Few things in the world that matter to most people as much as money.
Money is the #1 cause for divorce in the United States. Money is a big reason 70% of people are stuck in jobs they could care less about, according to research by the Gallop Organization.
Are you different? Have you managed to avoid the gravitational pull that money can have? If so, consider yourself lucky.
I used to think I didn’t need much money. I made a good living during my years working in the corporate arena. A few years ago I left that world, and my income went from well into the six-figures to zero.
I panicked. I had plenty of savings. I knew that I would generate revenue again when the time was right and after I wrapped up a year-and-a-half of travel.
Why did I feel so nervous?
I was not above the pull of money. It took me a while to come to terms with my relationship with money and lessen its grip on me.
Unless you’ve gone through a process of making a significant amount of money (whatever you deem “significant to be”) and then shutting off that income stream, you really have now idea how much your world is revolving around “the money game”.
The money game = work hard, make money, spend money, dream of the day you don’t have to work so hard. Rinse and repeat.
One way out of this twisted game is to spend less than you earn and invest the difference. Allow your nest egg to build up to the point where you can make the leap towards doing the work you want to do, instead of doing the work you have to do.
If the way out of the “money game” is to earn money, save money and invest that money so it can grow; the big question is: “How to invest?” Answering this question is what the rest of this blog post is concerning.
Why you might want to listen to me
I’ve made and lost a lot of money in the stock market. I’ve read dozens of books on investing. It’s a hobby of mine, and at a former profession (I interned during college at one of the largest asset management firms in the world, Merrill Lynch). Heck, my undergraduate degree was in Finance.
If you read some of my older posts on this blog, you can see first hand just how bad some of my supposed “advice” was. I’m writing this post to clear up the story and share what I am currently doing to preserve and grow my money for the long haul. It’s an approach I’ve used for the past 5+ years and expect to stick with it for the long-term.
A couple of comments before we dive in:
- Never purchase individual stocks. In this post, when I refer to “stocks” I mean low-cost index funds that invest in large groups of stocks.
- Nowhere in my post do I recommend “robo-advisor” like Wealthfront or Betterment. The fees are just not worth it. Even with a .10–25% fee structure, you will end up paying hundreds of thousands of dollars in fees over the course of your life, assuming you earn a decent salary and are committed to saving. Also, the claimed benefits (e.g. tax loss harvesting, superior asset allocation, etc.) are dubious at best. I recommend avoiding them.
Instead, follow the steps listed below to set up your investment system to win the money game.
Then get on with living your life!
How to invest money in 6 simple steps
I’m boiling down what can be a very complicated topic into a few simple steps. For those who want to read more on the topic of sensible investing strategy, I highly recommend Daniel Solin’s excellent book “The Smartest Investment Book You Will Ever Read.”
It also goes without saying that the tips I’m sharing are based on personal experience. I am not a certified financial planner, and you should do your own homework before taking my advice literally. That said, I do believe I know a lot on this topic 🙂 .
1) Open an investment account
I use Fidelity Investments for my brokerage, retirement and checking/savings accounts. I like Fidelity for several reasons. Their website is very modern and they have solid apps. They have a “smart cash account” feature that allows check-writing, ATM withdrawals and unlimited reimbursement of all ATM fees (saves me $100-$200 a year!).
I do all my personal banking with Fidelity, and it is easy to transfer money between accounts and have an overall view of how my assets are performing. They also have branches in most big cities in the USA which has come in handy for a few larger transactions I’ve done over the years where I’ve actually wanted to work with a human on something (e.g. buying a house).
That said, knowing what I know now, I would have opened an account with Vanguard and used that for all my brokerage and retirement savings. I would have opened a separate checking account with Fidelity or another bank for cash management.
This is what I recommend for you. Use Vanguard for your investments.
Vanguard is the only investment firm I know of that is wholly owned by its funds, not by outside shareholders. That means if you have money invested with Vanguard, you own the company. They have no vested interest in doing anything besides passing on any operational savings to their customers. They have the lowest fees in the industry. They are old-school, but in a good way! You won’t find any fluff with Vanguard. Their fees are the lowest around. That can save you hundreds of thousands (or millions) over the course of your life.
Why don’t I switch from Fidelity to Vanguard? Well, I own a bunch of Fidelity funds right now and a Vanguard S&P500 Fund for my 401K, which is also held in my Fidelity account. Switching would require my selling those Fidelity funds and paying taxes on the gains. Also, the total expenses I pay for my Fidelity funds are super low since I invest in Fidelity “Spartan” funds that are ultra-low cost. I’m content where I am.
2) Select your portfolio allocation
Asset allocation has a big impact on your overall portfolio returns and volatility. When I talk about asset allocation, I’m referring to the amount of stocks and bonds you hold, as well as the mix of assets across various countries and market sectors.
The simplest way to think about allocation is this: when you are young invest in stocks and as you age increase the amount you invest in bonds. Beyond stocks versus bonds, you should also invest in both the US and global stocks to maximize your potential gains while lowering risk.
Some financial experts also believe that a properly allocated portfolio needs to consider assets like commodities, emerging markets and real estate. I personally don’t worry about those things. I know that if I invest in a broad set of companies in the US and globally through low-cost index funds, that I will be exposed to all the necessary industries.
Figuring out your optimal asset allocation is more art than science. Warren Buffett will tell you to just figure out how much money you want to invest for the long-term and put it in the S&P 500, an index of the 500 largest companies in the US. Here is what Warren answered to Tim Ferris when he asked him this question:
“If you were 30 years old and had no dependents but a full-time job that precluded full-time investing, how would you invest your first million dollars, assuming that you can cover 18 months of expenses with other savings? Thank you in advance for being as specific as possible with asset classes and allocation percentage.”
Buffett let out a small laugh and began. “I’d put it all in a low-cost index fund that tracks the S&P 500 and get back to work…”
Many other experts and financial textbooks would disagree with Warren Buffet, and emphasize the presence of bonds and global stocks in your portfolio.
The good news is there are some simple questionnaires you can fill out online that will help you figure out the right asset allocation for you.
Another method you can use to determine your asset allocation is a rule of thumb in which you subtract your age from 120. So if you are 50 your asset allocation should be 70% stocks and 30% bonds. If you are 35, as I am, your asset allocation should be 85% stocks and 15% bonds. Keep in mind, this assumes you plan to use the money you are investing during retirement. If you have other sources of income, you may want to just keep investing like you were 30 years old, even if you are 80!
You should also consider the balance of global stocks in your portfolio. United States is no longer the majority of the economic productivity in the world, and an investment portfolio should reflect that. Charles Schwab has published research, corroborated by many other sources, on the fact that Global equity investments help to diversify a portfolio of United States stocks.
The chart below from Charles Schwab, shows investment returns over rolling 10-year periods. Notice how the “world” bars (this captures US and global developed market stocks combined) show equal gains but less loss than just US stocks.
The proper allocation of global vs. US investments is tricky. This is where investing is part science but mostly art.
For example, Vanguard recently increased the allocation in their LifeStrategy funds to have roughly 40% of their stock investments outside the US. You can geek out on more research from Vanguard here if you like. If you just look at the economic value, the US economy is roughly 50% of the global economy in total, so a 50% allocation to global stocks makes sense from that perspective.
Overall, according to research from multiple sources I’ve read, portfolios that hold between 25% – 50% of their stocks in global companies are getting the diversification benefit. So pick a number and move on!
In my portfolio I’ve been using a ratio of 75% US / 25% global stocks based on research I did many years ago and what was correct at that time. I will probably revise this when I take another look at my portfolio around tax time and increase the amount of global stocks to match what Vanguard recommends, closer to 40% global.
My Portfolio Allocation (9/2015)
3) Buy only low-cost index funds
The outrageous expenses charged by many financial advisors should in my view be illegal. Does anyone have a right to charge a percent of your hard-earned assets every year just for the privilege of being able to call themselves your financial advisor?
After all, research has shown that stock pickers fare no better than monkeys in picking winning stocks. You might as well invest in the broad-based market, which is a bet that the overall economy will grow over the long-term. Given globalization, technology improvements and growing populations, it is a safe bet that this will turn out to be true.
We are no longer living in a world where stock and mutual fund trades need to be filled by hand. Everything is automated. Information is available freely. Advances in mutual fund and ETF options mean that with less than one hour a year of your effort you can set up a system for investing in keep it going for the rest of your life without paying hundreds of thousands of dollars in fees to a broker or adviser.
After 30 years, a fund with a 1.5% expense ratio will provide an investor with several hundred thousand dollars less for retirement than a 0.15% index fund with the same growth. The image below that I found on The Bogleheads (originally created by AllianceBernstein) illustrates the impact of someone making $45K and investing 6% of their salary initially. Their salary grows over time to $85K as does their saving rate, which hits 10%. It shows what having just 1% greater return (e.g. 1% less in expenses) can do for you!
If you’re currently stuck with a financial advisor who is charging you 1%, 2% or even 3% just to manage your money – you need to fire your advisor immediately!
Which low-cost index funds to buy?
This is where the rubber hits the road and where most people get tripped up. What fund to buy? Most brokerage offer too many choices!
Daniel Solin’s book provides concrete recommendations on which funds to buy for Fidelity, Vanguard and a couple other discount investment companies. I highly recommend reading his book.
For me, I invest in Fidelity Spartan funds and also Vanguard for my 401K. Fidelity Spartan funds are ultra-low-cost and I can build a balanced portfolio with only three funds: a global market fund, a total US market fund and an intermediate-term US government bond fund.
I hold slightly different assets than what Daniel Solin recommends because I made my investment choices before reading his book. Currently, I don’t want to swap my fund choices now and pay tax on the gains. I’m happy where I am at, even though it might not be optimal.
As mentioned previously, my 401K is also with Fidelity, but is invested in a Vanguard S&P 500 fund.
If you are using Fidelity, use the recommendations from Daniel Solin in his book, or just refer to the following as a viable 3-fund portfolio using Fidelity Spartan funds as pointed out by The Bolgleheads website:
- Fidelity Spartan Total Market Index Fund (FSTMX)
- Fidelity Spartan Global ex U.S. Index Fund (FSGUX)
- Fidelity Spartan U. S. Bond Index Fund (FBIDX)
All you need to do is figure out your asset allocation for bonds and global stocks, and then buy those three funds. That’s it!
If all this confuses you, you can purchase a Vanguard Asset Allocation or LifeStrategy fund that automatically allocates and diversified your portfolio for you. However, be warned, similar funds at other brokerages (including Fidelity) are much more expensive than Vanguard, so make sure you check the expenses for any fund you are buying!
4) Add money at regular intervals
This point is obvious. If you want to build a sizable nest egg you need to invest. The way to make this painless is to automate your investing. If your company offers a 401(k) make sure you are maxing that out to get your corporate match (e.g. some companies will match your 401 contributions up to a certain amount).
Early on in my corporate career, when I was living like a monk and had few expenses, I set aside a very high percentage of my pay to be automatically diverted to my Fidelity brokerage account. As I received raises and bonuses over 14 years of working at my previous company the percentage of my salary that was automatically invested stayed the same or increased.
As a result I never had to make a conscious decision to invest my money. It happened automatically. This made it painless and easy.
Set up an automatic investment plan even if it’s $50 a week. Have the money automatically deposited from your checking account to your investment account. Increase the amount until it is painful and causes you to take a hard look at other spending, to make sure you are prioritizing your investments over anything else (aside from spending money on important life experiences, I’ll write more about that in a future post).
To accelerate your savings, whenever you get a raise, send half of the raise amount – at minimum – directly to your investments.
5) Rebalance annually at tax-time
Rebalancing your portfolio is critical. Research shows that by rebalancing just once a year we’ll garner most of the benefits though some people may choose to rebalance more often.
The theory behind rebalancing is to make sure you’re always investing in assets that are considered “a value” and that your asset allocation isn’t out of whack. “Value” assets are those that have not increased in value as much as other assets. It also ensures that you are getting all the benefits of diversification.
For example if US stocks have increased significantly over the past year while global stocks have increased less so, you will want to sell some of your US stocks and shift the money to global stocks when you rebalance. This this ensures proper diversification.
I rebalance once a year around tax time. I look at the allocation of my portfolio and compare it to what my desired allocation is. If any asset is off by more than 5%, I rebalance it. If you don’t want to sell one asset to rebalance, you can simply divert new investments to whatever asset is underrepresented your portfolio.
6) Get on with living your life
Spending time over-analyzing your investments is a waste of time. The most valuable investment you can make is in yourself. So once you’ve picked a strategy, chosen your brokerage and invested it’s time to get on with living your life!
If you are still working you should always remember that your biggest financial gains will come from your career and your rate of savings. Figure out ways to get ahead in your career, earn more money and save more. This is a much better use of time than and over-analyzing your investments
Below are some other resources worth checking out on this topic: