November 2020

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30 November 2020

Passive Income : ETF vs Mutual Fund

There are many ways to invest in order to grow your money passively. One of them is obviously to invest in company shares in order to generate capital gains on shares but also dividends. Obviously, this method requires a lot of time and energy to analyze the thousands of stocks in the world. To overcome this problem, there are ETFs and Mutual funds. Through this article, we will analyze the ETF vs Mutual funds duel and their respective advantages and disadvantages

Mutual Funds

General Mechanism

To better understand what an ETF is, it is important to understand what a Mutual fund is. It is a financial vehicle, managed by a financial organization, which will therefore hold a whole series of shares and bonds or other financial assets. The general idea behind this is to have a group of people who will invest in this fund and buy shares (like stocks). Thus, the investor becomes part-owner of the fund in the same way as if he had bought shares in a company. The difference with shares of a company such as those of Google is mainly the variability of capital which allows investors to move in and out of capital at any time.

Management

This money will be available to the fund which is managed by a fund manager who will be responsible for allocating this collected money to different assets (stocks, bonds, etc.) so as to obtain capital gains and/or income. for investors by respecting the investment objectives and strategies set for this fund.

By investment objectives, we must understand that there are all kinds of funds with very different objectives. For example, some funds are said to be more “defensive” in the sense that they will own a greater proportion of bonds than shares in order to limit the risk of loss of capital (bonds being less risky). Others focus on particular geographic regions or industries, etc. It is even possible to invest in socially responsible funds where the strategy is to allocate funds only in shares of socially responsible companies.

Advantages of Mutual funds

In our ETF vs Mutual funds analysis, we will now see the advantages of Mutual funds. Those are numerous and clearly demonstrate the reasons for the current trend towards this type of investment. Indeed, if you go to the bank to invest your money, there is a good chance that you will be directed to mutual funds. This is for sure an investment that can easily provide you with passive income.

Simplicity

One of the main advantages of mutual funds is their simplicity. Even if the strategies put in place can quickly become complex, these mutual funds are simple for the investor. Whether you are a seasoned investor or just starting out, these funds provide certain benefits (see below) without hassle. All you have to do is allocate some money and everything falls into place without you having to do anything.

Professional management

The first obvious advantage is the fact that your invested money is placed in the hands of a fund manager who is a professional who will therefore try to optimize the investments as well as possible to obtain the most benefits. A professional manager has the time and knowledge necessary for analyzing stocks and establishing a balanced portfolio. This point will be a major difference in our ETF vs mutual funds analysis.

Doing so, by buying units of a mutual fund, you benefit from investment expertise. The latter will prevent you from having to waste a considerable amount of time looking for and analyzing stocks and bonds in order to balance your portfolio in the best way. All these time-consuming tasks are delegated to an expert in the field.

Diversification

A second advantage is the diversification that such investment allows. One of the basic rules of investing is not to put all your eggs in one dish. A mutual fund is in a way a group of investors and thus has much greater resources than a single investor.

If an individual would like to diversify, he would have to acquire a significant amount of shares, which represents a significant amount. Via the amount of money invested in the fund, the manager is able to acquire a multitude of financial assets, which ensures optimal diversification. The whole can be accessible to an individual for the price of a share.

Economies of scale

Investing in a mutual fund allows you to benefit from economies of scale. Executed separately, each purchase of a share making up the fund would incur transaction costs. Thus, by purchasing a mutual fund, the individual can avoid all these costs although this does not exempt him from other costs as we will see later. The cost difference is the main point in our ETF vs mutual funds analysis.

Disadvantages of mutual funds

While mutual funds have many advantages, there are also a number of significant disadvantages that every investor should be aware of.

Variable income

Investment funds, like their constituent financial assets, are subject to a certain variability in income. Indeed, if the equities that make up a fund fall in price, it is obvious that the value of the fund will also be affected. It is therefore indeed a risky investment that can lead to a loss of capital.

Availability

As explained, investors can enter and exit the fund with ease. The backlash of such an advantage is that the fund manager must therefore keep a certain amount of money on hand in order to be able to redeem the shares of investors wishing to resell them. This money, kept available for this purpose, is therefore not invested and therefore does not bring in anything.

Costs

Although funds avoid a series of costs (transaction fees), there are still others. These costs are mainly used to remunerate the management company (and therefore also the work of the fund manager) but also the financial institutions which are responsible for marketing the products. We therefore find a whole series of costs such as:

Entrance fee
Management fees
Exit fees

These fees are nevertheless relatively high and are mainly charged regardless of the profitability of the fund. You could therefore invest in a fund with negative returns due to bear markets, but you would still be liable for management fees which often amount to 1 – 5% per year.

“Diworsification”

Often people think that while mutual funds offer good diversification, buying several will allow you to diversify even better. The risk here is to invest in funds which are in fact highly correlated which will have the effect of increasing the portfolio’s exposure to risk rather than eliminating it.

Transparency

Funds are not fully transparent in the sense that of course they have to report their core values but not all of their portfolios. This therefore does not allow the investor to have a clear idea of the actions where his money is placed.

Comparability

Unlike company shares, investment funds do not have ratios allowing a comparison between them (such as P / E Ratio, sales growth, etc.).

Exchange Traded Fund (ETF)

At the start of this article, mention was made of the investment funds that we have developed but also of exchange traded funds or ETFs. So, this ETF name is fine, but what does it correspond to?

The term ETF corresponds to Exchange Traded Fund or in French, fund traded on an exchange. It is actually a fund of financial assets, just like an investment fund, whose units are, of course, exchangeable on the stock exchange. The difference with investment funds is that ETFs are often “index funds” in the sense that they will be modeled on a stock market index (CAC 40, S&P 500, etc.). We often speak of “Tracker”. The advantages and disadvantages of this type of financial asset are relatively similar to those of mutual funds with a few exceptions which we will develop below.

Differences with mutual funds

Professional management

One of the main differences is the absence of a manager whose vocation is to seek out growing stocks that can outperform the market. Here, management is more passive in the sense that the ETF will only hold the shares contained in a particular index and thus replicate the performance of the latter. Thus, the possibility of outperforming the market (or underperforming) does not exist with this type of instrument.

Costs

The absence of financial analysts aiming to outperform the market by choosing strategic stocks also enables ETF management costs to be reduced. This is particularly the strong point of this type of instrument which, unlike investment funds, only generates management fees of 0.1 to 0.9% per year.

Exchange traded

Unlike mutual funds, mainly marketed by financial organizations, ETFs can be bought directly on the stock market. In this way, they do not impose a minimum subscription and are valued throughout the day where mutual funds are valued only once, at the end of the day.

Conclusion: mutual fund vs ETF?

Although I am not a financial advisor or anything else, from this analysis clearly emerges a benefit for the ETF. Indeed, the latter allows good diversification, just like an investment fund, but entails significantly lower costs. This difference in cost is not negligible, especially since management fees are punctured whether the fund’s performance is positive or negative. Given the current performance of the stock markets, having to pay additional fees of 1 to 5% seems more than absurd.

Moreover, Warren Buffet demonstrated by betting a million dollars that an index linked to the S&P 500 would beat an investment fund, active management of a portfolio cannot beat the market in the long term. This is also one of the advice of the Oracle of Omaha, according to him, it is an excellent way to invest. In his words, “The costs are really big in an investment, if the returns are supposed to be 7-8% and you pay 1% fees, it makes a huge difference to what you get in retirement.” And indeed, simply buying the top 500 US companies through an S&P 500-based ETF gives you a passive approach that protects you from mistakes fund managers can also make.

Personal opinion

For my part, I like equity analysis enough to devote time to it, but I still invest a portion of my portfolio in an ETF linked to the S&P 500. This way I benefit from passive management replicating the performance of these 500 large American companies and benefits from very good diversification.

I find it completely revolting the approach of funds in terms of management fees which remain far too high without much capital gain and above all without any assurance of positive profitability. Anyway, as in any area, I will always recommend keeping costs as low as possible (without compromising on quality).

I had also read an analysis on this subject which I would like to share with you:

An initial investment of 20,000 USD in an ETF following the S&P 500 index which grows for 40 years at an annual rate of 8% with management fees of 0.04%:
- Final investment: 477,811 USD
- Loss in costs: 7,655 USD
An initial investment of 20,000 USD in an mutual fund actively managed for 40 years at an annual rate of 8.5% with management fees of 1%:
- Final investment: 397,977 USD
- Loss in costs: 194,166 USD

This example perfectly shows that even if the annual rate of the investment fund may seem more interesting, the importance of management fees comes to ruin everything. Management costs clearly matter and should not be overlooked.

I hope this article will have helped you to see more clearly, do not hesitate to send us your opinion on the question or other questions!

Sources

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24 November 2020

How to develop amazing passive income with Nexo.io

Invest and Me 5

Introduction

We all wish we could let our money grow without any effort. “Let our money work for us” as Robert Kiyosaki told us, which therefore generates passive income. Unfortunately, the majority of people prefer to leave their hard-earned money in a savings account at the bank. It is true that this method remains the “safest” but the interest that you can hope to receive remains, despite everything, minimal. I would even say negative in view of inflation. That’s where Nexo.io can be helpful.

Passive income: The savings account?

As of today, in Belgium, the interest rates that one can expect to receive on a savings account are around 0.01% per year + 0.10% as a loyalty bonus if we leave our funds for more than twelve months. In France, the rates seem to be in the same order of magnitude. This does not seem to be the best option.

Savings account problems

It is obvious that the rates are extremely low, and that it is not via this instrument that you risk becoming rich. However, there is a second problem much more serious than the first, namely inflation. In 2018, Belgium’s inflation rate in 2018 was 2.34%. This means that over the course of a year you lose 2.34% of your purchasing power.

For example, if you had 100 € in your account, at the end of the year, these would only be worth more than 97.66 € since the prices, in general, will have increased by 2.34%.

Your purchasing power decreases from year to year. It is, therefore, crucial to manage to grow your money, at least, as much as inflation to maintain your purchasing power. So, comparing the 2.34% inflation to the 0.11% savings yields, the disproportion should alert more than one. Those who remain convinced that keeping their money in the bank is safest should realize that they are continually “losing” money by leaving it there.

Solution : Nexo.io

One possible solution is to invest your money, whether in stocks, bonds, real estate, etc. However, these investments all have advantages and disadvantages but are, in theory, all more “risky” than the savings account. It is moreover to justify this risk that the expected returns on these instruments are higher. However, with the advent of the Blockchain and Bitcoin, a series of other possibilities have emerged, including Nexo.io which interests us in this article.

The Nexo.io platform

Presentation

Nexo.io can be likened to a new generation bank, a bank responding more to the current era but despite everything not including all the functionalities of a bank. The idea of this bank is to be able to have a line of credit on the basis of the crypto-currencies that you place as collateral. So you can keep your bitcoin and other crypto-currencies while benefiting from a line of credit, all instantly. If you believe in the future of Bitcoin you might prefer to keep your crypto-currencies rather than to spend them. This platform, therefore, allows you to keep the upside potential of the asset.

Another functionality of the platform and the one I use is the generation of interest on the basis of either, your euro or dollar currencies directly, or of what is called stablecoins (USDC, USDT, DAI, …) . These are cryptocurrencies whose value is directly linked to that of Dollars (1 USDC = 1 USD). Thus, this second functionality acts in a way like a bank savings account but with much more attractive interest rates.

In terms of numbers, Nexo.io is:

The advantages of Nexo

High interest rate

The interest offered on this Nexo.io is 8%. Can you imagine being able to obtain 8% on your savings account, in a safe and continuous way? The interest offered on this platform would therefore allow you to beat inflation as explained above and even to earn money.

Compound interest

Unlike traditional savings accounts on which you earn interest annually, on the Nexo.io platform, you earn interest calculated daily. This daily distribution allows you to get the most out of compound interest. Thus, an annual interest rate of 8% allows you to generate interest of 0.022% per day, almost as much as what a savings account earns you per year. In addition, each day this interest will be paid and will increase the capital on the basis of which the interest for the next day will be calculated.

For example, a capital of 10,000 USD would bring you close to 2.19 USD per day and therefore 880.72 USD annually. While it may not seem like a big deal imagine the exponential gain it can add in the long run with regular investment.

Imagine having this kind of interest Daily :

Security

First, regarding regulatory compliance, Nexo.io uses Onfido which allows it to comply with KYC (Know Your Customer) and AML (Anti Money Laundering Law) international compliance standards. Onfido is a very well recognized company as approved by Coinbase, Revolut, HSBC, Nationwide, TransferWise and Bittrex.

Another security measure, Nexo.io has partnered with Bitgo which allows it to secure all crypto-assets. The latter is also insured with Lloyd’s, supported by Goldman Sachs.

In addition, the platform is fully automated, all with one of the best security through its 256-bit military encryption system.

Finally, the activity is regularly audited by one of the largest audit firms in the world, namely Deloitte.

If you want to know more about security, I invite you to consult this link.

Company leaders

Another important element in the benefits of this platform is the experience of the leaders of the company. “Nexo.io is led by a leading FinTech group serving millions of people across Europe for over 10 years, while being strictly overseen by several European banks and financial services regulators.” (Nexo.io). All while surrounding himself with advisers among industry experts such as the founders of TechCrunch and Polymath.

Personal experience

For my part, I first started by putting € 1,000 in my account (it is currently not possible to make smaller transfers). Once the platform receives your money, it is automatically converted into EURx which corresponds to a so-called “stable” cryptocurrency because its price is linked to that of the euro. In addition, the 1 for 1 EURx / Euros conversion is guaranteed, so you do not risk anything from this point of view.

The day after the deposit, I was able to receive my daily interest of 0.21 €. I gradually continued to add money until I had € 9,000 in this account (which is like a savings account where there is no entry / exit charge). Once this amount was deposited, the daily interest I received was € 1.90. And moreover over time, as you can see on the screenshot below, the compound interest has taken effect because the € 1.90 has become € 1.91.

It is clear that this is not a significant amount, but this amount should be compared with the amount that your savings would have brought you. Which makes this amount much more relevant.

Update experience

I have been using this platform for over a year and I am simply delighted. The simplicity of the platform and the pleasure of seeing your money grow every day is awesome. I use Nexo.io as a savings / investment account, because in two days it is possible to withdraw your funds without any worries and very easily. I experienced it, I withdrew 2,000 euros from the platform. The money was in my account two days later.

However, I prefer to leave as much money as possible in the account in order to take full advantage of the compound interest. But it is good to know that when needed, this money is easily recoverable.

In addition, Nexo.io has added a new possibility which is that of receiving daily interest on the main crypto-currencies (Bitcoin, Ethereum, etc.) of 4% per year. I, who want to invest in Bitcoin for the long term, is a significant bonus that allows me to grow this capital differently.

Since then, Nexo.io also implemented the possibility of earning increased interests by agreeing to receive them in Nexo Token. Which gives me daily income like the following:

Conclusion

As a conclusion, you will understand, I am absolutely a fan of Nexo.io. Also, as you know I’m a big fan of all passive income and Nexo.io clearly offers us that. In addition, Nexo.io has developed a very powerful application that allows you to watch your money grow every day which is still a real pleasure even with these small amounts.

Do not hesitate to tell me in the comments if you too have tested Nexo and what you think!

Sources

https://fr.inflation.eu/taux-de-inflation/belgique/inflation-historique/ipc-inflation-belgique.aspx
https://www.cafedelabourse.com/dossiers/article/qu-est-ce-que-inflation
https://nexo.io/fr/why-nexo
https://fr-be.trustpilot.com/review/nexo.io

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23 November 2020

How to get the most out of compound interest?

Invest and Me 1

We have already seen what the compound interests are and especially the strength of these. For the purpose of this article, I would like to go even further to ensure you have a good understanding of these and allow you to get the most out of them. I would also like to highlight the traps that exist where compound interest might work not for but against you.

As a reminder, compound interest is considered by many to be the eighth wonder of the world because its power is so impressive. In this article, we are going to dive deeper into the world of compound interest.

Reminder on compound interest

Simply put, compound interest is a financial concept that refers to earning interest on interest. For example, putting money into an account where you receive interest based on the amount in that account. After a year, you have received interest in this account and you leave it there. The year after, you will receive not only the interest on the amount initially deposited but on the amount deposited plus the interest previously generated.

Well, the best way to understand this concept is the image of a snowball pushed from the top of a snow-capped mountain. The more it goes down, the more it grabs the snow and gets bigger and bigger. With compound interest, your bank account could act just like this snowball!

If you want to have a concrete and quantified example of the difference between an investment based on simple interest and on compound interest, I suggest you to read our introductory article on compound interest. But to summarize the results of a comparison, I put below the graph showing the possible evolution of income thanks to compound interest (Annual investment of 1,000 euros at 10%). Please note that the red part illustrates the invested amounts while the green represents the interest.

Compound interest formula

Rule of 72

A formula widely used in the field of compound interest is that of 72. Did you know that this formula allows you to know when you will have doubled your money thanks to the compound interest? To do this, just divide 72 by your interest rate. It’s a very simple but terribly efficient calculation.

As an example, let’s imagine that you could have an interest rate of 8% on a savings account. You just need to divide 72 by 8 to have the time you need to double your investment. In our case, 72/8 = 9. So you would only need 9 years to double any investment made in this platform.

Complete calculation

This rule of 72 is not bad and allows you to get a quick idea of the capabilities of compound interest. But, if we want to go further in the analysis it is important to know how to calculate the end result of an investment benefiting from compound interest.

To establish this formula, we need to establish the variables that we are going to use:

In = Investment after n periods
I0 = Initial investment
i = Interest rate for a period
n = duration of the investment

The formula to use is:

In = I0*(1+i)^n

Take the situation previously analyzed of 8% interest per year where we would invest 10,000 dollars for a period of 5 years.

The result is therefore:

In = 10.000 * (1+0,08)^5 = 14.693 USD

So this formula assumes that interest is paid annually. But let’s imagine that the reality here is that interest is paid every day. We must therefore divide the 8% interest over the 365 days that make up a year and carry out the calculation over 365 days over 5 years and therefore 1,825 periods.

The real result therefore becomes:

In = 10.000* (1+0,00021918)^1.825 = 14.917 USD

This calculation demonstrates the power of compound interest. We see in the above calculation that in the same situation if the interest was paid daily, it would save almost 200 dollars more. This is logical because since we receive interest more quickly, the capital used as the basis for the calculation grows faster.

Examples of compound interest

Examples of positive compound interest

Investments

Take the example of peer-to-peer lending investments and therefore personal loans, for example through the Mintos platform. The platform ensures that once interest and/or principal repayment are received, these funds are invested directly in new loans. Thus, as soon as you receive your interests, they are directly reinvested and therefore increase the capital generating interest.

Thus, as soon as you have funds that you are ready to invest, the platform will be ready to invest them directly and thus set up this compound interest mechanism as soon as you place them.

Either way, as with any investment, but even more so in the case of compound interest, the sooner you start investing the better. The machine must be started as soon as possible.

Savings accounts

This example may seem a little more surprising, especially when you realize how little interest this type of account generates. However, it is indeed compound interest, like the investment developed previously, but with much lower interest.

In fact, your savings account generates interest every year. This interest is paid on the same account where your capital is located. So these interests increase your capital and therefore your basis for calculating interest.

The problem with these savings accounts is that the interest rates offered by them do not beat inflation. We are talking about inflation per year ranging from 1 to 2% in France or Belgium. The savings accounts only allow you to earn interest of 0.01% or even 0.11% if you include the loyalty bonus.

The calculation is therefore quickly done, by leaving our money in a savings account we lose money. Because the 100 dollars that you would have possibly placed in the savings account is actually worth only 99 dollars the year after (considering an inflation of 1%). Thus, it is crucial to put your money in investments that, at the very least, beat inflation.

Dividends

As you probably know, many stocks pay a dividend to their investors. A common practice in the investment world is to directly reinvest dividends received by purchasing new shares of the shares that generated this income. Thus, you hold more dividend distributing shares and therefore, with the next payment, you will get more dividends. So it is indeed the effect of compound interest that operates here.

Note that some stock exchange platforms allow the automatic reinvestment of dividends in shares to be activated directly. This option allows you to not have to worry about it and that everything is managed without your intervention and therefore also without risk of forgetting.

This phenomenon can also be found in mutual funds. These often offer the option “distribution” or “capitalization”. This second option allows the dividends that would have been received to be directly reinvested to acquire more units of said mutual fund.

Note that some stock exchange platforms allow the option of reinvesting dividends in shares of shares directly and automatically. This option allows you to not have to worry about it and that everything is managed without your intervention and therefore also without risk of forgetting.

Examples of negative compound interest

Clearly, we often talk about the benefits of compound interest and what it can do for us. But we often forget that this compound interest can also work for other people and therefore against us. Let’s take a look at some examples.

Credit cards

Credit cards are a prime example of the negative effect compound interest can have when used against us. When you have a standard credit card, you have the flexibility to spend money that you don’t have. So you have a credit balance that increases with your spending. So you’re going to have to pay interest on that balance the bank loaned you. This allows you to keep this credit with regular payment of a proportion of the amount.

But, and this is the trick, the interest you have to pay on that credit balance also comes on top of that balance. Thus, if you do not make regular payments, the balance on which the interest rate is applied will therefore increase by the interest you owe.

That’s why I’m going to recommend anyone not to get into this kind of credit system. It is crucial for your finances to repay the credit amount on your card as soon as possible.

Fees on investments

Another point of care to prevent compound interest from working against you is to be careful with investment fees. Mutual funds and ETFs generate fees for your investments. This is because you have to pay the manager of the fund or ETF a percentage of the amount you invested as management fees. As a reminder, in the case of mutual funds, we usually talk about fees of around 2% while ETFs these fees are of the order of 0.1%.

However, whether in a fund or in an ETF, the more your invested capital increases, the higher your fees will be. So, if we take the idea of capitalization mentioned in the point “Dividends”, your reinvested generated profits increase your interest-generating capital but also increase the capital at the same time as the basis for calculating costs.

I assure you, the gains generated by compound interest far exceed the costs incurred (especially in the case of ETFs). So it is still a good trade if you invest in solid ETFs. But it also demonstrates the value in seeking lower costs and not just increased earnings. Especially knowing that ETFs allow these two gains compared to mutual funds.

Conclusion

The most important thing when talking about compound interest is to start as early as possible. Even if it’s a small amount of money, although it’s not as consistent as it should be. The key is to start. The real power of compound interest is that no matter how small those investments are, maintaining this habit can have a significant impact in the long run. Compound interest rewards people who manage to establish a savings habit and continue to add funds, no matter how small.