How should a European citizen invest their savings

Don't lose your savings because of inflation but instead earn money passively

Where should you invest your money?

Two of the most common ways are investing in the stock market and investing in real estate. Of course, there exist many other investing methods like investing in a business, in precious metals like gold, by doing peer-to-peer lending, etc.

People are usually more familiar with real estate than stock market investing. Real estate is popular because it’s a physical investment than you can touch with your own hands. It’s a tangible investment that hedges against inflation, but the returns on real estate investments are often moderate. It also requires significant money out of pocket and often there can be a lot of work to manage your real estate investment.

On the other side, investing in the stock market is a liquid investment, which means it is easy to buy and sell. Stock market investments don’t require a big budget to start and it is easy to diversify your investments. But the disadvantages are that returns are often unpredictable and volatile.

There are many things to say about investing in real estate but since it requires a bigger budget the rest of this article will focus on stock market investing as that investment method is approachable to anyone and available for any budget.

How to invest in the stock market?

It takes special skills and good luck to get good returns on the stock market quickly. Getting moderate returns, though, is possible and can be a result of good diversification and a more long-term investment horizon.

There exist two most common ways to invest in the stock market…

The first one is to try to get bigger gains in the short-term and bet on companies that you think will raise their value in the future. While this method works for a short investment horizon, it is risky. People usually think they can beat the market, while in reality, it is big investor companies who make most of the money.

Investing for the long-term is less risky

An alternative and a smarter method for a small investor is to invest for the long-term and diversify your investments. By investing in the whole market instead of specific stocks, you are able to minimize risks and the effects of short-term volatility and price-drops.

With this method, your goal is to make gains based on the fact that historically the stock market has always grown. Statistically, since the year 1926, the stock market has historically returned an average of 7% annually (when adjusted for inflation and dividends). Though there are no guarantees and the market can be very volatile, the 7% average has held remarkably steady for long term investing horizons. Since you can expect stock market declines like for example during the recessions you need to be ready to sometimes suffer through the losses and be patient by waiting for the long-term returns. It’s important to notice that for this method you need to have an investment horizon of at least 10 years or longer.

Should you invest everything in stocks?

So once we chose our investing method we need to make sure to define the most important terms.

Though it is called the stock market and is primarily known for trading stocks, other financial securities — like ETF-s, bonds and financial derivatives — are also traded. Even though there exist several different classes of assets, stocks and bonds are the two that investors most commonly use in their portfolios.

Stocks represent an ownership stake in a company, while bonds are loans made to an organization.

You will need to decide on what percentage of your total investment portfolio you want to invest in stocks and what percentage in bonds. It will depend on how risk-averse you are... If you can sit tight and focus on the long game, when the stock market crashes and your investments decline rapidly, you’re a good candidate for investing most of your portfolio in stocks. But if your reaction to a market downturn will be to take your money and run, you should go for a less volatile investment portfolio by keeping more bonds in your portfolio.

Generally, it’s advised that the older you are the more you should invest in bonds since you want to be less exposed to volatility at a higher age. So, the usual advice is to invest in bonds a percentage of your portfolio that is equal to your age. But because of the recent low bond returns, feel free to lower the amount by 10 percent.

Bonds percentage = Age - 10

Following that strategy, let’s say you are 31 years old… That means you would invest 31–10=21% percent in bonds and the rest, 79% in stocks.

In which financial instruments should you invest

As mentioned before, the recommended method is to diversify your investments by investing in a global market. There are ways to get exposure to stocks and bonds from the whole world without having to buy each of the specific shares which would be very time consuming and difficult to handle.

No need to follow the stock graphs daily, ETF-s will simplify your life

The most common way to achieve this is by investing in a financial instrument called ETF (exchange-traded fund). ETF-s are funds that are tracking different indexes and are sold on the stock market. So they are different than stocks because they track many different shares. By investing in just one ETF you basically get investments in many shares at the same time and this achieves our goal.

If you have decided that investing in ETF-s is the right way to go, your next step will be to find a suitable ETF.

As a European, the general consensus is to invest in the ones that have the following features:

1. Broadly diversified ETF-s

By diversifying the exposure you are minimizing your risks and optimizing your potential returns.

2. Accumulating ETF-s

In several EU countries, accumulating funds are fiscally more advantageous than distributing funds. In accumulating funds, dividends are reinvested without leading to tax costs. In that way, dividends are translated into capital gains which are only taxed when the shares are sold. This does not happen with distributing funds. But some countries discourage investing in accumulating ETF-s, so double check what is the case in your country.

3. Nominated in local (EURO) currency

Find ETF-s that use the same currency to not spend additional money on currency exchange fees.

4. Based in Ireland

It is optimal as there is no source taxation in Ireland.

5. Full replication or physical sampling

Full replication and physical sampling are preferred replication methods. Synthetic ETF-s should be avoided as they introduce additional counterparty risks through swaps and derivatives.

6. Low total expense ratio

The total expense ratio (TER) is a measure of the total costs associated with managing and operating an investment fund. These costs consist of management fees and additional expenses and are expressed as a percentage amount. It is beneficial to find ETF-s that have low TER.

By following these criteria, some examples of great ETF-s are:

SPDR MSCI World ETF

iShares Core Emerging Markets IMI ETF

Vanguard FTSE All World ETF

iShares Core Global Aggregate Bond UCITS ETF EUR Hedged

How should your portfolio look like?

In which ETF-s should you then invest?

There are infinite ways you can build your portfolio, but to keep everything simple you can build your whole portfolio with just 2 ETF-s and still keep the returns and risks optimal.

For bonds, you can invest in iShares Core Global Aggregate Bond UCITS ETF EUR Hedged (EUNA). When it comes to stocks, it’s recommended to invest in global market capitalization-weighted equity funds. So you can invest in Vanguard FTSE All-World ETF (VWCE). Vanguard FTSE All-World ETF (VWCE) is equivalent to investing in about 3350 largest companies from both developed and emerging markets.

Alternatively, you could achieve a similar strategy with slightly lower costs by replacing the before mentioned Vanguard FTSE All-World ETF (VWCE) with 88% SPDR MSCI World ETF (SPPW) + 12% iShares Core Emerging Markets IMI ETF (IS3N). This would decrease your costs a bit but will increase the complexity of your portfolio slightly by adding a third ETF.

If you don’t want to invest all of the money you have immediately, you can consider dollar-cost averaging instead. This means you will be investing every month the same amount to reduce the risks of different market prices at a certain moment. This approach, compared to the lump sum investment, has its own advantages and disadvantages.

On which platform to trade on

If you have more than 100 000 € to invest you should probably choose Interactive Brokers or some of their resellers. They are the biggest trading platform and your money should generally be the safest there because they have the “SIPC” investor compensation scheme with the maximum coverage of $500 000.

Invest through some of the modern brokers

If you have a budget smaller than 100 000 € then you should choose Degiro or Trading212. They are cheaper to use for an investor with a smaller budget since Interactive Brokers charges higher fees. In any EU country with the exception of Belgium, Trading 212 will be a better pick because they have no fees. If you are based in Belgium you can use DeGiro since Trading212 is not available there.

Note: I do not provide personal investment advice and I am not a qualified licensed investment advisor. I will not and cannot be held liable for any actions you take as a result of anything you read here.