Investing is not rocket science. Brokers and advisers can make it seem unnecessarily complicated, while collecting fees along the way. I found that I did not need to learn everything about the markets; I needed to know where to start. Much of the process can then be automated.
The goal is to build a freedom fund, sometimes called “fuck-you money” or FIRE (Financial Independence Retire Early).
FIRE is a strategy of extreme savings and investment that can make it possible to retire much earlier than a conventional retirement plan.
A common rule of thumb is to build a portfolio worth 25 times your annual expenses, then live on relatively small withdrawals. That means withdrawing 4% of the portfolio each year. The average long-term return I use in my calculations is between 7% and 8%, although actual returns vary.
I spend €2,000 a month, so my target is €600,000 of fuck-you money. I would like to reach financial independence as soon as I can. In my example, investing €1,000 a month at an average 7% return would get me there in 19 years, when I am 54.
Here is how I plan to approach it.
The basics
I think there are three things to do when building a freedom fund:
- First, get out of debt and stay out of it. Interest on debt costs you money every day—compounding in the wrong direction.
- Spend less than you earn. Get a clear picture of where your money goes. Use budgets to help, and be honest about what you really need.
- Keep a safety buffer for unexpected expenses, then invest what you can in suitable funds.
Investments come with different levels of risk and potential return. You can leave your money in a bank savings account, where the risk is relatively low, but low interest rates may leave you with little growth.
At the other end of the spectrum are investments with much higher risk and the possibility of higher returns, such as equity in a startup or cryptocurrency.
Between those extremes are index funds.
Index funds
Over the long term, you might aim for a portfolio that is 80% lower-risk and 20% higher-risk investments. To begin, though, I would focus on index funds as the foundation of a portfolio.
Index funds track a financial-market index. Examples include the S&P 500, which covers 500 large US companies, and the AEX, which covers 25 large Dutch companies.
Investors collectively own the market and share its gross return. By owning a broad slice of that market, an index fund aims to capture its return at a relatively low annual cost.
Index funds also use a passive approach, which means less trading. Rather than constantly buying and selling, you can buy and hold for years, reducing transaction costs. Over the long run, stock markets have historically grown despite setbacks.
These investments can offer decent returns over time, although their value still fluctuates. It is a long-term game that uses the power of compound interest.
Compound interest
The earlier you start investing, the more time your returns have to compound. That is why I wish I had started sooner: compound interest can grow exponentially rather than in a straight line. Einstein is often credited with calling it the eighth wonder of the world.
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Compound interest means earning returns on earlier returns as well as on your original investment. Over time, that can make a substantial difference.
Here are some examples, using the assumptions in my calculations:
- If you invest €500 a month from the day your child is born, you will have contributed €150,000 by the time they turn 25. In this example, compound returns add about €256,059, for a total of €406,059 toward a house.
- If you start investing €250 a month at 20, you will have contributed €99,000 by age 53. In this example, compound returns add about €244,577. That could generate roughly €20,969 a year, enough for my own annual spending target of €20,000.
- If you start investing €500 a month at 35, you will have contributed €180,000 by 65. In this example, compound returns add about €426,438, for a total of €606,438 for retirement.
The earlier you begin, the longer compounding can work for you. I wish I had started 20 years ago.
The pitfall
Fear and stress are among the biggest pitfalls of investing. That is one reason I prefer index funds: they follow the market as a whole, which has shown a positive trend over long periods.
For an entire index to collapse permanently, many companies would have to fail together. When an individual company falls out of an index, another takes its place.
Prices will still rise and fall, so you need to think in decades rather than months. Market corrections have happened regularly. The money you invest should be money you do not need immediately.
Many investors sell when prices fall because they feel anxious, then buy when prices rise because they fear missing out. Bear markets have historically appeared every few years.
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No one can consistently predict the next rise or fall. That is why I prefer to own a broad part of the market and stay invested through short-term setbacks.
I also spread my investments across three to five funds and invest a fixed amount each month rather than investing all my savings at once. That way, I buy at a range of prices over time.
Brokers
Brokers and advisers do not always have skin in the game. They earn fees whether or not your investments perform well. One of the simplest rules I have learned is that fees matter.
A 1% annual fee sounds small. Over 30 years, though, it can take a large share of your gains because you lose the future returns on every euro paid in fees.
For example, suppose you invest €1,000 a month for 25 years and earn an average 7% return. My calculation puts the portfolio at €1,026,876. With a 1% annual broker fee, it ends at €819,620: a difference of €207,256, or about 20% of the first figure.
That is why I pay close attention to costs. A broker is a service provider, not a friend.
Getting started
Getting started is fairly straightforward. First, choose a broker with low fees. I chose DEGIRO, a Dutch broker that charges no fees for a selection of funds.
You need a way to access the market, and the costs of that access matter. Check your bank’s fees too; a higher annual charge can add up over decades.
I do not invest all my savings. I keep about six months of expenses—€10,000—in a safety buffer for unexpected events.
After opening a brokerage account, choose two or three index funds that suit your plan and buy them regularly, whatever the market price that month.
I started with these funds, which I could buy once a month without fees:
- Vanguard All-World (about 3,100 companies worldwide)
- iShares AEX (25 leading companies in the Netherlands)
- S&P 500 (500 leading companies in the United States)
For me, the key is to keep it simple and think long term. There is little point in checking prices every day when I do not plan to sell now.
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