Index Investing for European Investors

I’ve been reading about investing in the stock market for some years now, although with the market rising and rising, there seemed to be better investment opportunities to attend to, such as crypto and P2P lending. This doesn’t mean that I have totally abandoned the idea of investing in stocks, however.

On the contrary, I had actually invested in some hand-picked stocks that I had a good gut feeling about, and sold them all off at 100% profits in recent months. Of course, investing based on gut feelings is not something that anyone recommends, but sometimes an educated guess does the trick. Or maybe it was just the fact that so many stocks have performed well over the past 4-5 years due to the bull run that we’ve been experiencing.

That’s one thing that makes this perilous territory in my view. You never know if you really have an edge on the market and can thus book some nice profits, or if you are just gambling and happened to get lucky.

I also have a few friends from the IT space who bet much bigger stakes than me on tech companies and have turned millions in profits, and while I find this inspirational, I’m again unsure if they had an edge or whether they gambled big time and luckily got the desired outcome.

When seeking success, I usually like to pick a topic, find the best performers and learn how they do things, and then try to figure out a winning blueprint. It’s worked for me in several endeavors through the course of my life, but I have yet to find that blueprint in the world of stock investing that I can really trust.

Let’s consider the big styles of stock market investing that I’ve come across. I’ll use this article to continue noting down the results of my research and eventual actions.

By the way, you can backtest any strategy using this tool.

Stock Picking

When you pick individual stocks, you are assuming that you have an edge over the rest of the market. This could be due to having very deep industry knowledge, or perhaps being more agile than the active fund managers who are managing big sums of money and have more restrictions.

Most of the people I know who have booked big profits have been using predominantly this strategy.

Value Investing

For a year or so, I listened to Phil Town’s podcast where I learned more about this style of investing, although I’m not 100% sold either.

It’s a variation of pure stick picking, where you’re looking for companies that are undervalued by the markets and picking up those individual stocks.

This method has been made famous by Warren Buffet, Ben Graham, and Charlie Munger.

Net Net Stock Investing

Another strategy I’m looking into. Check the guide on NetNetHunter for a start into this strategy.

Mutual Funds

Mutual funds are typically managed by someone who claims that he has enough experience and knowledge to be able to beat market returns. Historically, very few fund managers have been able to do so over the long-run, although there is good evidence that a bigger number of them were able to weather the worst times of the market better than index funds, which is really quite logical.

There are usually early signs of an oncoming recession, and good managers will be able to take preventive action, thus avoiding big losses for their funds. Index funds, on the other hand, by definition are a reflection of the market, so if the market goes down big time, then so does your money. Let’s talk about them next.

Index Investing

The trend in recent years is for books and top investors like Warren Buffet to recommend index investing as the only real way to get richer through stock market investing without risking big time.

The problem with investing in the stock market for me, so far, has been the fact that the more I read, the more it seemed to me that the general common-sense advice indicated that one should invest in index funds rather than actively managed funds, or even worse, handpicking stocks.

On the other hand, there are several good arguments against index investing, see here for an example.

Passive investing has been all the rage in recent years, so let’s think about whether this is really a no-brainer investment, as many people want us to believe.

When we think of passive investments, what we mean is that we put our money into an investment that we have to spend little time on, hence the passive part. More importantly, we don’t need others to manage those investments for us. When we invest in funds that are managed, we refer to them as active management funds.

In a recent episode of Mastermind.fm, I interviewed Yoran Brondsema, a European index investor and entrepreneur.

In this episode, we focus on index investing, with a specific focus on European investors. We discuss how to track an index, what asset mix you should have in your investment portfolio, how and when to rebalance, how to choose an ETF and stockbroker, and how taxes play an important role in your investment returns.

I suggest you listen to that episode if you’re European and would like to get started with index investing.

It was a pleasure for me to interview Yoran and you’ll find that this episode is packed with information. I also recommend the book “Investing Demystified” that Yoran recommends. I had bought and read it a while back, but I am going to go back to it and give it another read, as I think there will soon be very good opportunities in the stock market, making it a great time to build a stock and bond portfolio.

The biggest benefits of index investing:

• it takes very little time for us to manage these investments
• we don’t need any managers to invest for us
• the commissions and fees are very low

The biggest downside in my opinion is the fact that you end up investing in, and thus supporting, companies that you might believe in. They might be companies that you are ethically opposed to (such as Coca-Cola in my case), or companies that you don’t think have a bright future ahead of them, but they would still be in the wide market index.

If you’re decided on using ETFs, you can use a site like JustETF to sort through the options.

JustETF is incredibly useful:

• You can use it to find key information about en ETF
• You can use it to filter ETFs for a given criteria
• You can use it to see the historical performance of ETFs

Oh, and it is free! If I could only choose one tool, I would select justETF.

You can learn how to use justETF for choosing an ETF here.

If you’re investing in ETFs, you need to decide whether you want distributing funds or accumulating funds. Whether you choose one or the other depends on many variables including taxation.

A rule of thumb inspired by Robert Carver’s book “Smart Portfolios” is to have a minimum investment amount of roughly 300 times the minimum transaction fee (300 * minimum_fee). In DEGIRO the minimum transaction fee is €2, which means that the minimum amount you should invest in any ETF is €600 (300 * €2).

If you’d have to invest a minimum of €600 in an emerging markets ETF, it means you’d have to invest €4,440 (€606 * 88 % / 12 %) in the developed world ETF. If your investment amounts are lower than those minimums, it is better to use the single fund alternatives.

Excerpt From: Mário Nzualo. “Introduction to investing in index funds and ETFs: A practical guide for investors in Europe.” Apple Books.

My preferred accumulating funds are the combination 88% iShares Core MSCI World UCITS ETF + 12% iShares Core MSCI Emerging Markets IMI UCITS ETF. This has a combined TER of 0.1976% (0.88* 0.2 + 0.12*0.18).

My preferred distributing funds are the combination 89% Vanguard FTSE Developed World UCITS ETF + 11% Vanguard FTSE Emerging Markets UCITS ETF. This has a combined TER of 0.131% (0.89* 0.12 + 0.11*0.22).

Roboadvisors

Robo advisors are software products that can help you manage your investments without the need to consult a financial advisor or self-manage your portfolio. They typically use simple investment strategies and make ample use of index funds. They do automatic rebalancing for you.

The advantage over picking and choosing your own index funds is that this is even more automated, and roboadvisors have access to better index fund pricing due to their huge volumes. Another advantage is the time saved due to there being no need to periodically rebalancing.

Dividend Growth Investing

While I like the concept, I don’t like the idea of keeping on top of so many stocks on an ongoing basis. The Humble Penny has a good article about this topic.

What I’m Doing

At the moment, I have not committed to any of these strategies. I had some good hunches a few years back and decided to try out investing in the stock market by picking a few stocks (Apple, Nike, Amazon) and then sold them later at 100% profits, which is great, but I don’t know that I can replicate that. Maybe I just happened to pick solid performers in a rising market.

For example, in the years 2016-2017, anyone investing in crypto also seemed to be an incredible investor, based on the increase in value of their portfolios. That was a kind of crash course in investing for me, as it thought me a ton about diversification, managing your emotions, building an investment strategy, managing timelines, market timing etc.

From what I’ve seen in my life so far, the best strategy is to have good cash supplies ready to be deployed when the market crashes. If you diversify properly at that stage, or are intelligent enough to pick the sector that will rise from the ashes and outperform the rest of the market, you will make a killing. This is exactly what happened with the 2007-2008 crisis and the resurgence of tech stocks.

The obvious problem is that we don’t know when the next crash is coming, and when it does come, we might not necessarily have enough liquidity to invest in the stock market in a meaningful.

As of early 2020, I am seeing some strong signs of market slowdown, and the current stock prices of U.S. companies seem very unsustainable, so I’m going to be building up my cash reserves in preparation for a stock market crash within the next two years. If that doesn’t happen, I will start investing in the stock market by committing a monthly amount, and thus avoid mistiming things by investing everything at once.

While I build up my cash reserves, in order to avoid having too much money idle (dying a slow death, really) at the bank, I am investing in highly liquid assets such as P2P lending and real estate via online platforms.

The following issues plague small portfolios and should be kept in mind:

• Whole shares – Most brokers require you to buy at least one share. If the share price is €70 and you have €100 to invest, €30 (30%!) will have to remain uninvested.
• Minimum brokerage fees – Minimum brokerage fees have a higher impact on small portfolios than bigger ones. A €5 fee has a high impact on a €100 transaction but a negligible impact on a €1,000 transaction.

Your portfolio does not need to be perfect. You can adjust your portfolio later. At this stage, increasing your savings rate is more important than having a perfect portfolio.

Note: I had written this article before the Coronavirus pandemic, and now that we’re in it, I think it’s an even better time to buy indexes or similar tools. I’ll keep updating this post as I learn more and make further decisions for my allocation and strategies in this asset class.

What do you think of all the above? Have you identified winning strategies to invest in the stock market that have worked well for you?