Protect yourself from yourself

“How will the markets treat us when investing our money?” – is what we explored in the previous post.

This post looks at the other variable in the equation: ourselves and our lives. We look at the mirror and see how our psychology, behaviors and life interfere with investing.

By the end of the article you’ll not only feel clearer about what it takes to start investing on a firm footing – you’ll also have a couple new tools at hand to quantitatively assess your own situation in that respect.

Executive summary

Here’s your key take-aways from this post:

• Investing requires discipline – forget any “get rich quick” scheme.
• Only invest surplus money to avoid painful divestments.
• Use accruals to easily overcome your big expenses.
• Keep a safety buffer: some money aside acting as a cushion for life’s surprises.
• Capital preservation investments like gold and bonds are no alternative to the safety of a bank account.
• Refrain from investing if you suspect you’re susceptible to panic selling.

Reach to each section for more background, and refer to the Glossary to explain any unfamiliar term and for a summary of key concepts.

Behind this article

The Swiss rejected a 2021 referendum which aimed at further raising tax for the rich.¹ Proponents noted that the wealth gap increased in the last 20 years.²

“What could be done to uplift the 99%?” – I thought.

Ignoring other relevant factors at play, one key difference between the two classes is investing.

Only one in six Swiss invests money in the stock market in the 99% group³, contrasted by everyone in the top-1%. And that’s not for lack of possibility, as the Swiss boast the second-highest disposable income in Europe.⁴ Yet most, like Scrooge McDuck, keep it all in the bank.

Investing requires some knowledge, time, and discipline. Keeping those savings in the bank requires none, but guarantees to shrink your wealth over time, and keep feeding that wealth gap.

This article aims at reducing that effort as much as possible – at least for the startup phase – and make your willingness the only thing standing between you and taking action.

If you wish to inspect methodology or reproduce results, download the Research Package, which includes all data sources at the time of analysis. Research, writing and review of this content took ~30 hours by the involved parties.

“Get rich quick” schemes

Let’s start by calling out where not to start 🙂

Investing is ultimately an instance of Delayed gratification: You sacrifice an immediate benefit now to get a larger benefit later.

Delayed gratification is absent in young children, develops into adulthood differently among different people⁵, and is highly correlated with various indicators of success in life. In the Stanford marshmallow experiment, researchers had 4-year olds sit alone in front of a marshmallow, promising an additional one if they’d resist eating it for 15 minutes. The children who did wait showed higher CAT scores in a follow-up study run 20 years after.

The children who did not wait, instead, are the favorite target of the “Get rich quick” schemes which beset contemporary social media.

Those schemes entice us with “simple tricks” that provide “huge gains” quickly! 🤑 A true Gold rush bombards us relentlessly, boomed especially since the advent of cryptocurrencies. Random people trumpeting their story of becoming a millionaire out of a $1000 investment in a few months only – with some celebrities pouring additional fuel on the fire by endorsing Meme coins for their own profit. Tom Brady, Gisele Bündchen, Kim Kardashian, Leslie David Baker are some infamous examples.

Those “tricks” are not investing: they are gambling in the best case, and fraud otherwise. They prey on the psychologically weak and susceptible.

Behind each trumpeter of triumph sits a loser of as much money. But we won’t read that loser’s story on social media. He caved in, regreting quietly in his cocoon of shame. And even if he would speak up, who’s entertained by bitter stories of failure? What stake would such stories gain in social media’s currency of likes and shares?

Connect with your sense of reason, discipline and patience before getting onto your investment journey. That’s what investing is about. The rest is gambling.

Only invest surplus money

Learning that your savings lose value while they sit in the bank might make you feel pressed to invest all you have straight away. Doing so without forethought is a terrible idea.

When you invest, your money is “locked in” for a certain timeframe. Having the money back will come at a price, if possible at all. Each type of investment comes with its own constraints, but let’s make a simple example with the stock market.

Say it’s August 2000 and you decide to buy S&P 500 stock, the world’s most popular index representing the broader US economy. Swipe your finger over the blue line in the chart below and you see that the price at that point in time was 1'485 USD.

Three years later you want to buy the fancy car you promised yourself for your 40th birthday. At 40'000 USD the car’s price is well beyond your savings, so you need to divest, i.e. sell some of the S&P 500 stock you bought.

But alas! It’s August 2003 now and the S&P 500’s price is 989 USD. 😱 WTH!!! You’re down 33% on your investment! 😱 Divesting 30'000 USD of your original investment will only give you 19'979 USD 😡

If only you could wait another few years, you’d double your original investment. But if your expense is bound to right now, well, sorry!

The volatility of the stock market exposes you to losing money if you’re forced to divest at specific points in time – no matter if the overall trend has historically been upwards. A rare case, yet still realistic.

How to mitigate that problem?

Only invest surplus money, i.e. money left over after all your monthly expenses, and those larger expenses that require saving upfront.

Here’s key learnings from the reasoning above:

• Invest with the assumption that your money will be locked in for a long time.
• Be conscious of major expenses you’ll incur in the next 5 years. New car? Wedding? House renovation?
• Only invest surplus money to minimise risk and keep stress away.

Accruals

A useful tool to efficiently handle future expenses is monthly accruals.

Accruals are a fixed amount of money that you set aside each month to cover for the larger expenses, no matter how rarely they occur. Smaller expenses are ignored because they can be covered by surplus money.

Here’s a fictional example:

For each salary coming in, pay your recurring costs, and then set aside the additional monthly accrual. Once that’s done, you can invest whatever amount is left of your salary, stress-free.

“How the heck could I, the 99%, possibly invest, if I must set aside 1'700 CHF after routine expenses?” – the example might prompt you to ask.

First, the example has exceptionally many planned expenses both large and nearby; half that amount is more common. Second, are those family expenses? If so, they’re likely split across two earners. And finally – yeah, the ability to invest is directly linked with one’s lifestyle and ability to save. How do you fare with saving? And with earning? What’s your strategy to improve both? If you want a post with a quantitative guide on that, let me know in the comments.

Finally, an alternative to accruals is “just-in-time saving”: you rush to save all surplus money you have just before the expense itself. So instead of accruing 500 CHF/month for your 4'000 CHF vacation each year, you accrue nothing during the year, and every penny left for the 3-4 months right before the vacation.

Both options work, as long as your discretionary income is large enough to accommodate that strategy. Accruals require a bit of planning upfront to provide safety and peace of mind thereafter; rush saving may yield you a little more at the cost of more balls to juggle and a bad surprise if something gets forgotten.

Safety buffer

We looked at how divesting can cost you bitterly, and how to defend yourself from that risk. How about unpredictable expenses?

Many situations may come with a hefty price tag: a job lost, a sudden health issue, a family member in need of help, or a car accident. Picture any of those scenarios occurring on an empty bank account. What do you do now? You look at your stock portfolio, but the market is currently down.

Don’t let small surprises rip havoc into your life. Keep a safety buffer to absorb those shocks, instead: money available to you quickly and surely. This could be:

• Money sitting in your bank account.
• Money you can borrow from your parents or relatives.
• Assets that you can afford to sell rapidly without sacrificing much of their value.

How much money should this safety buffer hold?

Calculate that based on your own situation. Think of what events could occur – rare but realistic – and how much capital would they require. Here’s some examples to get you started:

• Do you drive? How about accidents?
• Are you a freelancer? How about burnout, or professional damages to clients?
• Do you own an expensive house? How about a robbery or infiltration?
• Are you in a relationship? How about wedding costs? Or a sudden separation?
• Are you the sole breadwinner for your family? How about a kid requiring special treatment?
• Are you employed? How about suddenly losing the job? How about a surprise outstanding tax charge?

Assemble the biggest 4-5 scenarios to get an idea of the size of buffer you need. For reference, I like my buffer to be 10 times my average monthly living costs, and keep that money in the bank. Before sabbaticals, I double that.

What about gold and bonds?

You might have heard of investments for capital preservation, like bonds and gold. Those aim at preserving your savings first, and getting small returns is only a secondary nice-to-have.

There I see you thinking – “Let’s stash my savings in there – accruals and safety buffer. At least I’ll get something out of that money!”.

The problem with bonds and gold is that they are not really stable. Check out Figure “Gold price”. Gold price is surely smoother than the line in Figure “S&P 500 returns” – but how much smoother, really?

Say you decide to “stash” some money into Gold in September 1980. You’ll need to wait until October 2007 to get back the 697 USD/oz you paid 27 years earlier. And if you must sell anytime in between, your average loss is an astounding 42%.

What’s with bonds then? There, the State guarantees a certain fixed yield (= yearly interest rate) for a given number of years, after which it guarantees to pay back their full price (“coupon”).

In stable countries that’s the lowest-risk type of investment you can make, because hey – even if the State would be “short of money” by the expiry date, it can always print more money to pay you back.

So let’s have a look at the evolution of the price of long-term Swiss government bonds in the chart below. The solid line is their price, and the dotted line is their price combined with the dividends they produced since the start.

Now what!? 😯 How in the sky could they drop 12% in little more than 2 years!? 😱

The problem is, if you want to sell your bonds ahead of time to others, your buyer is free to offer you whatever price they please. And clearly, if newer bonds were issued with a higher yield, they’ll make your inevitably less attractive.

In summary:

• A bank account is the only really safe place for your money short-term. It costs you some loss, but it’s the price of safety.
• Gold and bonds, sometimes assumed stable, are subject to volatility too.
• Don’t gamble your safety buffer.

Sensitive to crashes

Regardless how safely you invest, most investments have volatility: there are times when the value of your investment drops lower than the money you put in.

This is especially true for the stock market. In face of its ease of access, flexibility and great returns, it has particularly strong short-term volatility. Here’s an all too frequent story:

1. Donald Duck invests some money in the stock market. All safe picks.
2. Some event triggers a fall in stock prices.
3. People see prices drop, and others selling; they don’t understand what’s happening, but sell themselves for fear of further losses.
4. This makes prices drop further, which triggers a vicious cycle that rapidly sinks prices.
5. Donald Duck notices the situation when prices are down 20% already!! 😱😱😱 He gets a giant scare and sells off.
6. The vicious cycle stops when prices get so crazy low that people break out of groupthink and resume logic.
7. People resume buying, prices raise again. But it’s too late – Donald Duck has sold off everything already to a loss, and is kicking himself watching prices recover.

History has various examples of this story. Some were triggered by real events – like the start of the 2020 COVID pandemic, when unclear perspectives on the future of the global economy gave the S&P 500 a 33% haircut within 4 weeks. Others have no clear trigger at all, and might be entirely endogenous – like the Black Monday (1987) crash causing the Australian market to drop ~40% within one day.

Why does this matter to you? Because Donald Ducks lose money, and potentially lot of it.

How can you tell if you’re Donald Duck?

• Do you often look to others for taking your decisions?
• Do you lack the safety structure in place? (safety buffer and accruals)
• Do you have low conviction of the safety and implications of investing?
• Do you mostly take decisions with your guts rather than reason?
• Do you score high in neuroticism?
• Picture yourself in the middle of one such situation as it develops. Prices fall strongly, you know little of the situation, except for this story, and you have no crystal ball. Will you divest?

If some of these applies to you, then reconsider if investing really is for you. If you do choose to invest, consider investment forms with lower risks and less volatility: they’ll expose you less to the problem.

Don’t underestimate this effect! Judged in hindsight, those selling frenzies seem stupid – but consider how many people it takes to trigger them. Can they all be “stupid”? Will you be better?

In summary:

• Psychology plays a substantial role in investing.
• If you’re strong in neuroticism, play it safe by not investing, investing with low volatility, or investing smaller amounts.

Conclusion

Investing safely requires looking at our life and at the mirrow.

With a couple of “checks” in place we can start our investing in a quantity and style which gives us confidence to be able to persist, and come out stronger on the other side.

This article clears the “gotchas” that people should know of before investing. With that, the arch is ready for the keystone – how to actually get started in the stock market.

Glossary & Essential concepts

Accrual • Monthly accrual

An amount of money which you set aside each month to cover for long-running expenses. Fictional example: Renovating your apartment costs you 20'000 CHF every 10 years. So you accrue 20'000 CHF / 120 months = 167 CHF/month to cover for that long-running expense.

Discretionary income

The amount of money left for you to spend after all basic necessities (lodging, food etc) are covered. It’s disposable income minus the cost of basic necessities.

Disposable income

The amount of money left of your paycheck after you paid taxes. Compare with discretionary income.

Divestment

The opposite of investment. Exit an investment (or part of it) to get some money back.

Panic selling

Selling triggered by some precipitous emotion like fear – typically triggered by observing others sell without questioning their reasons, which causes a vicious cycle of falling prices and large unnecessary losses. See panic selling for details.

Return • Total Return

The total gain you make out of an investment. Typically expressed in percent. Example: You invest 10 CHF in the stock market. You wait 5 years, during which the stock provides you with a total of 3 CHF of dividends, and after which the price has become 14 CHF. Your total return is 3+4 CHF, which is 70% of your initial 10 CHF investment.

Safety buffer

Some money you set aside “no matter what”, in order to prevent any unexpected expense in life from escalating into financial issues. It can be money sitting in a bank, or other immediately-cashable assets.

Surplus money

The amount of money left after all your expenses. It’s discretionary income minus all other non-necessary expenses.

Volatility

An indicator of how widely and quickly an investment may change its value. When you invest in highly volatile assets, your investment may lose you a lot of money at one point, and make you a lot shortly after. Cryptocurrencies – which qualify rather as gambling than investing – are hugely volatile as they might commonly lose a large part of their value intra-day. Higher volatility implies more risk and longer investment times. For more details, see volatility at investopedia.