22 years of research tells me this.

What are the keys to financial security?

  • You must live within your means. Simple.
    What does living within your means really mean? It means that to enjoy financial security, you must pursue a financial strategy something like the following.
  • Save.
    Before you retire, you must demonstrate good savings habits. You must save. Very simplistically, the more you save, the higher the standard of living you are likely to be able to enjoy in retirement. You can control your saving. You cannot control what investment returns you will experience.
  • In retirement, adjust your spending to the size of your investment portfolio.
    For example, one effective strategy is to calculate the size of your investment portfolio each year, and spend no more than 4% of the balance. If you can do this, then you can survive the tough periods so you can enjoy the good periods which usually follow.
  • If you learn how to become a good investor, this is the icing on the cake. We can help you with that part.
  • Discipline.
    There is no escaping that to be financially secure, you must demonstrate the discipline of saving and also keeping your cost of living within your means.

    The rest of the material on this page provides some of the historical evidence behind the above views.

    The long-term variability of investment returns can pose a threat to your financial security.

    This is very unfortunate because it would make life so much easier if we could count on the markets.
  • You might get a 10%pa real return from your share portfolio over the next 30 years. That would be a total real return of 1600% over 30 years.
  • Equally, you might get minus 2%pa real return over the next 30 years. That would be a loss of 45% of your portfolio in real terms over 30 years. The range of potentials is huge. Luckily really bad periods do not seem to happen too frequently.
  • Unfortunately, we are in a period of historic extremes, from a 200 year perspective, and therefore you should expect the unusual. This can be readily recognised by looking at 100-year charts such as Debt-to-GDP charts and also Price/Earnings Ratio charts.
  • But even if we were not at a period of economic extreme, 200 year history shows that 30-year investment returns are highly variable. Therefore you can never count on any particular outcome from your investment portfolio. Yes, it is true that long periods of good returns do happen such as in Australia from 1982 to 2007. This was the longest secular bull share market in Australia's history. Secular bull markets are followed by secular bear markets.

    Bottom lines keys to financial security:

  • In retirement, consume no more than 4% of your investment portfolio each year. This means that when your portfolio falls in value, you spend less. However, spending less enables you to survive the bad periods, so you can enjoy the good periods that invariably follow. For greater discussion and a long-term historical analysis, read the paper at this link. http://puzzlefinancialadvice.com.au/010501%20how%20to%20achieve%20financial%20security.pdf This paper discussed why the choice of 4% of your portfolio to consume each year. Clearly a range of strategies are available once you understand the basic principles.
  • Pre-retirement, save. Allocate a portion of your income to long-term saving, and budget for your living costs from the remainder. Don't spend all your income. Even people on low incomes can save and become financially secure. Build an investment portfolio sufficiently large, that you can live on the after-inflation annual returns each year. Once you have achieved this you no longer need to work. This put you in the great position of being able to choose to work because you enjoy working and because you enjoy your work. This is the recipe for financial freedom.

  • Some of the things I have learned about investments.

  • You can have negative real returns over 30 years.
    For example, in the UK at the beginning of the 1900s, there was a period that had negative real returns compounded over 30 years. So a strategy of "Time in the market rather than timing" can at times be dangerous to your financial health. Some times it works. Some times it does not.

    Another example that you might look to, is Japanese shares 1990 to 2009.
  • Unfortunately timing does matter a lot.
    This is unfortunate because it makes the challenge of investing far more difficult.
  • Not only should we not try to ignore market timing, if we want great investment returns we need to make market timing work for us.
  • Market timing is a challenge.
    > Market timing is a percentage game. You are not going to get market timing right all the time, because among other things, the unexpected keeps happening. There are different issues around short-term market timing as compared to long-term market timing. Market timing requires discipline.
  • Long-term (eg 30-year) investment returns vary dramatically
    . Long-term investment returns vary dramatically from one country to the next, and from one century to the next. While US, UK and Australia might have experienced approximately 6%pa real returns from shares over the last 50 years, history suggests that a country might experience a real return of less than 3%pa over 100 years as some Europeans countries like Belgium and Italy have over the last 100 years.

  • Share markets tend to have 20 exceptionally good years followed by 15 years of bad returns - on broad averages.
    But there is a lot of variability between cycles.
  • Big crashes in share markets tend to coincide with big crashes in real estate markets
    . This is from a study by the US Federal Reserve, looking at last 200 years. And in these big real estate crashes, real estate tends to fall as far as shares.
  • Long-term buy-and-hold investors never make money by buying during a bubble.
  • Economic depressions are a normal part of the investment cycle.
    They are a behavioural effect relating to very long debt bubble cycles.
  • Gearing takes you forward half the time, and backwards half the time
    . This is true even if you ignore transaction costs and taxes. So if you want to gear into markets, you need to learn how to time markets first. Otherwise you are gambling with your future.
  • Based on Australian experience over the last 100 years, you should expect a crash of 50% approximately every 20 years.
    Geared investors beware. I suspect many geared investors do not realise that they are gambling, and don't realise how much the odds are stacked against them.

  • Shares are not a sure thing.
    History indicates that at the end of the regular 20 year bull market in shares, "investors come to believe that investing in shares is a SURE THING."
  • It is important the consider the big emerging trends
    . Emerging Asia is a very importan trend now.
  • Long cycles are important.
  • The investment herd tends to buy at the top and sell at the bottom.
    Don't be part of the herd. Investors prefer travelling with the herd because it feels more comfortable because by being part of the herd, the investors behaviour is reinforced by their peers. Contrarian investing can be smart investing.
  • Markets tend to go through periods of over-optimism followed by periods of over-pessimism
    . Durig the periods of over-optimism, markets tend to be excessively expensive. During periods of over-pessimism, markets tend to be excessively cheap). These cycles can be 20 years long. Make this work in your favour.
  • No sure thing when it comes to investing.
    There is no such thing as an absolutely certain thing when it comes to investing. Therefore, don't bet everything on a single outcome because the unexpected regularly happens.
  • Always consider the downside risk?
    What if you have got it wrong? Since the unexpected regularly happens, always ponder on what will happen if the investment outcome you are looking for does not occur, or worse, if the reverse occurs.
  • Government bonds also have risk.
    There are many, including myself, who believe that western government bonds are in a bubble that will burst at some point over the next few years.
  • Don't pay more tax than you need to.
  • Learn how investment markets work
    . It is important to learn about investment markets, so you can make them work for you. Learn how to live with market volatility - it can work for you. Can you master your emotions when markets are emotional?
  • Money is not everything
    . Money is not everything in life, but it gives you choices in your life. It is a means and not the ultimate end-goal.
  • Do not let your emotions get tangled up with your investment decisions.
    The best investment decisions are made when you are emotionally dispassionate (ambivalent) to the outcome. If you find your emotions are inflamed when making an investment decisions, read this is a warning that you may be about to make a bad decision.
  • It is generally better to sell your dogs and let your winners run.
    Unfortunately human beings are emotionally wired to do the reverse. If you can change your behaviour, you are likely to do better. (Behavioural Finance).
  • The above points might sounds easy, but it is hard to get these right in practice.

    On risk:
  • Investors see risk as the potential to lose money.
  • Fund managers and investors define risk differently.
  • Risk to a fund manager is volatility. Most fund managers also focus on the risk of under-performing a chosen index. Therefore to a fund manager,losing less money than the index can be seen as good performance.
  • Risk is far more than volatility. Sometimes a very stable investment suddenly loses a lot of money.
  • The vast bulk of investors are not emotionally equipped to deal with the NORMAL volatility of a fully invested portfolio eg 100% into shares.

    One of the best definitions of risk that I have seen was that which was on the US Security Exchange Commission (SEC) web site in May 2004. It said as follows:
    • When you "invest," you have a greater chance of losing your money than when you "save." You could lose your "principal," which is the amount you've invested. But then, how "safe" is a savings account if you leave all your money there for a long time, and the interest it earns doesn't keep up with inflation? The answer to that question explains why many people put some of their money in savings, but look to investing so they can earn more over long periods of time, say three years or longer. Though there are no guarantees, investing means you may earn much more money than by relying upon no-risk savings. Investors are not promised a return, but they do get the opportunity of making money that more than offsets the cost of inflation.'


  • There is a “tendency of capitalism to grave instability”. In “The Economy Since The Wars”, John Kenneth Galbraith notes that “built into the systems are recurrent episodes of devastation”. Kerr Neilson 12/4/00 also reports George Soros‘s view “that markets are inherently unstable.”