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Life does not come with a user manual. But why?
This series of posts is addressed to my baby daughter and documents the aspects of life that I should have learned at school but didn’t.

You may want to read this when you are around 16. I’ve really dug into this topic when I was 32, and of course, I expect you to be at least 2x smarter than me.

TLDR: Here is my best advice about investing

• Choose Index Funds or ETFs with low fees that are automatically managed. Low fees will accelerate your returns and automatic management will remove human error out of the loop. Right now the best funds are SP500 from Black Rock or Vanguard. Holding an index will give you returns as the economy grows. No worse and no better.
• Compliment with Government Bonds and Gold (Physical)
• Dollar-Cost Average your entire portfolio
• Put your dividend-yielding stock in your tax-protected retirement accounts. That way, the compound interest from the dividend will be tax-free, and it will compound faster.
• Rebalance often and mercilessly. If you have a target of 60% stocks in your account – if their price falls, you will buy more to adjust your wallet %. When they rise again, you will sell some and convert to bonds. With rebalancing, the market roller coaster works in your favor!

I want to share these learnings with you because I could have really used it back in the day. You see, in 2005 my father (your Grandfather) died, leaving us some money. In 2007 I was approached by a smooth-talking salesman of a managed investment fund. In theory, the whole investment strategy made total sense. On top of that, the investment funds were red-hot in Poland, so my mom and I decided to invest. Only now we know that this was the time of the real estate bubble growing like crazy, but back then information was scarce and hype abundant. The money we lost had me stay away from the market for 10+ years.

Underlying concepts

Here are the concepts you absolutely need to grasp:

Compound Interest

The concept of interest is pretty straightforward. You have 100 USD with 10% Yearly interest – after a year you have 110%.

Compound interest is getting interest on your interest. The first year you will get 10 USD of interest. The next year – 11 (because you are now getting 10% of 110), the third one – 12.1. Not only you get interest, but this interest is accelerating. Over a long enough time, this makes a huge difference. Be extra careful before brushing this off. People are not used to thinking in exponential terms – and this is theoretically simple, but in practice, it’s very unnatural to think in those terms.

Diversification

Over a long enough time period, every asset class will go down significantly. It is very, very important to own asset classes that tend not to move in the same direction at the same time.

Typically what people advise is to own both stocks and bonds. The underlying theory is that when the stock market is doing very well (which means that the companies are having a grand time and people purchase a lot of everything) – bonds are having very mediocre results because people don’t want to keep money tied in bonds and inflation is higher.

When the stock market is doing worse – bonds will be safer because investors want to get out of the stock market and seek returns elsewhere. In practice, in 2008 both stock and bonds tanked because companies and entire banks defaulted. I highly recommend treating this as a serious possibility.

Another benefit of diversification is that when the stock market tanks and you have money stashed away in gold, Real Estate, or other asset class that was unfazed – you can buy stock cheaply which will give you extraordinary results.

The timing of your investment is also a diversification! When you invest the same amount (say $100 each month) regardless of the current price of the stock, you will by definition buy more stock when it’s low and less when it’s high. Do it daily for best results. The best 10 days of US stock exchange is responsible for generating almost 50% of the gains. This strategy is called Dollar Cost Averaging and it’s an extremely good one. I recommend just adopting it blindly.

Long time horizon

Some people get excited about get-rich-quick schemes and consider average returns unacceptable. What’s worse- these people tend to be loud and advocate for you to adopt their strategy (even if they don’t get anything from you participating). This is a mistake. Imagine that you have 1000 USD and you invest in a “Fund” that has only 1% of total failure every month but has a 10% yearly interest rate.

Over 10 years, that small 1% grows to 71% of the possibility of you losing all your money!

With compound interest, that $1000 can grow to $2,707.04, but you can have only a 29% chance of keeping it. That is why it’s very important to keep the possibility of total failure low!

I am only 35 years old, and already I have seen multiple events that “are not supposed to happen”. They were never included in the financial forecast of this or that investment fund manager. The impossible will happen and the only way to protect against that is to diversify aggressively.

So what can you invest in?

Asset classes:

• Cash deposits
• Bonds
• Stock
• Commodities, like Gold or Oil
• Real Estate
• Other currencies
• Alternative investments – cars, wine, collectibles

Investment vehicles

• Managed Investment Funds
• Index Funds
• Contracts, options and other exotic financial instruments

Cash deposits / Certificates of Deposit

If you decide, that the “investing game” is not for you – you are in fact defaulting to investing in cash deposits. This is what “Money in the bank” refers to. Broadly, banks are paying you to lend them money – you get a certain interest rate every year. Once they have this money, they can lend it to other people at a much higher interest rate, issuing credit. A mortgage for example is a form of credit from the bank to the person buying a house.

If you put money in the bank on a Certificate of Deposit (PL “Lokata”), you tell the bank that you won’t be needing this money for say 3 months. Then, the bank can be more certain it will have that money to lend to other folks.

Banks are somewhat safer than the other stores of value. That usually means, that you won’t be getting rich off this capital. There are a few points to keep in mind:

• “Money in the bank” is NOT actually 100% safe. In 2008 the world has seen banks disappear and restructure. I expect these kinds of events to continue in the years to come. To make banks somewhat safe-ish, each country has some form of Deposit Protection Scheme (Here is the EU one). If a bank defaults, your funds are protected by the country to a certain limit (in Poland 100 000 EUR).
  • For example – let’s say you have 30 000 EUR in a bank and the bank was irresponsible with its investments and had to declare bankruptcy. You will get that money back unless the country decides to default (that can happen too in case of a major international financial crisis).
  • If you had 130 000 EUR in the bank, you can be certain to get 100 000 back, but the fate of the remaining 30 000 is uncertain. That amount is per bank – which means that you can spread the risk a bit by holding money in a few different banks.
• The interest rate you get on deposits is tied to the “base interest rates” which government controls. In theory, the government may stimulate the economy by lowering the interest rates:
  1. People will get less interest from their money
  2. They will decide do spend it instead
  3. That spending will stimulate economy
• At the time of writing this, we are experiencing economic suffering caused by the Coronavirus Pandemic. The base rates in Poland are now 0.1%. In theory, these base interest rates may be negative and it was the case in Germany for a while.
• [[Inflation]] is when prices of everything gradually rise. In a healthy economy, it’s a by-product of people getting richer and an expected development. What you want to avoid is of course hyper-inflation. Historically, there have been periods where prices would rise uncontrollably:
• “A loaf of bread in Berlin that cost around 160 Marks at the end of 1922 cost 200,000,000,000 Marks by late 1923” Currently – since we are battling with the economic effects of the Coronavirus pandemic, all the governments are printing money. We are all uncertain about how it will end up.
• {Your Real Interest} = {Deposit Interest} – Inflation
• If your deposit interest is lower than inflation then you will be consistently losing money over the long term. Your loss will be accelerated by compound interest, which works both ways.

Bonds

Bonds are a form of lending money as well. A Bond is a promise from the Emitter (say the Polish National Bank) to the holder (say, you) that it will buy back that bond. To motivate you to agree – it will add some interest rate to make it worth it for you.

• Bond emitter may be a country, corporation, or even a city (these are called municipal bonds)
• Usually, bonds are tied to interest rates as well – that is why they are a real bad business right now when the interest rates are close to 0.
• The riskier the bond, the more interest you get. But you have to remember that if you buy a corporate bond emitted by a company and that company defaults – you never see your money back! That can even happen with countries too – Greece defaulted on their bonds in 2015. That is why Greek bonds are now having better interest rates than German ones.

Stock

Stock is pretty magical. When you buy company stock on the stock exchange, you are owning a piece of the company itself, with all the privileges and risks. If you really want, you even get to attend the shareholders’ meetings. Some companies decide to even pay dividends to their shareholders. I own some stock that is paying me dividends every half a year.

To buy stock you need a brokerage account. This only sounds complicated – most of the banks running these will let you access stock with the push of the button.

Commodities

Commodities are metals (gold included), oil, and a variety of other materials. Since Oil was the major source of energy during the 20th century, it has been historically a good way to include something “tangible” in your investments. With soaring inflation, oil was bound to skyrocket as well. I sure hope that oil is no longer a good investment in your time.

One very interesting asset is gold – it is one of the oldest and psychologically safest stores of value. People “flee to gold” in uncertain economic times and when everything else is falling. I hope you will grow up in a stable economy, but I have seen gold skyrocket twice in 35 years of my life and I am sure to see that again in the future.

Real Estate

Polish people love to invest in real estate and buy apartments.

• You can buy actual apartents / houses for rent
• You can “flip them” – buy cheaply, renovate and sell with a profit
• You can buy shares REITs (Real Estate Investment Trusts) – it’s similar to an Investment Fund, but you own a piece of a fund that holds Real Estate.

Real Estate is fraught with psychological risks. People like it because it’s very tangilble, but don’t trust anyone telling you it’s a sure-fire investment. In general, not trusting anybody that will try to convince you of a surefire investment is a good rule of thumb.

Managed Investment Funds

An Investment Fund is created by a group of people that pool their money to buy a wider portfolio of different stocks, bonds, or other vehicles.

Managed Investment Funds have smart people running around in suits and trying to use their knowledge to make the best deals and theoretically give the fund shareholders better returns. In theory that makes sense and I’m sure there are fantastic funds to invest in somewhere. But in practice:

• Managed funds are very rarely outperforming the average market returns. They are very often worse than just buying an average slice of the market (see next header). The companies creating those funds hide losses by creating many similar funds and killing off those who perform badly. That way, the fund that they promote in ads is one that has beat the market by chance so far, but it is unlikely to continue doing so.
• Because they are managed, they frantically buy and sell new assets, incurring transaction fees. It’s standard right now to see funds that take 2.5% of your money for their management – and they are losing it on top of this!
• What is infuriating – these funds are very often a matryoshka made of other funds with their own fees, making understanding the returns really hard.

Index Funds / ETFs

A stock index is a measure of how a broad set of companies is doing. An example of it is the S&P500 – an index of the 500 biggest american companies. Since most of these companies are global, it’s also a good approximation of the world economy.

This is a natural way of diversification – you don’t have to worry about picking stocks and you should not try that. Index Fund is managed by a computer. It monitors the Index – say S&P500 and allocates its money proportionately to all the companies in the index. Most of the index funds are market-capitalization-weighted. So if a company is worth more – it will “make up” more of the index. If I were to make an index fund consisting of 3 companies:

• Artur & Associates, worth 1000 USD, it would be 10% of the index.
• Borys Chemicals, worth 2000 USD , it would be 20% of the index.
• Piszek Pencils, worth 7000 USD, it would be 70% of the index.

Index funds are often Exchange-Traded Funds (ETFs – but not ETFs are Index funds). It means, that you can buy shares in them on the Stock Exchange, using the same account that you use for Stocks. In fact, it should be all that you do with your Brokerage Account. The fees for holding ETFs are:

• TER (“Total Expense Ratio”). For example, GPW:ETFSP500 noted on the Warsaw Stock Exchange has a fee of yearly 0.15%
• You also have to pay brokerage provision for buying and selling the shares of this index fund, just like any other stock. In Poland, it’s around 0.39% today. But if you don’t trade – just buy and hold these shares as long as possible, this won’t be much of an issue.

Exotic financial instruments

Options, CFDs, Currency fluctuation schemes, or leveraged options are parasitic instruments that are trying to make quick money. They are often doing pretty great over a short financial history, usually riding the wave of market inefficiencies. But almost always investors get wiped out by an “unforeseen” event. Noobs take their place in the money bleeding game until they also run out of cash.

These instruments have their uses for institutional investors – say a bakery that wants to limit their risk of grain price fluctuations, but this is not how you build wealth.

Cryptocurrencies

The same holds for Bitcoin (which is emerging as the major cryptocurrency now). I own some bitcoin – I buy it using my dollar-cost-averaging bot because dollar-cost averaging works extremely well with volatile assets.

I am doing this because I am curious about the hype, not counting on BTC funding my retirement.

Further reading

By no means don’t stop here. The goal of this post was to make things a little bit less scary, but you will need to educate yourself throught your entire life. For starters, I recommend reading:

• The Unshakeable by Tony Robbis
• [PL]: Finansowy Ninja Michała Szafrańskiego
• I Will Teach You to be Rich by Ramit Sethi