Stock market lessons crucial if you're saving for financial freedom
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 long-term. 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 GillenMarkets.com, 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
Sunday Indo Business