What is wealth? 

Simply put, wealth is the money that either you or your predecessors accumulated over time and did not spend. To understand the basics, money can be generated either by the so-called human capital (you work for the money) or by financial capital (your money works for you). Both human and financial capital generate cash flow and then one has to decide whether to spend it or save it. When saving money, you can either hold it in your bank account or invest it, leaving you with the choice between being an active or passive investor and between owning or lending.

Passive investors delegate the control of their money to third-parties. On the one hand, passive investors can purchase securities representing a credit towards countries or corporations, (de facto lending them money) e.g. bonds, certificates of deposits, treasury bills. On the other hand, passive investors can buy securities representing fractions of companies, real estate, or portfolios, i.e. stocks, Real Estate Investment Trusts, Exchange Traded Funds, and other funds (we will go through all of them in the next newsletter). 

Active investors control their money. On the one hand, active investors can lend money directly, either selling an asset and supporting the buyer with a loan (so called owner financing) or by lending money to other individuals or businesses (i.e. direct lending). On the other hand, active investors can directly invest money in businesses and/or real estate.

Regardless whether these investments are active or passive, they generate financial returns, which in turn increase the financial capital that one has.

Hence, whether your cash flow only comes from your hard work, you sell some assets and/or inherited money, the ultimate decision is whether to spend or save that money. As brilliantly explained by Morgan Housel in his The Psychology of Money “past a certain level of income people fall into three groups: those who save, those who don’t think they can save, and those who don’t think that they need to save”. In this article we will mostly focus on the latter two groups.

Why Saving?

Let’s start with those who don’t think they can save: it is true that people born after 1980 are dramatically poorer than previous generations. In fact, millennials have a median net worth significantly lower than that of Baby Boomers at the same age. For instance, as studied by William R. Emmons and Bryan J. Noeth “a family headed by someone born about 1970, for example, was likely to have about 40 percent less wealth (inflation-adjusted) at any given age than an otherwise identical family headed by someone born about 1940 when he or she was the same age (holding constant the level of education, race or ethnicity, health status, income, etc.)”. 

I know, it’s hard to think about investing when you struggle to keep up with bills, rents, and from time to time well deserved leisure. After long hours in consulting, architecture, or law firms, millennials (who are undoubtedly more educated than any previous generation) can barely afford a gin tonic, let alone buying a house or thinking about investing in the stock market. But you are here, therefore deep inside you know that there is more to that story. You want to break that circle and build a better future for yourself, despite navigating against all odds. And the good news is that you are right, there is a path to financial freedom that does not involve winning the lottery or becoming the next Zlatan Ibrahimovic.

On the other hand, those who don’t think they need to save may believe that if they can cover their expenses with salary / inheritance / sale of small assets and then with pension, why should they bother investing? Here’s the hard truths: 

• for the average person, their skillset will be less and less relevant over time (how many people do you know changing jobs in their fifties?) and there is little guarantee that you will receive a government pension at the end of your career; 

• how about if your plan does not go accordingly (e.g. you get fired)? 

Having capital instead of work generating income is about survival. In fact, we’re not talking (only) about how to get rich, but financial freedom is first and foremost how you will manage when you cannot work yourself out of bills. And we are here to guide you through our mental models and frameworks to try to deterministically build wealth / capital so that you won’t need to worry about future expenses. We also believe that the highest form of wealth is not linked to a number in the bank but to the ability to wake up every morning and do what you want, when you want, for as long as you want and, above all, with whom you want. Ultimately, freedom is the most rewarding benefit that money can provide.

Listen carefully, it may not look like a sexy path, but the math is here to prove to you that patience will be your strongest ally! You need to pay for your future self first. The moment you receive a payslip, the first thing you should do is set aside at least 20% of your monthly income and put it somewhere where you will not be able to touch it; then you should forget about this money for, let’s say, 30 years. As strange as it may sound, the latter is actually harder than saving in the first place. In fact, it is dramatically complex to resist the temptation to withdraw these funds for your partner's birthday gift, the deposit of the apartment you want to buy to stop paying crazy rents, or a new car that you really really need. 

Time Value of Money

The key point to understand is that time has a value, which is represented by interest rates. My background is quite quantitative, but you don’t need to be a mathematician to understand the basics. There are a few common-sense reasons to explain it: 

• if prices of goods and services go up (as they usually do, never heard about inflation?) €100 today are less valuable in a year as they allow you to purchase less things; and

• if you lend money to someone, not only that there is a chance that you won’t see your money back, but you could have been using (let alone investing) that money, and for those reasons ideally it would make sense if you receive back more than what you gave.

Therefore, €100 today should be worth more tomorrow, and how much more is determined by the interest rate. I can hear someone wondering in their room “but my employer and I are already saving, it’s called pension”: well I have some bad news for you. According to a poll by the Financial Fairness Trust and Institute for Fiscal Studies (IFS) only 11% of workers believe the state pension will “definitely exist” in 30 years’ time, while a third believe it will not.

Breath. Again. Now, what to do? If only you did not panic, I was about to tell you that if you do not touch your savings and invest them in the MSCI World Index (one of the financial indexes representing the global stock market) on average you made a 11.24% in the last 53 years (see here). This means that €1,000 invested in 1969 became almost €150,000 in 2023, a x150 return. One may say that the 1970s and the 1980s were characterized by high inflation, which should be accounted for; they are absolutely right. Nonetheless, the spirit of the argument still remains: if you consistently save your income and invest it, you will be better off in the long run. Please note that 11.24% is an average, made of periods of positive and negative returns.

Who Wants to Be a Millionaire?

But if you still believe you can’t afford setting aside at least 20% of your income, let’s talk numbers. Assuming for example that you are able to save just 20% of your income: according to Glassdoor the average gross salary in Milan —which is where Attilio and I live, but you can extend this reasoning to any city— is €32,000 per year or €1,750 net per month. Our mantra would suggest to the average person in Italy to mandatorily save at least €350 per month, which leaves one with €1,400 for needs, bills, and wants. No worries, we do know also that the average rent for a 1-bedroom apartment in Milan outside the city center is €900, which would leave one with just €500 to survive. If that is the case, either change your job or go and live somewhere else: as hard as this may sound, you are probably living above your means if you’re spending more than 50% of your income on rent. But we will discuss how to budget and make sure you take care of your financial wellbeing as well as your mental and physical wellbeing later. 

Now let’s assume you trust me for a second and you set aside €350 per month for 30 years and let’s see what happens:

At the end of year 30, your bank account will show a balance of €1,034,419.34: CONGRATS, YOU’RE A MILLIONAIRE! Literally someone earning an average salary in Milan can become a millionaire with method and patience, assuming the same historical returns of MSCI World. Even if you withdraw all the money because you’ll be afraid of a stock market crash, you may have the same salary you have been earning before (€32,000) for more than 30 years. It’s true that we’re ignoring inflation and taxation here, but we are also ignoring that someone’s salary will likely grow over years and so should their monthly deposits.

Is it simple? Probably yes. Is it easy? Definitely not. In fact, consistently saving 20% of your income regardless of unforeseen events, temptations, and little pleasures here and there implies one big challenge: saying no. Saying no to your friends for that other night-out you did not budget for, saying no to your partner for that piece of furniture they really like, saying no to yourself for not indulging in things you believe you deserve. It takes a lot of discipline and willpower to say no, but we will discuss in the coming weeks when exploring the psychology behind money.

Stock Market Myths

Okay, so let’s assume it’s the beginning of the year so on top of going to the gym your new year’ resolution is to start saving and investing to become a millionaire to free yourself from work. We are not (just) here to teach you how to do that and get there. We are here to show you how we do that and get there with our own money, making this quite an interesting quality investing social experiment. 

I can hear some readers already thinking:

• “20% of my income is just €1,100, it won’t make a difference if I save it, but my life will likely be worse off without that money”: tomorrow if there is no pension your life will surely be much worse if you don’t. 

• “stock market is risky, my cousin lost his fortune”: I don’t want to show lack of empathy for your cousin, but the reality is that you lose money only if you are forced to withdraw money at a certain point in time, otherwise –to date– you would have consistently made money holding either profitable companies or widely diversified indexes for the long-term.

• “stock market is gambling”: stocks are actual companies, with customers, revenues, profits, very much similar to the coffee shop next your house: the important thing is to be able to select the ones with higher chances of consistently delivering outstanding results. 

• “in crypto I can make that money for much less”: enjoy, next time I open a newsletter about crypto I’ll let you know.

• “real estate is safer than stocks”: just because you don’t ask your real estate agent the price of your property every month does not mean that these prices don’t fall.

• “but if I need the money I can’t have them stuck there”: do you remember those amazing returns I told you about? If an investor missed the best ten days in the S&P 500 from 1994 to 2004, their annual return would drop from 12.07% to 6.89%.

To sum up, you need to put money aside, invest it, forget about it –for real, do not touch it– and wait. If you want to do better as an investor, the single most powerful thing you can do is increase your time horizon. Time is the most powerful force in investing, it makes little things grow big and big mistakes fade away; it can’t neutralize luck and risk, but it pushes results closer to people's goals. The next natural question is: is the MSCI World Index good enough for me?