on building slow, steady wealth over time.
Do you want to know how are ETFs taking over the market? In the US alone, ETFs are now valued at ~$3 trillion.
If something isn’t clear, please do tell me so I can explain in more detail (or correct). Remember this is only for information purposes. This is NOT advice of any kind. Seek professional help if you need. Read the disclaimer.
And you reader, how do you see the passive investment strategy? Do you prefer the active investment option? What are your experiences in terms of investing?