Investments

From Early Retirement Extreme Wiki
Jump to: navigation, search

Investing is the act of moving money from the present to the future. The opposite of investing is borrowing which is the act of moving money from the future to the present, for example, to buy a house or finance a business. As long as there are people willing to borrow there is an opportunity to invest. Conversely, as long as there are people willing to save, it is possible to borrow. In reality, no money is actively transported from the future. Instead promises are made between people in the present. Investors give their money to borrowers in the present in the exchange for borrowers giving the money back to the investors in the future. Since only things in the present have value, investors must be compensated for giving up this money. Investors are compensated by borrowers in two ways. First they must be compensated for their deferred compensation. This is the real-risk-free component. Second they must be compensated for the risk of losing money.

Extreme early retirement relies on investing to meet its cash requirements in retirement. Without investing, one would need to save enough cash to last for the rest of one's life. For a typical extremely early retiree, this would means 50-80 years of expenses worth of cash. Depending on the actual safe withdrawal rate, this amount can be reduced to 25 years' worth of expenses for a 4% SWR or 33 years' worth of expenses for a 3% SWR.

Speculation is the act of picking investments that will appreciate more than what is indicated by the real risk-free return and the risk of loss. If you wish to speculate, you must be able to predict performance. This requires being an informed investor. Informed investors can profit (take money) from uninformed investors by investing actively. Informed investors serve to and profit from efficiently allocating capital. Conversely, uninformed investors allocate capital randomly and provide uncontrolled liquidity to the markets.

Many people realize that they are not informed investors and furthermore, are not able to find and pick informed managers. They are better off investing passively. Other people are either informed investors or able to pick informed managers. They are better off investing actively or letting properly picked managers do it for them.

The following strategies are popular with the ERE crowd and offer a mix of active and passive investing:

One size does not fit all! You need to be sufficiently wise to acknowledge whether you are informed or uninformed. If you believe you are an informed investor but you actually are an uninformed investor, you will lose money to informed investors. If you believe you are an uninformed investor but actually are an informed investor, you will lose opportunity cost. You must realistically determine this for yourself. In particular, you may decide not to spend the effort to get informed. Whether being informed is worthwhile depends on your capital base. For most people it is better to acquire more money through their labor acuity than their investment acuity since they have too little money, e.g. a 1% outperformance on $250,000 is only $2,500 which may only correspond to a few months' worth of savings, something that's more easily achieved than the knowledge required for a 1% outperformance.


See also: