A comprehensive introduction to investing with data
By: Janny Kul
Tags: Towards Data Science, Data Science, In Depth Analysis, Investing, Data

A comprehensive introduction to investing with data

A starting point for superior investment returns

come for the cute dogs, stay for the wisdom

Why should I invest in the first place?

Everyone should be investing. Whether you have $1or $1,000,000. Efforts to invest regularly add up over time and small investments today become huge sums of money in the future if consistently compounded at high rates of interest. Think of investing as a magic pot you put your money into today and it spits out multiples of this number at some point in the future. It’s just the present-you looking after the future-you. Look after the future-you.

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This isn’t a guide for get-rich-quick schemes that were suggested to you from your mate Dave that you met down the pub. This isn’t a guide to “become a Bitcoin billionaire” with photos of lambo’s and me sitting on the beach in Bali with my laptop. This isn’t the latest instagram f̶r̶a̶u̶d̶s̶t̶e̶r̶ influencer sitting atop the Charging Bull telling you how they made $2,384,264.12 trading binary options in 10 seconds. This is a guide to help you on the path to intelligent investing in order to earn superior returns over time and make your money work for you instead of you forever working for money.

As you can see, I’m not sitting atop the Charging Bull

I’m not going to harp on about passive income that isn’t really passive. You know the spiel — “start a blog”, “start an Amazon FBA product”, “start a drop shipping business”, “become a YouTuber”. Erm passive? Realistically, investing is as close to passive as you can possibly get but I definitely wouldn’t pitch it as passive income. Although some of our investment strategies are going to require a lot less attention than others.

Let’s say you buy a portion of a company, the entire operation of that company is tasked with growing your money for you. More specifically, the core goal of any publicly traded company is to increase shareholder value over time. Finding great opportunities will take work, time, effort and energy up front on your behalf, but I can assure you that time spent here learning is far better than time spent in your day job. You can scale and compound your investment returns at a significantly higher rate than you can your personal value to a company.

I can’t guarantee that you’ll double your money overnight. I can however guarantee that if you leave your money in cash you will lose money over time. It’s quite literally MasterTime™ reaching into your bank account every single day and taking a little bit out for himself. I can also guarantee that if you invest in a passive fund you will underperform the market every year. Again it’s TheBanker™ reaching into your investment account every day and taking out a little bit for themselves. I want to show you ways of earning superior investment returns, consistently over time, using data, in order to grow your wealth. (I haven’t really trademarked those terms 😏).

Let’s avoid TheBanker™ running off with your money

Inflation

Inflation erodes away your money over time. We’ve all heard stories from our grandparents who tell us that a house in Fulham used to cost £50,000 when they were buying in their youth and today it costs £2,000,000 (If you don’t know where Fulham is it’s a part of London where Chelsea-wannabe poshos live). A majority of this is due to inflation. If you don’t invest, inflation will continue to eat away at your money. Every. Single. Day.

Let’s start with an extreme example with a quick trip in the Delorean back to the 1900’s in order to really drive the point home (Delorean… drive… ha!). Let’s say back then you toiled away and worked hard and sweat and saved up $100 and not invested but just stuck your money in a little shoe box under your bed. On 1900’s wages that would probably have taken you about 2 months. Now let’s jump back into the present — that $100 you saved up in real terms today is only worth $2.34.

The time value of money has literally just chipped away at your hard earned cash. It’s not something you should stick in the back of your mind and not worry about. It doesn’t ever just miraculously stop. It’s a constant force that is sucking away at your precious money and the only way to counter it is with investing. Leaving your money in cash, leaving your money in a low-rate savings account means you’re synthetically short time. Don’t ever short time.

Due to inflation, your cost of living goes up every year. Take for example a cup of Starbucks coffee. This falls under food inflation.

The first Starbucks store opened in 1971 with the price of coffee back then as $0.25. Today that same cup of coffee costs $2.87. That’s a 1148% increase. Extrapolate this into the future and your coffee next year will cost 3% more than your coffee today. Doesn’t sound so bad does it? Well what happens if we keep going, your coffee in 20 years will cost not 20*3%=60% but ((1+3%)²⁰)-1=81%, because inflation is compounding.

I know, I know, 20 years is a long time. But the 20-years-into-the-future-you will be really annoyed with the present-you that you didn’t start investing today. You’ve worked hard to earn that money and leaving it in cash will just let Master Time eat away at it. Whilst everyone else is distracted with #YOLO and #instagoals this is your time to grow.

don’t be distracted by photos like this

small survey of 100 Instagram users

Passive Funds

Investing in passive funds whose aim is to “diversify your investments” in my opinion leaves much to be desired. Passive funds charge a fee for their services. This will guarantee that you’ll earn less than the overall market because of the 0.25–2% fee they are pinching from your investment account every year.

Passive funds are definitely good for some people. If you want a zero effort approach, a zero time spent approach, are very patient, have long term time horizons in mind, then find the lowest cost passive fund you can and be on your merry way. That wont be the purpose of our journey here.

You probably think 2% doesn’t sound like much but the amount you underperform the market over a 20 year time period is pretty ludicrous.

You’re pretty much sitting on half the number at the end of 30 years had you have not been paying fees.

The other reason why passive funds aren’t good enough is because drawdowns are pretty horrible. You want to avoid drawdowns at all times.

“Rule No. 1 of investing: never lose money, rule No. 2: remember rule No. 1” — Warren Buffet.

Here’s a little example to highlight the point. Let’s look at the last 30 years of S&P 500 returns vs the average S&P 500 returns across the same time period. The average return across the past 30 years for the S&P 500 is 9.21%. So the red line has the S&P 500 annual returns compounded (with drawdowns) and the blue line has the S&P 500’s average returns (of 9.21%) across 30 years without drawdowns.

The drawdown model achieves a >10x return on your initial $100, but the no drawdown model achieves a >15x return over the same 30 year time horizon. We literally generate 50% higher total return over the time period (with the exact same average returns) from avoiding drawdowns.

What makes matters worse is if you’re investing with the plan to take an income each year. The point at which you experience drawdowns makes a huge difference to your overall success. Specifically, your success is predicated by whether the drawdowns hit at the beginning of your investing journey or if they hit at the end.

Let’s take the S&P returns again over the 30 years and run two simulations, the first where the drawdowns all hit at the beginning of the 30 year period so assume the nasty periods around 1999–2001 tech wreck and 2008 housing crash all happen within the first few years, and the second where all the drawdowns happen at the end. This assumes you’re taking $5 out of every $100 as an income.

If your drawdowns hit at the end, you’re fine and likely to have a successful investing career. If however, they hit at the beginning, you’re bankrupt within the first 7 years. If you’re planning on taking an income from your investment pot, you have to prioritise avoiding drawdowns at all costs.

Drawdowns ruin your investment returns. The average investor misclassifies risk, looking only at the upside ignores the most important rule of investing. Don’t be the average investor. Don’t ever lose money.

Compound interest

“Compound interest is the most powerful force in the universe” — Albert Einstein

The world is divided into two types of people; the first who understand the power of compounding and the second who do not. Compounding is a huge contributor to the wealth divide in the past 15 years.

Top 1% of earners vs Bottom 20% of earners

Let’s say your parents put $1,000 into a magic pot the day you were born. Let’s say the magic pot grows at 1.5% a month (I think 1.5% monthly returns are very achievable for most people). On your 21st birthday you’d have $42,603. Incredible, right?

However, if you manage to achieve 3% monthly returns you’d have $1,717,831 (I didn’t put this on the chart because you wouldn’t be able to see the other lines 😃). A 2x increase in monthly interest (3% instead of 1.5%) gives you a >40x increase in total returns over the 21 years due to compounding. Even more incredible, right?

I know all of these are hypothetical numbers but I believe they are all achievable. You’re going to be alive for the next 20 years anyway so you might as well invest. If you start with an investing mind set then you’ll maximise your value increase over the next several years you spend on this Earth. Compounding (and consistency) is the key.

Why should I use data to invest?

There are three stats you need to know with every investment.

What’s my downside?

What’s my upside?

What’s the probability I get said downside vs. said upside?

From here it’s just a matter of letting statistics and probability theory play out. If you don’t know these three numbers to within a tight range, stop what you’re doing immediately. What you’re doing isn’t investing, it’s speculating. It’s worth noting here, just because an asset or product has gone up every year for the past 10 years or 20 years doesn’t mean it’ll keep going up in the future.

Avoid trading speculatively

Everyone has a view on investments. Tom will tell you to invest in big brand names and you can’t go wrong. Dick will tell you to buy penny stocks and you can’t go wrong. Harry will tell you to buy Bitcoin and you can’t go wrong. It’s important to avoid this noise until you’ve had a chance to do your own work and understand the data behind investments.

a herd of sheep. bahhhh

Humans are herd creatures and it’s hard to not be influenced by outside opinions; it’s how we’ve survived for so long. Unfortunately, herd mentality does not help you when it comes to investing. Herd mentality creates bubbles and subsequent crashes.

The dangers of heard mentality:

Tech Wreck of 1999–2001

Crypto Mania of Dec 2017

Any other bubbles out there today that you can see? What was the last investment Dave told us about?

It’s important to formulate your own view about investments, using data, and then afterwards actively seek people who have a different view to yours so you can self-validate your own idea. Use other people’s views to decide if you’ve missed something in your analysis, not to dictate your investment decisions.

Understand global trends

We can however make inferences from macro trends. Trends that hold true are around consumer habits, supply and demand, market share disruption. Some of these can arrive within a year or two and last decades. Here are two strong trends over the past fifteen years. Do you think they’ll continue? If so, why? If not, why not?

If you understand the underlying reasons behind each of these trends it’s relatively easy to make inferences about the future. Who’s going to benefit from these trends? Who stands to profit? What are some attractive investments today to take advantage of these trends playing out over time?

Some trends are easier to spot than others and it’s really the spotting of these trends early and making correct inferences about the future that drives superior investment returns, not jumping on the back of an already firmly established trend.

What are the different types of investment?

I like to think of investments as either income or growth. Am I getting a regular income from this investment or do I hope that the asset I’ve purchased appreciates in price over time. Typically growth investments are more abundant and when done correctly far more profitable than income investments. This is easy to explain because income is paid from a portion of earnings but growth comes from an appreciation of value. However, income investments are a lot more stable and give you a regular stream of cash flows. A good portfolio will have a different ratio of the two depending on your goals.

Investing for income

Income investments are generally from productive assets. These include (but are not limited to) value stocks, corporate or government bonds and property. Investing in a catalogue of music rights to earn royalties can also be considered an income investment. Diversifying across income-producing investments is very important to ensure the taps aren’t turned off when you need them the most.

Investing for growth

As a company and as an individual, we can create 20% increases in value much easier than we can pay 20% a year out of earnings. Think about the amount of value you’ve received from this blog post and it cost me literally nothing but my time to put together. Value creation is much easier than paying a fixed number out of returns. Company valuations are based off of a multiple of forward earnings expectations but dividend payments to you are out of this years earnings which are after all expenses and taxes.

growth is impressive but not nearly as impressive as this leaf which is both growing and levitating

The Bezos model of reinvesting earnings in growth is much more lucrative for share price appreciation. It’s also worth noting, a large diversified basket of growth stocks outperforms in good times but value stocks outperform in bad times.

Basket of Growth Stocks vs Value Stocks, rebased to $100, across 15 years

Furthermore, value is created at a much higher rate of return in early stages of the business lifecycle. As a business matures, its incremental value creation is a lot lower. The highest returns are from getting in on the ground floor. Once a business has reached maximum market penetration it’s far less likely you’ll have a 50% annual share price appreciation.

Business age vs average YoY quarterly revenue growth for a subset of Nasdaq constituents

Different asset classes

Buying stocks receives a bad rap. The majority of the public believe investing in stocks equates to gambling. Quite frankly this has more to do with how the industry has been set up to firstly entice and secondly screw over retail investors as opposed to anything else. I want you to know I am here to help cut through all the noise and misinformation with data. All of the opinions I share with you will just be opinions but they’ll all be backed by data. This should hopefully help you make up your mind. You can bin the uncertainty, the speculation, the emotional decisions and start fresh with data informed opinions and clarity.

We’re going to deep dive into stocks, property, investment funds, alternative investments like art, whiskey, watches, domain names and even look at very alternative investments like comic books.

Summary

I hope that introduction was useful. To summarise what we’ve covered:

If you don’t invest, you’re guaranteed to lose money over time due to inflation.

If you invest in passive funds you will underperform the market, due to fees.

Your goal should be to invest in high rates of return with little-to-zero drawdowns & then compound regularly.

You need to use data to guide every investment decision. Don’t listen to Tom, Dick and Harry.

Investing for growth trumps income for long-term returns but which you do depends on what stage of your investment journey you are.

Join me next time when we’re going to get stuck in with comparing which is a better investment vehicle: stocks or real estate (using actual data and not just past prices!). If you want to get in touch before then, I’m responsive to either article comments or my linkedin.