Investing 101: The Tried and True Method
I get a lot of questions on how and where to invest.
Where should I put my money?
Which stocks should I buy?
How much of each should I buy?
There is no black and white answer because there are many roads to Rome; that said, I highly recommend that the majority of people keep the bulk of their investments in plain vanilla index funds that have the lowest expense ratios.
The Easiest, But Slowest, Way To a Massive Portfolio
In a previous article I wrote (Smart Wealth-Building Life Hacks You Should Know), I pointed out that you can hit a 7-figure account if all you did was invest just a few dollars a day, using basic math. This is by far the surest way to build wealth, in the long haul, with minimal risk.
Over a life-time of consistent investing, you will achieve substantial wealth this way (barring an Armageddon-like event that throws the world back into the medieval ages).
What About Buying Individual Stocks of Hand-Selected Companies that I Like?
If you want to try to make it big with individual stock picks, allocate no more than 5% as “play money.”
You can do more than just 5%, but only after you have enough in your portfolio to meet your basic needs.
The reason for this is because the goal isn’t to just get rich, but to not end up being poor.
So by constructing a strong base of index funds that will meet your expenses, anything in excess can be used for more adventurous ventures.
The Passive, Low-Fee, 3-Fund Index Approach is the Surest Way to Long-Term Investing Success
Personally, for my wife and me, the majority of our core holdings are with Vanguard. Within both our tax-advantaged and taxable accounts.
I use Admiral Share funds in my 401K and IRA/ROTH IRA, and ETF-equivalents in my taxable account.
I also do loss harvesting with partner funds using taxable accounts at Schwab. (non-retirement accounts).
What Types of Funds Should I Buy for my Core Holdings?
Here are the 3 core funds that should make up the majority of your portfolio:
- Total Stock Market
- Total International
- Total Bond
For example, to look for the ticker symbols for the actual funds, you can google “total stock market index fund vanguard” or “total international stock index fund Schwab.”
The Total Stock Market Consists of Big Domestic Companies
Referring back to the 3 fund index approach I mentioned above:
The Total Stock Market consists of domestic stocks (US companies).
And it covers all the multi-national brands.
Some household names you’re probably already familiar with:
The Total International Consists of Big International Companies
Similar to the domestic companies I’ve mentioned above, the international fund consists of the international multi-national brands.
Some household names you’re probably already familiar with:
The Total Bond Consists of a Mix of Mostly Intermediate Duration Bonds
The total bond index fund is a mix of intermediate duration bonds: treasuries and investment grade bonds.
I have to admit, bonds are boring. Personally, I think if you’re in the accumulation stage, and if you have a strong stomach for volatility, you can forego bonds.
Keep in mind, you may not know what kind of stock market volatility you can take, if you haven’t been in a sever bear market like the one we had in 2008.
What Investment Company Should I Go With?
I recommend going with any of the big providers that offer index funds with low expense ratios (I’m not getting paid for endorsing any of these companies by the way):
- T. Rowe Price
As I’ve mentioned above, most of my money are in Vanguard funds. I also have some in Schwab, and about $300,000 in a taxable account using TD Ameritrade.
Wait, Some of These Have Minimum Requirements for Me to Buy In!
I find that very often, people who are just getting started don’t have enough money to buy into all three of the funds; nor do they have enough money to meet some of the minimum requirements that are out there.
For example, investor-share funds for Vanguard typically have a $3,000 minimum requirement whereas admiral-share funds have a minimum requirement of $10,000.
So depending on your situation, you can go with a provider like Schwab, where there are funds that start with a minimum of $100.
What Kind of Percentage Allocation Should I Go With for Each Fund?
Another question that’ll inevitably come up is how much of what?
So what percentage of my portfolio should consist of domestic stocks vs. international?
Or how much in stocks/equities vs. bonds vs. cash-equivalents?
This is called asset allocation. And it differs for everyone because everyone’s financial situation, needs, appetite for risk, and desires are different.
Some popular allocations are 60/40 (so 60% stocks and 40% bonds), or 50/50 (50% stocks and 50% bonds).
And the percentage of US stocks vs. International varies for everyone as well. Some go all US, with no international. Whereas some people tilt International due to global valuations (as of the time I’m writing this, the US has way higher valuations than International, and out of the international markets, Emerging Markets has the lowest valuations).
General rule of thumb, the more risk-averse you are, you should have more bonds than stocks.
But there is a trade-off because stocks historically have had higher returns than bonds. There’s a quote I heard somewhere that went something like this: “stocks will help you eat, and bonds will help you sleep.”
What Type of Investment Vehicle Should I Prioritize, It’s All So Confusing! 401K or IRA, or What?
Here’s my preference:
1. 401(k) up to your company match (if available at your employer – max this out for both you and your spouse, if applicable)
2. HSA to max (if available at your employer)
3. Roth IRA to max (if your income is within Roth IRA parameters – max this out for both you and your spouse, if applicable)
4. 401(k) to max
5. Taxable (invest in a taxable account only after you max out all of your available tax shelters)
One big thing you should consider when investing, is to make automatic contributions set up, so that you’re not tempted to use your money when your paycheck hits your bank account. It’s really important that you “pay yourself” first! Rather than consuming your hard-earned money.
Start Investing ASAP! Create that Money Snowball!!
If you haven’t read my older article about the “Money Snowball Effect” you should check it out. The concept is simple. Just like creating a snowball and rolling it down the hill.
Everyone needs to create a “money” snow ball that they can “roll down the hill”, so at some point the snowball gets large enough that it tumbles down the hill on its’ own. Even without your help.
In other words, you need to amass enough income-producing assets to get to a point where your assets make more money, by itself, than you can ever make by working a 9-5 job.
Related: The Money Snowball Effect
The Wall Street Journal – Why Critics of Passive Investing Are Wrong
Investopedia – Passive Investing
What are your thoughts on passive investing vs. active investing? Which camp do you fall under? Do you have any personal horror stories from failed experiments/investments? Share in the comments below!