By Garth Mackenzie (27 October 2024)
Two things happened recently. I turned 45 last month, and I’ve recently befriended a young guy who has just turned 21 years old who shares my interest in 90’s classic SL Mercs.
How these things relate and why I decided to write this article will soon be apparent.
At 45 years old, my career in the financial markets spans almost 25 years. As you can imagine, I’ve learned a few things in that time that I didn’t know when I was 21.
My 21-year-old friend is a film maker who does really impressive work. He has recently returned from a 7-week adventure around Europe as part of the film crew making a motorcycle series for Amazon with some high-profile biking enthusiasts.
He earns well for this work. He has managed to earn much more at 21 than I had at that age. And much more than most 21-year-olds could dream of.
But he has a problem: He’s 21 and he is somewhat naïve when it comes to managing money.
That means he has a high propensity to take a trip down Silly Street with the money he is earning.
Being a fellow petrol head, he now wants to buy an Aston Martin!
I’m trying to guide him to be wise with his money. I hope he will read this article.
He has the opportunity to set himself a solid financial foundation for life if he chooses to be smart with his money instead of buying a depreciating British sports car.
This got me thinking about what my 45-year-old self would say if I could go back and have a conversation with my 21-year-old self.
Where was I at 21?
I’d just finished university and started out my career in the equity derivatives market at as a junior futures dealer. Since then, my career has always been quite focused on equity derivatives.
Derivatives are leveraged instruments. They’re racy. My first boss described futures to me as being like a turbo-charged Golf GTI, whereas straight shares are like a Volkswagen Beetle.
By virtue of my work being focused on equity derivatives, I have had a career that has been in active trading rather than passive investing. But I’ve worked alongside spot equity people too: portfolio managers, analysts, stockbrokers, fund managers. I’ve had a buffet of the racy derivatives game, and also a decent taste of the more sedate equities business.
In the early part of my career (the mid 2000’s) it was a raging bull market and the equity derivatives business I was working in was flying. I thought my older spot equity colleagues were wussies with no risk appetite. “Why invest in straight shares when you could add a turbo to those shares in the form of Single Stock Futures?” I thought.
Well, the thing about adding so much horsepower is that when the crash happens, it happens at much higher speed.
I saw that in 2008 when the financial crisis left our derivatives business as a mangled wreck. Clients lost fortunes as their leveraged bets got margin called and their accounts destroyed. And my days of earning big quarterly bonuses came to an end.
Suddenly those boring equity guys that I was working beside looked smarter. More sustainable. Their clients came out the other side alive and able to enjoy the bull market that followed after 2009. Most of my derivatives clients were finished! I learned some valuable lessons about longevity then.
As I’ve gotten older, I’ve found that my risk appetite has waned. I’ve become more sensible and more appreciative of risk. I’ve come to realise that slow and steady really does win the race in the end.
If I could have a conversation with my 21-year-old self, these are ten lessons I’d teach him.
If my 21-year-old friend heeds some of these lessons, he could become very wealthy by the time he is 45. That’s “if” he chooses to heed these lessons rather than rush out and buy a fast car.
1. Time is your greatest asset when it comes to investing. Use it wisely.
Albert Einstein once said: “Compound interest is the 8th wonder of the world. He who understands it earns it. He who doesn’t, pays it”. A key element of this compounding concept is TIME. The more time that is allowed, the more powerful the effect of compound returns will be.
Let’s look at an example of the power of compound returns on an investment of £30,000. (That’s roughly the value of the Aston Martin my young friend wants to buy). Let’s assume that instead of buying the car, he invests that money in an equity portfolio of shares that generate a compound rate of return of 7% per annum, and a dividend yield of 3% per annum, to make a total return of 10% each year. Assume the dividends are reinvested back into the portfolio each year.
That £30,000 investment grows to £523,000 by the time he turns 50. And that’s assuming he never adds another penny to the initial investment.
(Age on bottom axis. £££ on side axis)
If he leaves the money invested until he is 60, it becomes £1,357,000.
The extra ten years of compounding adds over £800,000 to the value of his investment.
(Age on bottom axis. £££ on side axis)
Now let’s assume he buys the Aston Martin, messes around for another 20 years and at the age of 40 decides it’s time to start investing some money for the future. He’s now older, possibly has a family, a house and all the associated costs that it comes with. His ability to save is severely compromised, but let’s assume he decides to start investing £1,000 per month at the same rates of return mentioned previously.
By age 50, he will have invested a total of £120,000. At age 50, his total investment is worth £207,000.
If he continues saving £1,000 per month until age 60, he will have invested £240,000 and it will be worth £762,000.
(Age on bottom axis. £££ on side axis)
Notice the difference?
Despite only investing £30,000 at the age of 21 and never investing another penny after that, his total investment at age 50 and 60 is significantly higher than if he waited until age 40 to start investing £1,000 per month, every month.
Suddenly that Aston Martin doesn’t seem like such a smart choice, does it?
That’s the power of COMPOUND returns.
That’s the power of using TIME wisely.
COMPOUNDING and TIME are an incredible force when combined.
2. Keep investing regularly and start early.
If you have a lump sum to invest when you’re young like my 21-year-old friend, that’s a huge bonus. But most people don’t have a lump sum to start with.
In that case, try to save a portion of your earnings every month and invest it into the market. How you invest and what you invest in obviously matters, but the discipline of saving regularly is just as important. The more you can afford to save, the better.
Often, youngsters have the greatest ability to save as they have a lower cost of living and more disposable income if they are earning relatively well. Combine that ability to save with the benefit of time, and you can start the compounding process that much earlier.
Unfortunately many youngsters are blind to the value of the time on their side.
The chart below shows 3 separate scenarios.
The first scenario in blue assumes my young friend starts to save £1,000 per month now at age 21, and continues to do that every month until he turns 30. Then he stops saving and leaves the investment to continue growing. He doesn’t take anything out of the investment and doesn’t add anything. It is left to compound at 10% per annum until he turns 60. At that stage, the total investment is worth £4 million!! (His total capital invested was £108,000).
The second scenario in orange assumes he only starts investing at 30 years old, and invests £1000 per month, every month until he turns 60. By 60 he has invested £360,000 and his total investment is worth £2.5 million.
The third scenario in grey assumes he only starts investing at 40 years old, and invests £2,000 per month, every month until age 60. By age 60 he has invested £480,000 and his total investment is worth £1.7 million.
(Age on bottom axis, £££ on side axis)
Do you notice how powerful the benefit of starting early is?
Do you notice how powerful the benefit of investing regularly is?
3. Be patient with a sound strategy. See the bigger picture.
Discipline in investing is really important. If you have a sound strategy, the best thing you can do is to stick to it religiously and consistently. Don’t chop and change your strategy or chase after the latest fad. Slow and steady wins the race, remember. Keep your eyes on the horizon and continue to execute a sound investment strategy. Allow compound growth to work in your favour.
Even if your strategy is not the best strategy, an average investment strategy that is applied with consistent discipline will beat an inconsistent, ill-disciplined approach.
4. Markets mostly go up over time.
Equity markets go up over time. There are two main reasons for this: Inflation and the desire for companies to grow their earnings.
The chart below is the S&P composite Index going back to 1900. As can be seen, the market has continued to trend gradually higher over time, notwithstanding some very nasty corrective periods along the way.
Don’t get me wrong, there are times to be under invested or to adopt an active approach to avoid getting caught in the deepest of market pullbacks. See points 7 and 8 below.
5. Take risk, but don’t be reckless.
When you’re young, you have the time on your side to repair any damage to your investment portfolio. This allows one the ability to take greater investment risk early on in life. That’s not to say you should be reckless however.
Taking risk means allocating a part of your capital to investments that may yield high returns. These are typically businesses that are at the cutting edge of new, disruptive technological advancements and future themes. They’re the types of businesses that have a lot of runway to reinvest their profits back into the business and grow earnings as they penetrate new markets.
There are plenty of examples of disruptive businesses that have gone on to be enormously successful. Think Apple, Google, Meta Platforms, Tesla.
But keep in mind, these are the success stories that have survived and thrived. Many aspirant, disruptive businesses may not thrive. Think Blackberry and Nokia.
So for that reason, it is important to ensure that you hold a diversified exposure to various different asset classes and industries. A small allocation to a company that becomes a massive winner can move the needle in a big way. But an unnecessarily large allocation to a company that fails to survive can be financially devastating.
Take risk, but don’t be reckless with the amount of exposure you take to risk assets. Hold a diversified portfolio. (And cut losers quickly.... see point 8).
6. Growth shares over high-dividend shares.
This is a lesson that I learned the hard way quite soon after the financial crisis in 2009. Having managed to preserve my wealth during the crash of 2008, I decided to dial down the risk and play less in the racy derivatives space and more in the physical shares space. I decided to join my boring equity colleagues and start owning some shares that paid high dividends.
The trouble with high dividend paying shares is that they are usually mature businesses that have reached the peak of their growth cycle. They’re cash generative businesses, but there is limited scope for their earnings to grow because they have usually saturated the market they operate in and have become large and cumbersome businesses. Think of telecom providers, utility stocks, and large banks. They are old industries with some big players, but they have little scope to grow. They therefore have little need to reinvest their profits. So they can pay out those profits to shareholders in the form of dividends.
That’s all very well as a shareholder. You might receive chunky dividends each year, but the share price growth in these types of businesses is usually very limited.
Take a look at the likes of Vodafone, Lloyds Bank and National Grid. They pay very generous dividends but their share prices have been stagnant for a decade or longer.
As a young person in the market, you need to realise that high dividend paying companies are usually not the types of businesses that will give you the sort of growth potential you should be seeking.
Mature businesses with legacy systems are often slow to adapt, and are the most vulnerable to disruption by smaller growth businesses.
Rather look to invest in companies that have a lot of runway to grow and expand their businesses. Don’t fixate on high dividend yield.
7. Nothing good happens below the 200-day-moving-average.
The 200 day-moving-average is a long term read of a share’s direction. It equates to around 9 months’ worth of trading activity. If a share is growing in value, it will naturally stay above the 200-day-moving-average. Large institutional shareholders will often use the 200-day-moving-average as a guide to add to or invest in shares when their prices pull back. If a share’s price trades below the 200 day-moving-average, it is an indication that there is not much buying interest in the stock.
Paul Tudor Jones – one of the most successful investors of all time – is credited with the saying “Nothing good happens below the 200 day-moving-average”.
If a share that you owns begins to trade consistently below it’s 200dma, you should exit. You can always re-enter again if it recovers.
Use the 200dma as a health barometer for your stocks. If they trade under the 200dma, exit.
In my experience, all share price collapses have begun with the price gradually falling underneath the 200dma. It usually happens slowly and allows you plenty of time to re-allocate that capital before things get any worse.
8. Cut losing positions quickly. Add to winning positions and be patient to hold them.
I’ve mentioned that you should take greater risks when you are young. But you also need to make sure that if your investments are not yielding a return, then you cut them before they lose you too much money.
Cutting losers and letting winners ride is one of the key principles of capital growth.
In general, if a share position that I am holding moves against me by 7% or more from my entry point, I’ll cut it to minimize the loss. I can always re-enter again afterwards if things start to improve.
More often than not, I have found that cutting a losing position has been the correct decision as things continued to get worse after I’d cut.
Sure there are times where I’ve cut and then watched the share price recover, but those are generally the exception.
Human nature is often to hold onto losers in the hope that things will come right. We’re not wired to accept a loss. But that’s exactly what you need to do in order to keep your portfolio’s risk under control.
Also important is to add to winning positions. If you hold a share that has upward momentum on its side, then look to add to that position.
I once asked the late Dr David Paul what separates successful investors from unsuccessful investors. He said that when unsuccessful investors have a losing position on, they become optimistic, thinking that their position will recover. When they have a winning position on, they become pessimistic and worry that their profit will disappear. So they snatch at profits too quickly and let losers run.
On the other hand, successful investors become pessimistic when they have a losing position on, and cut it quickly in fear that they will lose more. When they have a winning position on, they become optimistic, believing that their winner will continue to grow. So they add to winners.
This was one of the wisest perspectives I’d ever heard.
9. Active trading is not suitable for most people.
I‘ve made a career of active trading, and running courses in active trading and selling active trading strategies. I consider myself to be competent as an active trader of CFDs and futures. But on the whole, I’ve made more money holding longer term positions in spot equities (since 2008) than I have through active trading. Admittedly I’ve also allocated far more capital to my spot equity investing than I have to active trading in CFDs and futures. But I’ve also managed to more easily hold onto delta 1 (unleveraged) positions than to active, leveraged positions in futures and CFDs.
Active trading requires a specific skill set that most people simply don’t possess. It also requires far more time and focus than most people realize.
Active trading service providers (CFDs and futures) are required to publish the percentage of clients that lose money using their services. The number always varies between 70% and 80% of clients that lose money. That number tells you that most people are not suited to active trading.
If you want to take on the challenge of active trading to see whether you can make a success of it, do it with a small part of your investible capital and ensure that it’s money you can afford to lose.
10. Financial doomsayers are to be ignored.
Bad news always sells more than good news. Have you noticed? It appeals to our primal need for protection and safety. Our attention is instinctively piqued when there is a threat to our well-being. And in the financial world, there is no shortage of potential risks that are ever present. Financial doomsayers will highlight these risks to draw attention to their work. It’s all just noise. Over time I have found myself being too susceptible to financial doomsayers and they have negatively affected my ability to keep sights on the bigger picture. I wish I knew this at 21.
The end of the world will only happen once, if it ever happens at all. And when it happens, your investment portfolio will be the least of your problems. So until then, accept that the sun is likely to continue rising every day and human ingenuity is likely to continue proving unstoppable.
I hope you’ve found this helpful. I hope my 21-year old friend reads this and accepts the guidance from this middle-aged guy who was also once 21 and who has walked the path that he is setting out on.
This is not an exhaustive list of pointers, but they were ten ideas that sprung to the top of my mind. Obviously each individual’s circumstances are different and these ideas can be expanded upon.
But, applying these ten basic lessons to investing will be incredibly beneficial.