Mr. Becoming FI says that what really convinced him that Financial Independence would be feasible to us, a middle-class family with middle class income, was reading the Stock Series by the legendary JL Collins, author of the highly praised book “The simple path to wealth”. Check it out in your local library and if they don’t have it, ask them to order it – that’s what we did!
A couple of months before we discovered the FIRE-movement we finally had decided to start investing in the stock market.
Great decision! What could possibly go wrong?
After a couple of meetings with our bank they did what banks normally do; they sold us an actively managed mutual fund with an expense ratio of 1.55 %. Some months later Mr.become.fi, now much better educated about the impact of expense ratio (fee charged by the investment company to manage the funds), did the simple math and was struck in disbelief seeing the numbers the bank would make on us over horizon of multiple decades.
Looking for alternatives we found out that our bank also offered an index fund which invests in US mid-cap & large cap stocks with an expense ratio of 0.2 %.
Much better! And on top of the major drop in costs, the index fund outperformed the mutual fund – of course it did!
Because history has shown that it´s extremely difficult to beat the returns of passive index investing year in and year out. Actually roughly 90 % of US large-cap, mid-cap and small-cap funds actively managed by fund managers did worse than the S&P 500, according to S&P Dow Indices data (see the research and more compelling arguments why it's hard to "beat the market").
Soon we realized that most banks will never mention index funds to you since they earn tens- maybe hundreds of thousands of euros feasting on the lack of knowledge of the average investor.
Let’s take our example, the expense ratio difference from the mutual fund to the index fund was 1,35%. It doesn't look so bad for the untrained eye, does it? It’s only 1.35% - who cares?
Well, we do now, and you should too!
Let’s run the math or let a nice calculator, courtesy of begintoinvest.com, run it for us.
Let’s say we started with 50 000 € and add 15 000 € every year for 30 years, assuming a 6 % investment return, the cost of our investment would look like this:
Mutual fund with 1.55 % expense ratio. Cost: 381 059 €.
Index fund with 0.2 % expense ratio. Cost: 56 544 €.
This is mind blowing! The difference is a staggering 324 314 €!
No wonder our bank sold us the mutual fund and most probably laughed at us the second we were out of the door.
Low cost index funds
Luckily, we discovered low cost passive index investing and our mistake not long after our initial investment and moved everything to the index fund.
Still you might say 0.2 is still not really low cost and we agree! Compared to what’s possible in the US it’s not, but we don’t have those insanely cheap options in Finland or in the Nordic countries. We are still on the way to figure out cheaper options and we will certainly keep you posted if we find some.
So, the first step on our path to wealth was switching all of our actively managed mutual funds to index funds, including those of our children.
Net worth tracking
The second step was starting to track our net worth, a measure that is considered the single most effective way to manage your finances. Frankly, before starting to track our income and our expenses we didn't have a clue where we were standing. We have always been good with money and fairly frugal and therefore there was always plenty left after having all our wants and needs covered. So, we didn't see the reason. Now we know better.
Since February this year we are tracking all our expenses down to the last euro. The proponents of net worth tracking claim that everybody will be shocked or at least surprised by some expense. Since we live in one of the more expensive countries in the world, we knew that our grocery bill makes up a significant chunk of our monthly expenses. Seeing it black on white that this item made up a mind-boggling 33 % of our total spending, was however somewhat shocking.
We are both excited to see the full year figures soon. The result will tell us how much money we need to save and invest to reach FI. That is, when we have at least 25 times our annual expenses invested in income generating assets. Additionally, it will give us the cold figures where we should draw down our expenses in the areas which are not valuable to us.
Real estate investing
The third and soon to start step is our decision to start investing in real estate. In the early beginning of our journey we thought that real estate isn't for us. Index funding was our way to go. After several months of listening to the fantastic Paula Pant and her Afford Anything podcast we were convinced of the advantages with this kind of investment. Getting future income from rental properties will secure us a cash flow and make us less dependent on the stock market. Plus, we still hope that building our small real estate empire eventually will get us faster to our destination!