Have you ever heard the investing advice:
It sounds reasonable, since there’s always a risk of capital loss in the stock market, right?
Well, I think it’s just bad advice (to a certain extent, of course).
Let’s start first with how much money are we willing to lose?
I’ll go first. Maybe $5,000?
Then what would I do with the rest of my money though?
Money we use today, be it in our bank accounts or in our wallets, are known as fiat currency. This is currency issued by the government, without actual backing by an asset like gold (as it used to be). Fiat currency is only backed by the government and their promise to maintain the value of the currency.
Fiat currency is one of the causes of inflation, which refers to the drop in purchasing power of a currency over a period of time. This tends to be caused by introducing new money into the economy by the government such as through quantitative easing measures.
I know this all sounds like a bunch of technical jargon best left to the economists at the Ministry of Finance or the Monetary Authority of Singapore, but wait up, I’m almost at the main point!
This means that if I were to invest, say, 10% of my total cash, i.e. the amount I’m willing to lose, I would still have another 90% sitting around somewhere. This 90% is losing value every day to inflation.
If we took a sum of $100,000 sitting around in your bank account over the last 20 years and an average inflation rate of about 2% per year, the value of your money would have fallen by almost 1/3. This means that you would require almost $150,000 to buy the same amount of goods as you would have been able to 20 years ago!
Thinking back, it wouldn’t make much sense to leave so much of your money in your savings account to be lost to inflation…
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What to Do Instead?
Well, perhaps I would correct the original advice to:
“If you treat the stock market as a casino, invest only money you’re willing to lose.”
This is my main issue with the original piece of advice. It treats the stock market as a casino and investing in stocks as gambling. Sure, there is an element of luck to investing, but your returns should not solely be due to luck. If they are, then perhaps the original advice was meant for you. Your investments should be backed by sound investing principles.
In the famous book, The Little Book of Common Sense Investing by Vanguard Founder, John C. Bogle, he says that only 5% of your investment assets should be allocated to your “Funny Money” account, where you get to pick your own individual stocks, with the rest being put to index investing.
What he also implies by this is that when you invest in safe investments, you can allocate more to it than money that you’re willing to lose, for it is a safe vehicle to grow your wealth. It is not an investment that requires luck to succeed, nor is it one that is a gamble.
How else would anyone be able to become financially independent otherwise through the stock market?
Such safe investments, of course, as implied by the late John Bogle, are index funds or index ETFs. These are investments that are well-diversified and have an extremely long track record of doing well over the last century and then some. This will also give you the peace of mind to sleep well without constantly worrying about your investments going to zero.
All of this is of course, with the understanding that all your other financial needs are taken care of, such as your emergency fund and short-term savings for upcoming large expenditures. This is certainly not a free pass to invest your HDB downpayment into the stock market!
I understand the feeling of putting a large portion of your net worth into the stock market may seem daunting at first. I definitely felt it when I pulled the trigger on my first index ETF purchase. You feel like you’re putting all your precious savings on the line.
But it definitely gets easier.
Understand the principles that make index investing work and it’ll get easier. Spend more time in the stock market and it’ll get easier.
It definitely does.
Photo by Annie Spratt on Unsplash