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Investing Basics: A most concise guide

2018-07-04, Michael Thompson

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Investing Basics: A most concise guide

This article explains what you need to know to get started investing. It has been made as concise as possible. Links are given where you may want additional information.

Foreword

There's no single investment portfolio (set of assets) that's best for everyone. One reason is that people have different goals: one person may need to always have 95% of their initial investment available for an emergency scenario, while another is willing to risk big losses for a chance to double her money in 5 years. Neither person is right or wrong, they just have different goals and situations.

How much should I invest?

A commonly accepted rule for the average working person is to save about 15% of every paycheck for retirement. This is assuming you start investing in your mid 20s and want a comparable amount of disposable income during retirement. Click here for more information about how much to save for retirement. It's also recommended to have an “emergency stash” (in additional to above) to cover yourself from an unexpected event (e.g. car repair, loss of job for 4-12 months, medical issue). Don’t forget savings for other needs or desires (e.g. kids’ education, house down payment).

What should I invest in?

The table below summarizes asset classes (types of things you can invest in) used by the most renowned investors in the world including the percentage of money said investors place in these classes and specific funds recommended. Notice the huge variation in the left column -- even the top few investors have vastly different goals and opinions. Experts recommend shifting your portfolio towards more conservative investments as you approach times when you'll need to withdraw/use the funds (e.g. retirement). This reduces the risk of withdrawing an oversized percentage of your investment at a loss (e.g. selling stocks at the bottom of a recession, read more here). Notice that cash is not listed – most experts agree that holding excessive cash is an almost guaranteed way to fall behind long term. Within each asset class (row in the table), diversification is always recommended. E.g. savings in US stocks shouldn’t be in just one or a few companies (or even industries). This is easy to achieve with low cost index funds like the ones listed in the rightmost column.

Percent of total investmentAsset classRecommended fund
20 to 90*US StockVTI
10 to 50International StockVXUS
0 to 35Long term US treasury bonds (20yrs+)VUSTX
0 to 25Real estateVNQ
0 to 15Intermediate term US treasury bonds (7-10 yrs)FIBAX
0 to 15US Treasury inflation protected bonds (TIPS)VTIP
0 to 10GoldIAU
0 to 8CommoditiesGSG
0 to 3CryptocurrencyBitcoin

*Warren Buffett and Jack Bogle recommend investing up to 90% in the S&P 500, while Ray Dalio and David Swensen recommend as little as 20% for reduced volatility.

How do I get my money into these investments?

Please see our quick start guide for more information about getting your money invested. We recommend using Vanguard if you plan to passively invest in Vanguard funds (Jack Bogle and Warren Buffett recommend this approach). As covered in our quick start guide, you'll start by creating an account with one of these brokerages and then wiring money to them from your bank account.

Anything I should do with my current employers 401k?

If your employer matches a reasonable percentage of your 401K contributions (over 25%), most experts recommend taking full advantage of that. A 401K (and IRA) has the added benefit of reducing your taxes - the IRS removes your traditional 401K contribution from your income when computing your taxes! We recommend setting aside a few hours to investigate the investment options (mutual funds) available in your 401K, along with the expense ratio of each. High expense ratios (over about 0.5%) typically lead to subpar performance. See the first table here regarding the impact of seemingly small expense ratios over time. We recommend passively managed index funds (e.g. VOO and VTI have a 0.03% expense ratio). You may want to redistribute the money in your 401k to different funds, but beware of transaction fees too!

Who to go to for help.

Experts recommend consulting a fiduciary financial advisor. You may have to pay a bit more to get a fiduciary (as opposed to a non-fiduciary advisor), but experts highly recommend this to ensure your advisor is looking out for your best interests. Click here for more information about the differences.

Other notes from the experts.

  • Roth IRA or 401K. Roth accounts (IRA or 401k) are an alternative to traditional IRAs and 401ks. The difference is the way they are taxed. A Roth is taxed on the initial investment, at the time the investment is made. You pay no taxes when you withdraw money during retirement. Traditional 401Ks and IRAs are taxed when the money is withdrawn (no taxes until then). Although no one is sure, most experts expect taxes to increase significantly in the future, which could make a Roth a better option.
  • Jumping in. If you’ve been saving cash, the thought of suddenly investing it all and then experiencing e.g. a stock market crash is daunting. This prevents some people from investing. Experts agree that holding too much cash is the most likely way to fall behind financially, long term. One strategy to avert this fear is to gradually invest the money over time (e.g. see dollar-cost averaging).
  • Life insurance. Surprising to some, life insurance can be a good deal, primarily due to tax breaks. Money invested in these policies can be invested, grown, and withdrawn tax free (no taxes at any step). However, one must be careful to select a beneficial policy. Policies from not for profit organizations like TIAA-CREF are recommended.

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