Investing — principles of creating an individual strategy

Choosing an investment strategy is one of the most frequently discussed topics in the FIRE communities. Graham’s value investing, Markowitz’s portfolio theory and venture capital policy — all these can be puzzling. But such a variety of methods is used by professional investors, who set different goals — from short-term speculative investments to the acquisition of controlling stake.

The set of investment tools for FIRE is not so big. It is different for each country and often depends on the individual status of the investor. To use all the benefits properly, it is necessary to determine the possibilities and objectives. Below, we share some tips based on our experience of communication with investors of Before investing, we recommend to get a personal consultation from financial experts.

Who am I?

When planning FIRE, first it is necessary to answer a number of questions. Honest answers will help you build the right strategy to create passive capital:

  • For how long do I plan to work?
  • How much do I spend per year and will this amount change in the future?
  • How much can I invest every month?
  • How much should I invest to make my income equal to my current earnings?

The second step is to study various tax relieves and government programs. Most countries have programs that encourage generation of independent savings for retirement. For example, the UK and Russia provide a compensation of income tax for such investments through ISAs and an individual investment account (IIA), respectively. Certainly, it is only possible to compensate the amount of the income tax, which has been paid. This is not relevant for large investors, but allows to increase the returns on individual pension investments significantly.

Third, it’s necessary to decide whether you are planning to have additional income after retirement. Having additional income and a possibility to return to work in case of emergency, you can choose a more risky investment strategy to increase the fixed capital quickly.

Reserves & loans

Where to get money in case of emergency? This important question should be answered before quitting the job. It is usually difficult and time-consuming to withdraw cash from long-term investments. Besides, you will lose the income and have to pay substantial fees. Even the most highly liquid exchange-traded assets, such as government bonds, cannot always be realized immediately, as the exchanges close during the Christmas and public holidays. To solve this problem you can create a personal reserve fund in a bank in the amount of 3–6 months income. This money will always be available, and you won’t have to get a loan or borrow from friends.

On the other hand, money in the reserve fund will not generate income. Moreover, it can lose its value due to inflation. It is necessary to estimate how often there may be urgent needs for money. If there are no risks, it is better to consider the option of getting a loan. Funds allocated in investment projects usually provide sufficient loan security. Such choice should be individual. Getting a loan is more profitable if the income from investments is higher than the interest rate on the loan. A reserve fund will be an option if it is difficult to get a loan quickly. It is also worth consulting with the bank, which makes the investment payments — probably, a credit card with an overdraft will be enough to solve the issue.

Portfolio diversification

Returns on investments directly depend on their reliability. There are first-tier securities, such as government bonds of the world powers and shares of transnational corporations. Real estate and gold can be reliable investments too. Such investments are protected against total depreciation, but their profitability is only slightly higher than inflation. On the other hand, there are high-risk investments in venture funds, start-ups, cryptocurrencies, etc. Their profitability can be huge, but the risk to lose all funds is also very high.

Experts traditionally recommend to invest at least 50% of funds in reliable assets, and the other 50% — in risky assets. When the profit is received, the volume of investments in reliable assets increases proportionally. Such advice is suitable for those who invest and work at the same time. If investments are the main source of income, this strategy is too risky. The lost profit will cause additional losses as it will be necessary to review the current expenses. The optimal solution is to invest no more than 10% of capital in high-risk assets. The main capital should be distributed between the companies, whose reliability is confirmed by DJI and S&P 500 indexes. This can be done independently, without involving investment funds. In this case, you can experiment with “undervalued” assets. Distributing funds between 10–20 securities will be enough. If the diversification is higher, the situation can get out of control.

Investing for FIRE has its peculiarities and differs much from the work of professional investors. FIRE investors manage their own funds and are not bound by loan commitments. This allows to react to short-term market fluctuations calmly. At the same time, such investors can fully manage the earned income. That is why the risky high-income investments look more attractive to them. One should remember that the objective of FIRE is to create passive capital and make minimum changes to the working investment portfolio.