Renowned author and financial blogger JL Collins says it is essential for investors to stay away from complex investments, as they are not only costly but are less effective too.
Investors often get trapped into complex and enticing financial investments, which only profit those who create and sell them. One should note that often, the simple investment strategies win and that’s why one should stick to basics and avoid risky investments, Collins says.
“Complex investments exist only to profit those who create and sell them. Not only are they costlier to investor, they are less effective,” he says in the book The Simple Path to Wealth.
Understand basics of personal finance
The American researcher speaker and consultant says it is essential to understand the basics of personal finance, as money is the single-most powerful tool that can influence investment decisions. Having basic knowledge of personal finance can position an investor to make money work for her, and not against her, which can help make investment decisions independent of money, instead of the reverse.
“Since money is the single most powerful tool we have to navigate this complex world we’ve created, understanding it is critical. If you choose to master it, money becomes a wonderful servant. If you don’t, it will surely master you,” he says.
In his bestselling book, Collins offers effective tips and resources to better understand the world of investing.
Secret to achieving financial freedom
Collins says the secret to achieving financial freedom is to spend less than one earns. Also, he feels investors should invest back the surplus amount that they have and should stay clear of debt.
Collins feels accumulating debt by buying things that are not essential is a waste of time and can weigh investors down in the long run. “If you intend to achieve financial freedom, you are going to have to think differently. It starts by recognizing that debt should not be considered normal. It should be recognised as the vicious, pernicious destroyer of wealth-building potential it truly is. It has no place in your financial life,” says he.
How to handle debt
Collins says it sometimes becomes impossible to avoid debt. In those cases, if one has to repay debt at an interest rate of less than 3%, they should pay the debt it off slowly and put more money in investments.
If the interest rate for debt is between 3-5 per cent, it is up to the discretion of the investor on how she plans to repay it. But if the rate is higher than 5 per cent, it is best to pay it off as quickly as one can.
Maintain a simple lifestyle
Collins says the most important tool that money can buy is financial independence, which is a very valuable asset that one can have. He asks investors to maintain a lifestyle that they can afford and avoid getting into the trap of leading a luxurious lifestyle just to maintain a social status.
“Money can buy many things, but nothing more valuable than your freedom. Being independently wealthy is every bit as much about limiting needs, as it is about how much money you have. It has less to do with how much you earn (high-income earners often go broke while low-income earners get there), than what you value. Money can buy many things, none of which is more important than your financial independence,” he says.
Focus on outcomes that can be controlled
Collins says it is important for investors to not worry about things that are out of their hands. Instead, he feels, one should focus on outcomes that they can control and should spend more time with people that they can learn from and those who can add value to their lives.
“One of my very few regrets is that I spent far too much time worrying about how things might work out. It’s a huge waste, but it is a bit hardwired into me. Don’t do it. The older I get, the more I hold each day precious. I’ve become steadily more relentless in purging from my life things, activities and people who no longer add value while seeking out and adding those that do,” he says.
Two stages of investment
According to Collins, people often make the mistake of thinking about their financial life in terms of age. They work hard and save when they’re young and spend and relax when they retire.
He thinks this is not the right approach to follow while dealing with personal wealth.
He lists two stages of investing that people should follow when they look to make investment decisions.
- Wealth accumulation stage
The first stage is the wealth accumulation stage, where people should earn and save, irrespective of their age, and can be extremely aggressive with an investment portfolio.
- Wealth preservation stage
The second stage is the wealth preservation stage, when people should leave their investments to grow and provide a stable income when their own earnings slow down or end.
“Your stage is not necessarily linked to your age. The wealth accumulation stage comes while you are working, saving and adding money to your investments. The wealth preservation stage comes once your earned income slows or ends. Your investments are then left to grow and/or are called upon to provide income for you,” he says.
Stock market is a core wealth-building tool
Collins recommends investing in stocks as he considers the stock market the core wealth-building tool. According to him, to accumulate gains in the stock market, investors need to be patient and should be brave enough to weather the ups and downs.
He says the key to achieving success in the stock market is to hold shares through the downturns and never sell for less. He advises investors to buy more when shares cost less and not worry when the share price drops.
There will be many times when one may have to watch her wealth disappear during an investing career, but one should hold on during these tough times. “So you would embrace two concepts – understand that you don’t ever sell in a panic just because it went down. That is simply not an option you will ever consider. And then depending on which investment stage you’re in, either use bonds or use cash flow to smoothen the ride,” he says.
Why investors lose money in stocks
Collins says most people tend to lose money in stocks because they think they can
- time the market
- pick the right individual stocks and
- pick winning fund managers.
“The truth is no individual can reliably time the market, nor can one be sure of picking the right individual stocks over time and also no one can be certain of picking winning financial managers,” says he.
Instead, investors should adopt a simple yet effective strategy for accruing wealth. Which is:-
- Follow a simple investment strategy
One should think about the acceptable risk level and the time period she would like to hold an investment before making an investment decision.
One should keep stocks at the core of their strategy. One should consider buying some bonds to diversify her portfolio, particularly in the wealth preservation stage of life as they can act as a deflation hedge. Also, investors should keep as little cash as possible.
“Even the playing field with bonds. Keep at least a 20-75 split where you hold 20 per cent in bonds, 75 per cent in stocks and 5 per cent in cash. You can change that ratio depending on the risk you feel comfortable with,” he says.
- Invest in index funds
To avoid short-term volatility, Collins recommends investors to pick index funds as they are pretty safe bets and may provide best returns over time and serve as a hedge against inflation. Index funds are low-fee funds that mirror the performance of the entire stock market.
“One of the beautiful things about the index is what I call self-cleansing. And by that, what I mean is that if you look at any specific company in that index, you can only lose 100 per cent of that company. But any other company in that index — and Google is a wonderful example of this over the last few decades — can grow exponentially. The losers fall off, and they don’t actually go to 100 per cent before they get delisted and you are continually getting new blood added to it as new companies come up. And as an investor, I don’t have to figure out who the winner is going to be, because I own them all,” he says.
- Educate yourself
Collins advises investors to learn about investing before starting their investment journey, which can be achieved by reading and learning from the investment philosophies of the investing greats.
- Manage your own portfolio
Collins is of the view that investors should prefer to manage their own portfolios and shouldn’t trust financial advisers. He feels while some financial advisers may be very good, there may also be some who are incompetent and their interests may not necessarily be aligned with what’s best for an investor.
“In terms of financial advisers, I don’t think you need them. If you follow an approach of simple investing, you don’t need them for that. But there are other aspects where they can be useful. The problem with financial advisers is while there are good ones, there are a lot who are not. By the time you know enough to choose an investment advisor wisely, had you invested that time learning it yourself, you would know enough to do it on your own,” he says.
- Follow a flexible lifestyle
Collins says if an investor follows a flexible lifestyle then she will have the ability to bear more risk than the ones having a rigid lifestyle. He says when the market goes down or when an investor’s income slows down, investors having a greater ability to cut costs or create new income opportunities will be able to deal with these setbacks better and prosper when the others will tend to panic and falter.
“Flexibility. How willing and able are you to adjust your spending? Can you tighten your belt if needed? Are you willing to move to a less expensive part of the country? Of the world? Are you able to return to work? Create additional sources of income? The more rigid your lifestyle requirements, the less risk you can handle,” he says.
(Disclaimer: This article is based on J L Collins’s book “The Simple Path to Wealth” and his presentation at Talks @ Google, whose video is available on YouTube).