Over a quarter of my net worth is from investment growth and at least 15% is from real estate growth. So 40% of the wealth that allowed me to retire didn’t come from working and saving, it just came from taking some risk and letting my money work for me.
I already admitted I’m not an investing genius and I was my own worst enemy when I thought I was.
The most important thing with investing is to know yourself. What level of risk are you comfortable with? When will you need this money? How will you behave in a market downturn? There are lots of risk tolerance tools out there, this one from Vanguard is a good one. When you complete this questionnaire, be sure to think about how you will behave, not how you should behave.
So here’s a sad story. I have friends who were very successful small business owners. They sold their company and invested the proceeds with a reputable financial planner. I can only assume they discussed their risk tolerance with that planner. When the downturn in 2008 hit and the stock market lost over 31%, they sold their stock investments and moved to bonds. I don’t know exactly when they sold but the S&P 500 dropped to 800 that November, today it is at 2,159. They potentially missed the recovery and run up of 170%. Know thyself . . .
I rode out that downturn and many others because I subscribe to the Jim Collins decree that the market always goes up.
Do you need a financial advisor? Maybe.
Here’s my sad story. I engaged a financial planner and paid for a review of my investments about ten years ago. His $500 plan told me I needed to shift all of my investments to his more costly funds on which he would earn commissions. It clearly outlined in lovely charts and graphs that my investment earnings and risk would remain the same. Hmmm, thank goodness I didn’t implement that plan. Bye, bye $500.
I would use a fee only financial advisor if I needed help with something other than managing my investments. For instance, they can be great resources for finding insurance like long term care insurance or helping you figure out your risk tolerance and asset allocation.
Why wouldn’t I have a financial advisor manage my investments?
I need just as much education about investments to hire a financial advisor as I need to make my own investment decisions. Yes, you have to educate yourself about investing in order to hire a great advisor. You cannot hand over the reigns to your financial future to someone else and blindly go on your merry way. No one cares about your money as much as you do. Start here: Jim Collins’ stock series. This started out as letters to Jim’s daughter but ended up being turned into a book The Simple Path to Wealth.
The fees are just too high. A typical financial advisor charges 1% of your portfolio or places your portfolio in funds with fees that are 1% higher than you could get elsewhere. 1% doesn’t seem too bad right? But the S&P 500 has returned 10.125% over the past 30 years, your fees would be about 10% of your return. When you adjust the S&P 500 for inflation, the return is 6.94%, your fees would be about 15% of your return. A 1% difference in your return can equate to hundreds of thousands of dollars in lost wealth. Here’s another way to think about this 1%. If you invested with an advisor for 100 years (I recognize this is a stretch!), you would have paid her 100% of your investments.
How can I make investing easy?
If you know yourself and you are very comfortable with stock market risk, then you can follow Jim’s suggestions for investing. He recommends one bank account, one Vanguard bond index fund and one Vanguard stock index fund. What could be easier than that?
Most of my invested assets are in VTSAX, Jim’s recommended stock index fund. I have some other funds only because I would have to pay taxes on the gains if I sold them. I do make small moves with those investments every year or so if it makes sense. I try really hard to not chase trends, I do not try to time the market and I keep my investment expenses low. I don’t own bonds.
When does it make sense to change your investments?
If the expense ratio is high compared to other similar funds.
If that fund consistently (over 5 or 10 years) underperforms other funds with similar underlying investments
But pay attention to your tax impacts. Move your non taxable accounts (401k, IRA etc.) around at will but be careful with your taxable accounts or you’ll end up with a large tax bill.
What is timing the market and why is it a bad idea?
People who time the market try to sell when the market is high and buy when the market is low. That seems super smart, right? But I say try to because no one knows what the market is going to do. With market timing, you have to be right twice–at the sale and again at the purchase. Study after study proves that timing the market does not work. Timing the market does not work, time in the market does. Gosh I hope Mr. Ms. Liz reads this paragraph. . .
What does it mean to chase trends?
If each year I looked at the earnings on all mutual funds and moved my money to the one that had the highest earnings last year, I would likely be chasing a trend. Investments ebb and flow so one year real estate investment trusts may be “hot” and produce great returns and the next year it may be small companies or growth companies or Spanish companies or . . . Just like every mutual fund disclaimer, I’ve found that past performance doesn’t dictate future performance. I figure most of the money has already been made in that hot sector and I don’t chase it. So I don’t sell a fund just because the underlying investments are out of favor right now–I will sell a fund if it is underperforming other funds with the same underlying investments.
Why I don’t own bonds or bond funds in 2016.
Bonds are debts of companies or governments. You are loaning money to them and, in exchange, they pay you interest. The interest rate you receive typically stays the same throughout the life of the bond. As interest rates move up and down in the market, the value of your bond goes up and down. When interest rates rise, the value of your bond goes down because if you sold it, the buyer would need to earn a higher interest rate than you were earning or else she could go buy someone else’s bond at a higher rate.
With interest rates currently at historic lows, I believe there are significant risks in the bond market. A general rule of thumb is that for every 1% increase in interest rate, the value of the bond decreases 1% for every year of maturity. So if I paid $1,000 for a bond that matures in 10 years, my bond is worth only $900 if interest rates go up 1%. With bonds paying about 2% today, the potential decrease in bond value seems to me like significant risk without adequate reward. I prefer to invest almost fully in the stock market. I expect sometimes scary volatility but I expect to be rewarded for the risk I am taking.
All things worth doing require some work, investing is no different.
- Educate yourself.
- Decide, based on your timeframe and risk tolerance what your asset allocation should be (% bonds, % stock, % cash etc.).
- Rebalance to your asset allocation periodically (around annually) to your target allocation.
But, investing doesn’t need to take over your life.
- You do not need to watch CNN or pay attention to the various talking heads. I believe you are better off to ignore them. Investing is a long-term game, what is happening today doesn’t really matter in a time horizon of decades.
- You do not need to research individual stocks–low cost index funds work fine.
- You do not need to find the next hot fund–investing in low cost index funds will give you average returns. Average is good enough, below average is not.
It is probably impossible to achieve financial independence without investing.
Your investments can be in the stock market, a small business or rental real estate. Success in any of these require education and work–in my opinion, investing in the stock market is far easier than the alternatives.
Investing is risky, this reflects my opinion and is for informational purposes only. Proceed with caution, do your research and seek professional advice if necessary.