The Most Important Topic In Trading

Feb. 22, 2017

We dance around in ring and suppose,

But the Secret sits in the middle, and knows.

-Robert Frost

When we talk about trading, there are a lot of things to talk about.

We could talk about trading systems; we could talk about psychology; we could talk about money management. All of those are important.

But none of those things truly gets us closer to trading-for-a-living. Knowing that information doesn’t help us make the journey from job/cubicle/mortgage/stress/misery to freedom. We’re looking for a life where all our bills are paid and the only thing on our schedule is maybe sitting a hammock. A new Stochastics setting isn’t going to get us there.

So how do we get there? How do we go from where we are now to complete independence? Where do we even begin?

The truth is: It all begins with your monthly expenses.

If you’re thinking of trading-for-a-living and don’t know your monthly expenses, then you have more work to do. If you don’t know your expenses, do some quick calculations and come right back.

Great.

Once we know our monthly expenses, we can get started. We now have a number to get to. If we don’t have that number, then we don’t know what size account we need, and we don’t know what trade size to use, and we don’t know how much profit our system needs to generate.

Without that number, we’re just aimlessly dancing around with our friends, discussing trading methodologies in the sunshine until our families call us in for dinner. We’re going nowhere until we know that number.

Once we do know, though, it begins. The Plan magically takes shape.

Let’s say our monthly expenses are $2,250. Is that a ridiculous number? Well, it’s the exact number that Mr. Money Mustache uses. Who’s he? He’s the guy who quit his job at 30 and has lived solely off the profits of his initial nest egg.

What was his process? First, he saved. Then he quit at 30. Twelve years later, nothing has changed. He’s doing that exact same plan. Money is not an issue.

Isn’t that what we signed up for? Isn’t that what we dream about? We want trading to pay all of our bills so our lives are entirely ours. That’s exactly what Mr. Money Mustache has done.

So there it is. Mission accomplished.

Now how do we stop dancing around and do it ourselves?

Again, we first need to know our monthly expenses. Before he retired, Mr. Money Mustache (MMM) calculated his annual expenses to be no more than $27,000, or $2,250 per month.

Once that was calculated, MMM needed something to pay him that amount. He chose trading.

Well, not really trading. MMM doesn’t believe in trading. He’s under the assumption that technical analysis has been proven to be futile (author’s note: I believe him to be categorically wrong in this assumption, but let’s continue).

Because he believes trading is futile but investing is foolproof, he decided to put all of his money into a Vanguard Index Fund.

Now let’s go through the numbers.

His family needs a max of $27,000 a year to be free forever. If we look at the 15-year performance of a basic Vanguard Index Fund (VFINX), we see that this fund has averaged 7.21% per year. That’s interesting, because internet research shows that the stock market as a whole has averaged about 7% per year since the 1920’s. Depending on when you decided to start your calculations, it might even be more than 7%. But let’s just stick to that 7.21% number.

Back to the Plan.

If he needed $27,000 a year, then how much did MMM initially have to save to feel safe in retirement?

The answer: $374,480.

However, that number is the bare minimum. We know that the market doesn’t go up 7% every year like clockwork. Far from it. What happens if the market has a bad year the first year we retire? Then, of course, we still take out $27,000 and also watch our original nest egg shrink. If the nest egg gets too low, then we have to change our trade size. If we change trade size, then that return number isn’t accurate.

It would be better to build in a little margin of safety.

How do we do that? MMM offers a very simple rule: take your annual expenses number and multiply by 25. If you do that, all of the ups and downs should be mathematically accounted for.

Taking that into account, if we multiply $27,000 by 25, we get $675,000.

He and his wife had nice jobs, so MMM had that saved up in 2005.

He’s been going strong ever since. Trading pays his bills and the rest of his (and his family’s) life is free.

If those numbers sound doable to you right now, you’re also free. You don’t have to read any more blog posts or do any more research. You’re done. See you in Zehuatanejo! Or somewhere else.

But you probably have some questions.

My expenses are bigger than $27,000. What then?

And what if I don’t have that much saved and won’t any time soon?

First, if your expenses are more than that, you could go on a expense-cutting mission and cut out things you don’t need in your life. You might be surprised at how much money you waste each month. I know I’ve wasted money on stupid things.

Or you could save more money. Let’s do the numbers.

If your expenses are $5,000 a month, then you have annual expenses of $60,000.

$60,000 times 25 = $1,500,000. If you can save that much, again, you’re all set–if you like Index Funds.

Second, if saving $675,000 is not doable, it’s not over.  Not at all. All you’d need to do is make more than 7% per year.

Keeping MMM’s example, if you could make 15% per year and have $27k of expenses, you’d only need about $350,000 to retire comfortably. That’s a much smaller number.

And that’s the Secret. Once you know your expenses, all you have to do is find a vehicle that produces the necessary returns. If you believe that trading is impossible but Index Fund investing is real, then your blueprint is above.

If you totally disagree with the idea that trading is impossible, then you have all sorts of crazy options.

I’ll leave you with one of those crazy options.

Let’s take a robot I’ve traded since 2014. That’s not 100 years of proof but it’s not yesterday either.

If you used a moderately aggressive trade size and had $27,000 of expenses per year, you could hypothetically retire on a $150,000 nest egg.

To repeat: If you had $150,000 and used that simple robot, you would have been able to hypothetically pay your bills and have your nest egg grow slightly in the past three years.

That’s only if you believe in trading, though.

Talk soon.

Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.