Why knowledge of investing is critical for financial independence

I cover a lot on investing here on SaveInvestBecomeFREE (IBFREE).  There is a reason for this.  Savings is the only way to build your wealth but once you have quite a bit saved and plan on using that money to fund your lifestyle for a long time (maybe 50 years for a very early retiree!), good investing becomes the main factor between financial success and failure.

Your post-job, lifetime financial success depends on how you manage the money you saved.

Once we achieve FI, the game is not over.  Of course work becomes optional, so in that respect we’ve won the game.  But we still need our investments to pay us for a very long time so we need to manage them well.

This is where investing knowledge comes to play.

The only way I know to be a good investor and assure your long-term financial future is to learn about investing.

Many would argue that experience is key as well because investing is as much psychological as it is math.  But without a good base of knowledge on investing, including a critical knowledge of investing history, you’ll be hard-pressed to make good investment choices to set up your investment portfolio and keep grounded during the inevitable swings your investments will make.

I’m not a big history buff.  I’m much more of a future-thinking person.  But for investing, I make an exception.  Patterns repeat in investing so understanding the past is a critical tool in building the right investment mindset.

If you follow the “just gain experience” route instead of learning from others, including their mistakes, the process of gaining experience is likely to be very unpleasant and leave you much poorer.

In this blog, I want to add content around investing as this is an important part of our lifetime financial journey and is covered less than many other FIRE topics.  Hopefully this is useful for those early in their FI journey and learning about investing (where mistakes are cheaper!) as well as those that need to be very comfortable about investing their large amount of savings to make it last upon ending gainful employment.

Understanding how our minds work in relation to investing is a critical part of being a good investor in my view. I side with the many experts who believe successful investing is more about psychology and behavior than it is about investment selection skill, so I try to cover a lot about our psychological biases and how to overcome them to be a better investor.

Step 1: awareness.

Remember, most of the blogs on FIRE are quite new and most contributors are either on the journey to FI or they have only recently achieved FI (myself included).  Few have the experience of living off their investments for long periods of time.

Saving money from your job, and living off your portfolio for decades, are very different things and require different skills and knowledge.  We need to make this transition well if we want to maximize our happiness and not worry about money our whole lives.

Investing Can Be Simple

Luckily, successful investing can be quite simple (although not necessarily easy).  To jump to the conclusion, a few  diversified and low-cost index funds with a relatively high stock (or other income-producing investment like real estate) allocation and a low-enough safe withdrawal rate, and there is an extremely high probability that you will be set for life.  But……

You’ll need to learn enough about investing to actually believe this and be able to stick with it over time.

Many very knowledgeable and successful investors advocate this approach and have walked the talk in their own lives.

Warren Buffet has recommended this to others and when he dies, plans to have 90% of his wealth (after donating most to charity) put in an S&P 500 index fund for his surviving spouse.

Of course John Bogle, the founder of Vanguard and champion of index funds (and individual investors everywhere) is a huge proponent of index funds.

JLCollins is one of the more famous FIRE bloggers who writes about this and he even wrote a book with a large focus on the benefits of index fund investing.

I mentioned before that few FIRE bloggers have actually had the experience of living off their portfolio.  But the Bogleheads forum has many members who have been living off their portfolio for decades (very successfully it seems!).

The fundamental portfolio a typical Boglehead has is a set of simple, low-cost index funds.  Some of the people in this community are expert investors.  As an example, Larry Swedroe, a pretty famous wealth manager, is a key member of this group with thousands of posts.  He’s read over 300 investing books and written 15 himself.  After all that he’s learned and studied, what is his conclusion?

A simple, low-cost portfolio of a few index funds is the best way to invest!

The most commonly recommended portfolio is a simple 3-fund portfolio of

  • Vanguard Total Stock Market Index Fund (VTSMX)
  • Vanguard Total International Stock Index Fund (VGTSX)
  • Vanguard Total Bond Market Fund (VBMFX

There are endless discussions on the exact amounts of each but roughly 40% US stocks, 20% foreign stocks, and 40% bonds is common, so an overall 60% stocks/40% bonds allocation for those in retirement.  This is not my personal recommendation since I’m not a big fan of bonds right now and I think early retirees need a higher stock allocation, but these are smarter people than me so you’re likely to do quite well following this advice.

In addition, Bogleheads is a good forum for support in sticking with your asset allocation when times get tough.  In the next bear market, if you’re wavering, I suggest using this community for support so you don’t do something stupid like sell and go to cash after your investments have declined a lot 🙂

The additional advantage is that it takes almost no effort to manage your money in retirement with a simple approach like this.

Don’t forget this key benefit!  Your time is precious and is a key reason we are pursuing financial freedom in the first place.

We don’t want to keep exchanging our time for money.

The reason index funds are much better than actively managed mutual funds is because of their low fees.

What about stock-picking skill?  Certainly the brightest minds on wall street can pick stocks better than random chance right?  It’s out of the scope of the post but I’ll link to some very good books at the bottom that will explain why the data does not support this.

Even if there is some higher skill stock-picking skill in actively managed funds, the huge fees completely swamp any skill advantage if it’s there.  Actively managed funds clearly underperform a simple passive approach over time.  The data is quite clear on the matter.

A quick note on fees.  They are critical.  A typical actively managed fund has fees of about 1%.  This is because all that stock-picking and “active” management means investments are bought and sold regularly.  This trading costs money but doesn’t seem to boost returns. Plus of course they want to make a lot of money from their investors.

The unique thing about Vanguard, the champion of index investing, is that the funds actually own the company.  This unique ownership structure is key.  It means that Vanguard tries to minimize the costs of its funds compared to all the other firms that are incentivized to increase their costs.

Back to that 1%.  It sounds quite small.  But 1% in investing is huge.  As I’ve written about before, I recommend a 3% safe withdrawal rate for early retirees (the standard 4% rule is fine for traditional-age retirees).

So a 1% fee is a full 1/3 of your annual spending money!  Does 33% of your annual expense budget still sound small?

An index fund is about 1/10th of this (0.05% for an S&P 500 index and 0.15% for a foreign index fund for example) so maybe 2-5% of your annual spending budget.  That’s a lot better than 33%!

BTW, if you use a financial planner, the standard fee is another 1%.  So if your financial planner is also using active mutual funds, you’re paying 2% in fees every year.  This cost would be 67% of your annual spending in early retirement if you follow a 3% withdrawal strategy!

If this is your plan, I hope you are extremely frugal and get a lot of personal happiness by donating most of your money to financial professionals.

If you tell me you don’t want to learn about investing and feel more “comfortable” working with a professional financial planner, then that is your choice.  Just understand how incredibly expensive your ignorance of investing is going to be.

My advice is to face any fear or disinterest of financial matters you may have and learn.  It’s one of the most lucrative pay-offs you can achieve.  The lifetime $/hour benefit is likely to be far above anything you could achieve in your job or side-hustle.

The great thing is that once you have some knowledge, a passive, long-term approach is great for investing (regardless of whether you use index funds or not).  So it takes little effort once you know enough to believe in a passive investing approach.

To give you an example of a passive long-term approach being ideal, Fidelity completed a study where they tracked down their most successful investors looking for common attributes.  They zeroed in on investors that did the best over a full decade, from 2003 to 2013.  In combing through the data, they found two groups that had superior investment returns.

Group 1: People that forgot they had an account (e.g. changed jobs)

Group 2: Dead people.

This should be telling us something.  Active trading both creates transaction fees but also tends to be the wrong decision due to emotions (e.g. buy high and sell low).  A buy and hold strategy works better.

I could give many more examples but I think you get the point.  A simple, diversified portfolio of low-cost index funds held for life, is by far the most effective investing approach.  And it won’t take much effort which is an extra great benefit.

Your investment workers are very effective and self-motivated.  If you micromanage your busy working dollars, they will get annoyed and charge you more.  Just leave them alone to work and they will take care of you.

I know it feels weird making money by doing nothing, but that is what passive investing is.  Others are happy to take your capital and use it to make even more money.  They are happy to pay you for the privilege.  Embrace it and let your hard-earned capital do the work for you.

You can let go and do something else that is more fun and fulfilling.  You are free!

If you want to learn more, below are some really good books that I highly recommend on investing in stocks.  As a disclaimer, I’ll get a small referral fee if you end up buying through these links on Amazon (no cost to you).

I’ve read a lot of books on investing and believe these select books provide a great foundation for investing.  Many others recommend them as well.

Note the list below is different from my photo on this post.  I have many of these books in electronic format and several of my physical books are on loan to friends since they are the first ones I loan out to help others with investing.

The first is a great one on the history of investments so you understand the inevitable cycles and bubbles that occur as well as some inner workings on Wall Street.

A Random Walk down Wall Street: The Time-tested Strategy for Successful Investing

The next few provide a really good foundation on stock market investing and why index fund investing is so advantageous.

Stocks for the Long Run 5/E: The Definitive Guide to Financial Market Returns & Long-Term Investment Strategies (Management & Leadership)

The Four Pillars of Investing: Lessons for Building a Winning Portfolio (Personal Finance & Investment)

There are of course thousands of books on investing but I think these few cover 90% of what you need to know to be a successful long-term stock market investor that can fund thier future spending forever at a minimum 3% withdrawal rate.

Happy investing!

3 thoughts on “Why knowledge of investing is critical for financial independence”

  1. I liked the reference from Fidelity about the characteristics of their most successful investors, especially the “dead ones”!

    One other point about S&P 500 index investing is that the S&D 500 is a dynamic index that regularly sheds low performing companies in favor of higher growth ones. For example in 1994 Microsoft was added to the S&P 500, 8 years after its IPO. And in order for Microsoft to be added, another company had to drop from the list.

    This dynamic helps accelerate S&P 500 growth because the index is not made up of a static list of 500 companies but a dynamic list that changes every year. Further, when you look at the list of companies that are removed from the S&P 500 list and those that are added, it makes for an unmatched level of stock picking that is perhaps the best in the world.


  2. Good point about how the indexes like the S&P 500 and are created and maintained. It makes index funds more like a portfolio of businesses that need to meet certain thresholds of financial characteristics like positive earnings over several quarters, large market cap, high liquidity and a few others. This is different (and better) than the stock picking you usually get through high turnover, high fee active management as they try to predict the next stock price winders and not necessarily the best businesses.

    Thanks for the comment!


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