Last time we said that idle money loses value, so you need to put it to work. That’s why you invest, so your savings will grow in value over time. At today’s rates, the traditional safe methods, bank savings accounts, CDs, and money markets, offer negative real (after subtracting inflation) returns. In order to put your money to work, you need to invest it in the financial markets.
If investing in the financial markets gives you pause, well, it should. It’s a risky business. Last time we discussed the need to determine the amount of risk you can afford based on where you are on life’s path and the personal factors affecting your income, expenses, and savings. These are deeply personal considerations, and vary a great deal from person to person.
As a result, there is no one-size-fits-all method for prudent investing in the markets. Even a ‘spectrum’ of investment choices begs serious personal questions. The analysis of an individual’s own personal situation and best interests is a basic principle of ethical financial planning and investment advice. That analysis defines the goals and the risk you can afford to reach them, which in turn shapes your personal investment strategy.
With that in mind, here are some of the considerations that affect a prudent investing strategy during various stages of life.
Early Career (10-15 years)
If you’re just starting out in your career, time is on your side. Which is a good thing, since at this point you probably have more human than financial capital. For the first 10-15 years of your career, focus on savings. Save and keep saving more. After awhile, you’ll start to have enough that how you invest begins to make a difference.
Meanwhile, do the smart things: Have savings deducted from your paycheck before you can spend it. Fully fund any employer matching amounts in any sponsored plans for which you are eligible.
In addition, contribute up to the allowable combined limit in a Roth IRA, unless the sponsored plan also is a Roth plan and offers low-cost index funds for investing. Finally, split your deposits 75/25 between a total stock market fund (VTI) and a corporate bond fund (LQD). Typically, you can afford the risk of a heavy stock allocation early in your career.
These sheltered funds are the foundation of your retirement savings. Aside from incurring a 10% penalty, don’t touch them. That comes later, much later, after they’ve had decades to compound and grow.
Early on, you don’t need too fine a point on it, though the allocation could vary depending on circumstance, 75/25, 60/40, 50/50, 40/60. And the choice of bond fund—total bond market (BND), TIPs (TIP), corporate (LQD), or high-yield corporate (HYG)—might also vary. All that will come in time as your account grows in value and other parts of your financial life come into focus.
Mid-Career (20-25 years)
It doesn’t take long for life to get complicated. And much more expensive. You marry, start a family—$$$. You need a bigger place—$$$. Add a car, or two, since the bigger place is farther from work—$$$. You get better at what you do, you get promoted, some raises, a bonus now and then, maybe options—now you have more $$$ to manage.
Junior starts school, then dancing lessons, golf lessons, math tutoring, soccer travel league fees, and you’re lucky if it’s just four things. High school comes along. Another car and cell phone. And you’ve been saving in a 529 plan for college tuition, right?
This is maybe the busiest and most complicated time of your life. Financial planning and investing strategy become both uniquely personal and critical for maxing your resources and avoiding costly missteps.
Be well insured with term life, liability and disability plans. Be cautious about expensive enthusiasms like owning aircraft and boats. Avoid debt and divorce!
If you own your own business, set up a tax deferred plan and contribute to the max. Unless you have a C-Corp, Uncle Sam will tax your company’s profits personally each year, so get him to contribute to your retirement fund via a tax deduction. For mom and pops, you can put away up to $50k a year through an Individual (Uni-K) 401(k). If you have a bigger small business, a Simple IRA or SEP-IRA plan may be appropriate. Don’t neglect this important benefit of having your own business.
Along with the tax deferred plan, split your allowable contributions into a tax-free Roth plan, and, if possible, invest in an after-tax long-term account as well. Having investments in all three tax statuses provides distribution options in retirement that can lower your taxes then, enhancing your available income.
A basic 60/40 diversified multi-asset allocation like this is a starting point for long-term accounts:
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The planning and portfolio tools that I or any competent, objective planner use allow us to shape this kind of basic portfolio into a personalized, efficient (low-cost) investment strategy that closely aligns with your situation and goals at the risk level you can afford.
Note that the portfolio consists of low-cost exchanged traded funds (ETFs), which are baskets of stocks or bonds that trade like single shares of stock, at a fraction of the expense ratio of traditional mutual funds. There are now over 1,200 ETFs available that slice the financial markets in every conceivable way, while spreading risk across hundreds of individual securities.
Using different ETFs (slices of the market) in varying combinations, I can design a portfolio that is well-suited to your individual financial situation. I’ll leave the discussion of managing risk and return and portfolio strategy for later posts.
Once your portfolio is in place, you should rebalance it periodically. This is harder for many to do than it sounds, since it means selling those assets that have appreciated and buying those that have lagged. Although this is the formula for the classic “buy low, sell high” dictum, many find it hard to sell ‘winners’ and buy ‘losers.’ But today’s loser is tomorrow’s winner and visa versa, so rebalancing allows you to take advantage of market cycles over time while maintaining the same balance of risk in your holdings. There are many strategies for rebalancing, including allocating new contributions into lagging assets—another good topic for a future post. Also, this is one way a good investment manager can add value to your account.
Also note that real estate is a key diversifier in an investment strategy. If you don’t own a house, you might need to increase the weight of real estate in your portfolio. And now is a great time to buy a house, at prices well below recent highs and with historic low mortgage rates.
This period of your life is the accumulation phase. It’s the critical period in which you build your life’s savings on top of the foundation you started in your early career years. Your success in managing your savings and investments during this period will have a large impact on your lifestyle in your retirement years.
If you haven’t been as successful organizing your savings and investments as you would like, it’s never too late to get started or to change your approach! Contact me to discuss further.
Next time, the most conservative period of your life, the pre-retirement years.
Disclosure: The author is long VTI, VGK, EPP, and DEM.