Category: Migrated

Let me start by telling you about my strategy and why it’s probably not the best one for you. I invest about 70% of my income, and almost all of it into a single global index fund.

But I have a few things that make this make sense:

1. My house is paid for already
2. I don’t have car payments
3. I’ve learned to be frugal and tone down my lifestyle
4. I have a decently high income
5. I have lost a lot of time baying off student loans and the like
6. I have paid off all of my debts and have an emergency fund

So I am making more than most people in Japan, but in a sense I started investing late. Since I don’t have the advantage of time, I am trying to make up for that by contributing a lot more. Had I started 10 years earlier, I would only need to contribute roughly half as much.

Friends have asked me about my investment strategy and said “Oh that is smart.. I’ll do that too!” Imitation is the highest form of flattery and all that – but some of these people have credit card debt and no emergency fund. Some fave dependents they need to take care of. Some are younger than me, and most have less earning power.

I don’t just think that trying to pick stocks, gamble with FX or options, or “invest” in cryptocurrency are too risky for almost everyone – I believe that investing all of your cash flow into an index fund is still too risky.

First, it doesn’t make sense to invest in a an index fund with an expected wobbly ~7% return (on which you will have to pay taxes in many cases) when you have credit card debt at 12%. If you realize this (as I did) then you need to become ruthless about paying down your consumer debt. Anything over 4% needs to go, for sore – and as quickly as humanly possible Let me say it plainly: You can never invest if you owe consumer debt.

That cold harsh reality hit me a few years ago, and I just stopped. No more new phones, no more new computers, no more fancy clothes, no more cafe lattes at Tully’s coffee, and especially no more drinking and karaoke with co-workers. No more eating out. I just went scorched earth for 2 years and paid everything off. Student loans, credit cards – everything. Neew new clothes? Muji or Uniqlo. Need to eat? Cook it. Paying off your debt is something that just needs to be done now if you are interested in financial freedom. Living below your means isn’t as fun, to be sure, but not only will you need to do that to pay off debt – you will need to do it in order to invest too – so it’s good practice.

Secondly, if you are most people, you need an emergency fund. I added this later, because I know I would be tempted to spend it if there was cash laying around – but you need a way to cover unexpected short term expenses, and a credit card usually isn’t the best option.

Finally, even once you have paid off your debt and built up an emergency fund, you also need peace of mind. It’s easy to say “I will be fine if my portfolio drops 30%”, but most people react differently when it actually happens. I know I don’t, since it’s happened multiple times – but most people do. There is a simple way to tame the volatility of the stock market – just keep some portion of your money in cash.

You don’t need to get fancy with precious metals, bonds, or foreign currencies – just keep some percentage as cash. For example, if half of your portfolio is in cash, then when the market suddenly drops by 30%, your holdings only drop by 15%. The same, of course, is true on the upside – but you need to be able to hold your position in order to make the earnings you deserve in the long term. If you say to yourself “I want that juicy 7% return, so I am going all in on stocks!”, but then you can’t sleep or start considering selling the first time the market drops 30% – well then were never going to earn that fabled 7% anyway.

So, I implore you to think deeply about how much you are really going to mind when the market drops – because it certainly will. Calibrate your investment ratio based on that. maybe 20% cash is enough for you, maybe you need 60%. There’s no shame in that. None at all. You will be giving up some long term returns in theory – but you will be more likely to stay the course and at least get the projected returns you deserve. Holding cash isn’t actually more conservative in this case, it’s more bold in a way. You are essentially saying “If I have this much in cash, then I can promise myself not to sell at the bottom of the market and lose money” – and that is the most important thing of all.

You can always adjust your ratio as time goes on and you find out what lets you sleep at night. If the market drops 50% and it doesn’t bother you that much, then perhaps you can reduce your cash position. It will be an opportune time to buy stocks at a discount, after all. If that 50% shocks you to the core and causes sleepless nights, then start saving more cash rather than selling the stocks you already own. This ratio is deeply personal and different for everyone – there is no right or wrong. Someone with more mouths to feed would probably be better to have more cash, while someone who has a very stable government job might need less on hand. The “right” amount of risk is the amount that keeps you in the market for the long term.

There have been a lot of posts online recently which basically say something like “Buying government bonds that only yield around 1% when the inflation rate is closer to 2% is nonsense! Only a fool would do that!”

That’s just silly. Assuming that were true, the corollary would be that holding cash is even more foolish, because it earns no interest at all. And yet people do, and should hold cash.

Ideally, for most people, their money should be separated into two buckets:

1. Short term money – held in domestic cash.
2. Long term money – held in investments, such as stock indexes.

I’ll gloss over the definition of “short term” here, except to say that I would use a rough cut-off of 5 years. Likewise, long-term implies anything over 10 years.

This is because you can’t pay your electric bill or rent with stocks, bonds, real estate, or gold. You need to sell those things, and then use the proceeds to buy things. Not only can the value of these things fluctuate in the short term, there are often transaction fees associated with buying and selling.

Besides covering monthly expenses, cash also lets you keep your options open, so that you can afford to spend money even when the stock market or price of gold is down. In other words, it can help prevent you from needing to sell at a loss.

Yet notice that there is a gap between the 5 and 10 year numbers. Even if you used 1 and 15 years instead, there would be a gap. There is always going to be a gap, and you can exploit that gap by investing in very low risk assets that earn at least some return.

Say you have 10,000,000 yen. You decide you need 200,000 yen per month for living expenses, and you are happy with a 3 month buffer. That means you have 600,000 sitting around in cash, with 400,000 left over for investing. In this kind of case, I don’t really see the use of government bonds, because the amounts involved are small enough to perhaps not be worth the effort.

If you have instead 100,000,000 yen, the same 200,000 yen monthly expenses, and want a 6 month buffer – well then you might opt 600,000 in cash, and another 600,000 in government bonds. You can invest the rest knowing that you have a 6 month buffer, and if the worst does happen, you will have plenty of time to sell the government bonds during the first 3 months. Since you probably won’t have to sell them, you can collect interest on them in the majority of cases.

Another thing to keep in mind is that holding cash or bonds isn’t foolish just because they earn less than inflation – you just want your overall portfolio to at least keep op with inflation. If half of your money is earning 8%, and the other half is earning 0%, then you are earning 4% on average. If you convert half of the 0% cash into bonds that earn 1%, then you will be earning above 4% on average while taking on close to zero additional risk. (Sure, the government might fail in some doomsday scenario, but in that case paper money would be worthless too).

In my estimation, money can buy your 4 different things:

1. Stuff
2. Services
3. Time
4. Options

Stuff is the most obvious of these. Money can buy you that new Sony Xperia Phone, that new MacBook Pro, that fancy new car, or high brand clothes. Material things in general tend to lose value quickly, and we usually grow bored of them more quickly than we think we will.

Services could be anything from insurance on that fancy car, a flight to Paris, lodging and a lift ticket for your ski trip, or something like a hair cut or medical care.

What about time? Well, this usually comes about from buying things or services that save you time. For example, you can buy a washing machine, a dishwasher, or a robot vacuum cleaner. All will do some labor for you that would have taken you time and effort. Something like a trip to the barber might be along the same lines. People with higher incomes tend to spend more on this type of thing because their time may be a lot more valuable. For example, if you are an independent attorney you might well rather spend an extra hour on a case where you can bill 10,000 yen for that hour as opposed to spending it hand washing clothes in the bath tub – which you probably aren’t particularly good at anyway.

Options, or flexibility, is probably the most overlooked category. If you decide to forgo spending money on that fancy car now, it opens up the possibility that you could buy an even fancier car later – or a fancy car and a new coffee machine, or pay for a down payment on a new house, or be more generous with your friends and family. Knowing that they have options also tends to give people peace of mind.

If you spend all of your income as soon as you make it, you can buy all the material stuff and services you want, but you will forever be lacking options.