Part IV. Investing
Once you've started saving some money, you might start to wonder how you should invest those savings. And that's the topic that this page is all about.
First things first...
Before I jump into the nitty gritty of investments, I do want to revisit my belief that you should only begin investing once you've established a strong personal financial foundation for yourself. I describe that foundation in more detail on the main page, but it especially includes having established an emergency fund as well as having certain core insurance policies in place.
The (perhaps surprising) topic not covered on this page.
One more thing before the investments nitty gritty, and this one might surprise you. What you won't find on this page are a discussion of retirement plans (such as a 401(k) or IRA), or other specific investment vehicles such as 529 plans or Health Savings Accounts. Why? Because those are all vehicles which hold investments within them. They are not the investments themselves. With a few nuances, any prudent investment can be made within any of those different vehicles.
What this page covers is formulating a prudent investment approach, which can then be implemented within whatever investment vehicle you choose. The Personal Balance Sheet Page covers all the important details of the different vehicles you can use to house your investments (including retirement plans).
Alright, so with that out of the way, you're ready to start making some smart and effective investments!
But wait... what are your goals?
Ok, I'm sorry but I lied. You're not quite ready to start investing. Why? Because first I want you to get clear about your why. Why are you investing?
Of course everyone has some goal in mind when they invest in the stock market. But I often find that goal is not quite specific enough. Now you might thinking, "I mean come on... isn't the goal obvious? You invest money to make more money! Duh."
And yes, of course that is true. We want the money we invest to turn into more money. But more money is never an end in and of itself. Having more money is simply a means to facilitate something happening in your life. What is your actual, real-world goal? What do you want to be able to create? What do you want to be able to do? Enjoy a secure retirement? Fund your children's college education? Put a downpayment on a house? Ok, now we're getting somewhere.
What's the big deal about goal setting?
In the realm of investing, specific goal setting provides us with two critical inputs. First, a specific goal tells us how much money you'll need in the future to accomplish it. And second, specific goals tell us how long you have to reach that goal. We call that your investing time horizon.
Together, these two inputs tell us how much you'll need to save along the way to reach your goal. They also help us determine the risk level (and corresponding asset allocation) appropriate to help you achieve your goals.
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Where do you want to focus your efforts?
Investing requires two different areas of work. First, you need to establish a plan. Behind that plan is a guiding framework, or philosophy. Second, you need to implement, or execute, that plan.
The way I look at it, you're going to have to do a little bit of hard work in one of those two arenas.
You can develop a quick and easy framework around investing and then have to do a TON of work implementing that plan. OR... you can burn some calories developing (or coming to understand) a more sophisticated and nuanced investment framework. And then enjoy an easy and low-effort implementation of that more sophisticated philosophy.
Like everything in personal finance, the choice is yours. (Remember how I've said personal finance is just that, persona? Well, it's true!)
That said, I believe the right choice for virtually everyone will be to adopt a more sophisticated investment framework and then take a pretty relaxed approach to implementation. Especially in the area of investing, I believe it's important to be evidence-based and data driven. And the evidence and data is clear that passive, diversified, low-cost and tax-efficient investing is what drives long-term investing success.
OMG, what ARE all those terms? Learning what's behind those terms is the work I was talking about. Once you understand them, implementing the plan is pretty easy.
Click on the orange section headings to expand
Investing should be kept really simple. Why? Well, because simplicity is easy. It requires you to burn less calories and simply spend less time obsessing about your investments in general. Oh, and another reason simple investing is cool is because that's the method that yields the best investment returns.
The data are really unambiguous about this. Actively managing your investing by trying to find the right time to move in and out of the stock market, or to pick specific companies that are "sure" to outperform in the coming months.... it just doesn't work. Sure, people get lucky from time to time, and there will always be a few money mangers who beat overall market returns for short periods of time. But over the long-term? Those active managers virtually never keep up with the returns provided by simply buying and holding a broadly diversified mutual fund (or ETF).
What Simple Investing Looks Like
Simple investing might not (at least at first glance) look all that simple to you. But it is as simple as possible. I have links in the Implementation & Resources sections just below which will help you actually implement this "simple" strategy - it's not as daunting as it might seem at first glance.
So let's break down the four key components of a simple, boring and effective investing strategy: passive, diversified, low-cost and tax-efficient.
Investing strategy can either be active or passive. Active investors are investment managers who believe they know what company's stock to buy, or sector to invest in at this particular time. They believe they know when to move money into and out of the market (e.g. they time the market). The data are clear that active management produces sub-par investment returns over the long-term. In contrast, passive investing acknowledges that active investing doesn't work and says "well, if we can't beat 'em, join 'em." And the 'em in that sentence is the overall market. The return of the overall market is usually better than active managers (again, over the long-term). So passive managers just say, screw it, let's just mimic the overall market in our portfolio and be happy with those returns. Because market returns have been pretty darn good over the long-term. So let's not be greedy.
Diversified means that we hold a wide variety of stocks and bonds. And we actually hold such a wide variety that we're basically replicating the overall market within our portfolio. We don't take big, out-sized positions in specific companies. Why? Because no one can predict the future with precision and we have no clue if those individual companies will outperform, or underperform, the overall market. By making our portfolio look quite similar to the overall market, we'll be happy with market-level returns. If you want to learn more about the academic research and theory underpinning this approach, check out the Resources section below.
One of the many benefits of this passive and diversified approach is that it's low cost. As I've mentioned, the implementation of this strategy is not a ton of work. Hence, you don't have to pay a bunch of professional money mangers a lot of money to do that work. That means that the internal fund costs (often known as an expense ratio) will be quite low. Good mutual funds have expense ratios well below 1%. In contrast, actively managed funds can often have expense ratios well over 1%. This expense is actually baked into the price of the mutual fund (or ETF) so you don't really ever see it clearly. But it is there. And high expenses will aggressively eat away at your returns over time, which is a real bummer.
If you're following an active management strategy, you're buying and selling stocks and getting in and out of the market all the time. You could either do that yourself, or purchase an actively managed mutual fund or ETF which would actively trade on your behalf. Either way, you'll be incurring a ton of taxable events along the way and have to pay additional tax when you file your tax return each spring. In contrast, passive and diversified funds don't buy and sell holdings frequently, so there are far fewer taxable events. This is an admittedly complex concept, but it is important. Paying taxes along the way quickly eats into your long-term investment performance.
Well, call me a cynic, but I believe the reason is money. A large chunk of the investments industry profits off telling you an (admittedly compelling) story about how the investment world is complex and fraught with risk and the Only Way to successfully navigate that world is with their sophisticated investing strategies and expert guidance.
And I mean, the first part is true. The investing world is complex and full of risk. But you don't need their fancy (and expensive) investments to navigate it. You just need to purchase a boring, well-diversified portfolio. That's not a very sexy story is it? High-priced active investment managers can tell very lovely stories about their superior solutions, and they might even believe it themselves. But the data isn't on their side.
The other big industry that benefits by making the world of investing seem complex and scary is the media. I know blaming the media is all the rage lately, and not all financial media coverage is evil. But we have to remember how the media makes money. They make money through advertising. And what is important to advertisers? Attention (and eyeballs on their ads).
How does the media grab your attention? With emotional appeals. Fear, greed, panic, outrage - these are the emotional hooks the media often employ. Are those the type of emotions that are pleasant to experience? Not particularly. Are those the types of emotions that are useful when investing? Again, no.
Do I sound paranoid? I dunno. But I do know that Margo Aaron wrote a brilliant essay talking about how this all plays out.
So take all the information you hear about investing with a grain of salt. What incentives do they have. And how can they know what they profess to know?
If all of the information on this page feels too boring and or overwhelming, I feel you. You don't really need to understand all the arguments I'm making on this page. I've basically provided a long argument why you should buy boring, low-cost and tax efficient index funds. If you're already on board with that approach, awesome, let's jump in to execution.
Ok, but how and where do I actually invest?
There are many good investment options out there that meet all the criteria I've been talking about. I'm not going to go through all of them. I'll just share with you the two resources that I tell my friends to use: Vanguard and Betterment.
To the best of my knowledge, Vanguard was the first mutual fund manager to advocate investing in broadly diversified, low cost and tax-efficient index funds. Investing directly through them is super inexpensive and easy. Do they have great customer-facing technology? They do not. Can their websites be a bit confusing to navigate? They can. Will you get really solid investment products? You will.
What funds should you use? Well, the easiest thing is to use target date funds. What is a target date fund? Here's a good overview article from NerdWallet. I like NerdWallet's overview here, but I would caution you that I don't really like all of their alleged "best target date funds" - many of them have hidden fees and other BS. So here's an overview of the different Vanguard Target Retirement Funds. (And as always, these are NOT affiliate links - I get no kickback from Vanguard for pointing you there. I just think they offer one of the best solutions. I never earn any money from recommending a specific product or service - that's part of my fiduciary oath.)
Is a target fund the best solution for you? Probably not. But is it more than good enough? I suspect it is. There really is no such thing as "perfect" in investing. Rather, it's about getting things good enough. As in all areas of financial planning, implementing a very imperfect plan that's supported by a good and well thought-out foundation is so much better than no plan at all. (And my goal with this guide is to give you that well thought-out foundation!)
If you want to get a bit more bespoke with your portfolio construction, you can also build a simple 3 fund portfolio. What the heck is the basic three fund portfolio? Here's a good overview. Also, you can find a wealth of great information on the Bogleheads Wiki. What's a Boglehead? They're the fan club for the founder of Vanguard, Jack Bogle. They are a very active community of DIY investors, who for the most part share good advice. It's a very supportive community, so check it out if you're up for discussing the more technical side of investing.
You might also want to check out the books I recommend below in the Resources section.
If all that sounds too complicated, I suggest considering Betterment.
If you're looking for a technology-enabled experience that will walk you through setting up different goals and then investing in an appropriate manner for each, Betterment is an excellent option. Betterment allows you to plug in a wide range of different mutual funds and ETFs into their system. And good news - Vanguard is one of them! So Vanguard would be my pick (since it's the one I'm familiar with).
(And again, these are NOT affiliate links - I get no kickback from Betterment for pointing you there. I never earn any money from recommending a specific product or service - that's part of my fiduciary oath.)
Are there any other good options besides Vanguard & Betterment?
I mean, yes there are. There are many other good and trustworthy options out there. But I'm just not familiar enough with all of them to recommend them. Is it possible that some of them are better than Vanguard funds? Sure. Better enough that it would make a big difference? I seriously doubt it.
The only way you could get a much better outcome is to bet on a few stocks that turn out to be the next Google or Facebook or Tesla or whatever. But that's not investing in my mind, that's gambling. Sure, it could work out great... but there's a better chance it'll work out quite poorly.
Great question, glad you asked. I have hired my own financial planner, Scott Frank (no relation) at Stone Steps Financial. He has me invested in a portfolio of Dimensional Fund Advisors (aka DFA) investments. Prior to working with Scott, I used the three fund portfolio approach through Vanguard.
Why did I switch to DFA funds? I believe they offer a small but meaningful improvement over Vanguard. Is that improvement going to change my life? No, but a small improvement is worth it to me.
I also use DFA funds with my clients. DFA funds are only available if you're working through an investment professional, making Vanguard an excellent alternative for the DIY route.
What I usually recommend is to purchase diversified investments over time, something called dollar cost averaging (or DCA for short because of corse there has to be an abbreviation).
If you have a larger amount of cash to invest, you could set up a program to invest a certain amount of that lump sum over time (say each month for 12 months) - which this is just dollar cost averaging again.
Or you could invest it all at one time (that's called lump sum investing). The "invest it all at one time" approach probably feels more risky and uncomfortable, but the data show that lump sum investing usually performs just as well as (and often better than) investing that lump sum in small chunks over time. I suggest that you do what feels most comfortable to you. As they say in AA, easy does it... but do it!
But what if stocks are at All Time Highs?!
Should you still be buying investments when everyone is worried that stocks are too high and ripe for a fall? I believe the answer is yes.
The fact is no one knows when the stock market will crash or rocket, despite what they say. Stocks may indeed be overvalued, but they could still go up another 20% (I'm making that number up), before crashing back 15% (also making that number up). Or they may indeed crash tomorrow. Or they might not crash for several years. We don't know. No one knows. Some people think they know, but they don't know either.
The inability to know what the market will do means it's critical to understand the timing of your goals.
If you're investing for retirement 20 years from now, what happens in the next several months (or next several years) really doesn't matter very much. If you're investing for a house downpayment you'll need in the next twelve months, you're money shouldn't be in the stock market in the first place! In my opinion anyway.
There are a lot of great books out there providing solid investing advice. Unfortunately, for every solid investment book, there are probably 100 that offer terrible investing advice. And 100 might be a low estimate.
My Top Three Recommended Books
I'll give you my personal three recommended books if you want to learn more. There are other excellent books out there that are great, these are just the three I point people toward.
(The links below are to Amazon. I have mixed feelings about that. They're not affiliate links, but I do find that Amazon is easiest for many of us. But if you'd like to support your local bookseller - or anyone other than Amazon - I totally get that. Heck, you might even be able to get them from your local library. And did you know you can borrow electronic versions of books from most libraries? Until about a year ago, neither did I. It was mildly life-changing information.)
If you're looking for a great, general overview of how to manage your financial life and get started with investing, an easy and very approachable read is The Index Card: Why Personal Finance Doesn't Have to be Complicated.
If you want to go a bit deeper, especially on the investing side, I also love The Bogleheads' Guide to Investing. This book also provides a great overview of personal finance in general. WTF is a Boglehead? Read the book and you'll find out! You might even become one.
And if you really want to go deep into the academic underpinnings of sensible investing and Modern Portfolio Theory, check out A Random Walk Down Wall Street. While academic leaning, it's still quite readable.
Keen to read some blogs or listen to some pods?
Workable Wealth recently did a really excellent series presenting (in a very accessible way) the foundational knowledge to understand what this world of investing is all about:
Part One: What You Need to Know About the Market
Part Two: What Investment Strategies Should I Use?
Part Three: What’s in an Investment Portfolio?
Real Personal Finance Podcast Episodes
Better Investor Series: 10 Steps to Investment Success
Better Investor Series: Understanding Asset Allocation
What's the Best Investment Strategy for a 5-7 Year Timeframe?
Is Now a Good Time to Buy Stocks?
You may have been hearing quite a bit of chatter around Bitcoin and cryptocurrencies in general. In late 2020 and early 2021, Bitcoin hit some astronomical highs and many people started wondering if they should get in "before it's too late." (I have no idea what "before it's too late" really means in any area of life, but I guess it's what some people say.)
I don't know what will happen to the value of Bitcoin (and neither does anyone else despite what they might think) but an alternate asset like Bitcoin can have a place as a part of an overall diversified portfolio. Of course everyone's portfolio is different, but for most people if Bitcoin starts to be close to (or over) 10% of your portfolio, I'd consider diversifying.
I don't believe Bitcoin is a must-own asset. Yes, it could be the best returning asset of all time, or it might end up in the dust bin of history. Only time will tell.
Here are what some other financial planners have been saying about Bitcoin. And by the way, there are some solid financial planners out there who are huge proponents of Bitcoin. I just don't happen to be one of them.
Real Personal Finance Podcast: Should You Invest in Bitcoin?. This is what I would call a Bitcoin-neutral view which is similar to my perspective.
Money Owners Podcast: Bitcoin with Pierre Rochard. In contrast, this is a very Bitcoin-positive discussion. There are some great points made here although I can't say I'm entirely picking up every opinion Pierre is putting down. Worth a listen if you want to get into the nitty gritty.
Need a break? Do it! 🧘♀️
And if you're still raring to go... 🚀
Let's learn about Risk Management & Insurance!
Standard Not Advice Disclaimer
Just a friendly reminder that none of the information included anywhere in this guide is financial, legal or accounting advice. I don't know the specific financial circumstances of your life (or your private practice), so there's no way I can make blanket statements about what's right for you.
What I offer in this Guide is a suggestion on how you might think things through and then decide (for yourself) what's right.
For some topics, I've also included what I've learned works well for most people. But you're not most people, you're you. You might be in that minority where the general suggestions are the wrong approach.
Take everything said here (and anywhere else online) with a grain of salt, and seek out professional advice if you suspect you need it. Of course, I'm always happy to have a no cost introductory conversation with you to see if I can help.
I know this sounds like a legal CYA (that's cover your ass) statement. And yah, it is that. AND it's also an extension of loving kindness to you, the reader.
The way I cover my ass here is by making sure I don't encourage you to do anything that ends up causing you harm. I don't want that for you, and you don't want that for you. Take your time, think things through, be deliberate and seek out professional advice if you suspect you need it.