Stock mar­ket lessons cru­cial if you’re sav­ing for fi­nan­cial free­dom

Sunday Independent (Ireland) - Business & Appointments - - FRONT PAGE - Rory Gillen

ASK peo­ple if they’d like to be fi­nan­cially free by their early to mid-50s and most will re­spond with an un­equiv­o­cal yes. Ask them how they can get there and most have no idea. Noth­ing about fi­nan­cial or in­vest­ment plan­ning is taught at school or uni­ver­sity. Yet, it is a cru­cial as­pect of our lives.

If the av­er­age per­son earn­ing the av­er­age gross in­come of €45,000 saved just 10pc of their in­come through a pen­sion struc­ture from the age of 25, they could achieve fi­nan­cial free­dom by their mid-50s.

When you add in the 5pc your em­ployer will most likely also con­trib­ute to your pen­sion an­nu­ally, take into ac­count that you can roll up all gains and in­come tax-free within a pen­sion struc­ture, and that you can earn about 4pc more an­nu­ally through the stock mar­kets com­pared to bank de­posits, you are al­most there with the maths.

The sim­ple fact is that busi­nesses, on ag­gre­gate, gen­er­ate much greater re­turns than bank de­posits can ever do over the medium- to longterm. If you want fi­nan­cial free­dom early in life, learn three things: save 10pc of your in­come, learn how to live off the re­main­ing 90pc, and learn how to earn the higher re­turns busi­nesses gen­er­ate.

If I wanted to teach my nephew about the power of equities (busi­nesses), I’d prob­a­bly send him on a bus to the lo­cal Ap­ple­green ser­vice sta­tion and ask him to ob­serve what goes on. When he re­turns, I’d ask him to take out Ap­ple­green’s 2016 an­nual report and to read how much it earned after tax in 2016. It was €17.2m. I’d then ask him how much cap­i­tal Ap­ple­green had in­vested in its business. It was €115m at the end of 2016. Pri­mary school math alone will show him that Ap­ple­green earned 15pc after tax on the cap­i­tal that was in­vested in its business in 2016. That same cap­i­tal sit­ting in a bank cur­rently earns noth­ing.

If I asked him to re­peat the ex­er­cise for 20 other com­pa­nies in a range of dif­fer­ent in­dus­tries in Ire­land and in­ter­na­tion­ally, I’m fairly sure that he would end up learn­ing that those 20 com­pa­nies were earn­ing mid-teen after-tax re­turns on the cap­i­tal in­vested in their busi­nesses, on av­er­age.

While more ex­pe­ri­enced in­vestors will spot my over-sim­pli­fi­ca­tion, this sim­ple ex­am­ple will teach him why stocks have de­liv­ered far bet­ter re­turns than bank de­posits over the past 100 years, and why they are likely to con­tinue to do so.

If you are sav­ing for fi­nan­cial free­dom, it’s the stock mar­kets you need to learn about. Only a mi­nor­ity in so­ci­ety ever starts a business (which can speed up wealth gen­er­a­tion but also car­ries much higher risks). How­ever, ev­ery­one in so­ci­ety can own small slices of many busi­nesses, and thus ben­e­fit from the su­pe­rior re­turns on of­fer. In a nut­shell, the mar­kets of­fer the or­di­nary per­son in so­ci­ety a way to ben­e­fit from the higher re­turns that busi­nesses gen­er­ate.

Yes, there are down­turns and lots of volatil­ity, but a quick look back at his­tory will show that con­tin­u­ous up­ward progress over the decades has been the norm. De­spite the in­ter­rup­tion to growth from the global fi­nan­cial cri­sis, liv­ing stan­dards in Ire­land to­day are prob­a­bly be­tween four and five times higher than they were even a gen­er­a­tion ago.

The Gov­ern­ment ap­pears to be mov­ing in favour of mak­ing pen­sion sav­ing for those em­ployed an opt-out choice — com­pared to the cur­rent opt-in choice. It’s a move in the right di­rec­tion, in my view, and it would be en­cour­ag­ing if fi­nan­cial and in­vest­ment ed­u­ca­tion was also em­pha­sised and sup­ported. Rory Gillen is the founder of Gil­len­mar­, the in­vest­ment train­ing and as­set man­age­ment business Any in­vest­ment com­men­tary in this col­umn is from the au­thor di­rectly and should not be seen as a rec­om­men­da­tion from The Sun­day In­de­pen­dent

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