Whew! Writing a guide to saving $40,000 sure sounds like a tall order …
… but it’s not. It’s shockingly simple.
The truth about investing is that it’s not hard or complicated — unless you want it to be.
Sure, you could delude yourself into believing that you’re going to “beat the market.”
You could devote your days to pouring over SEC filings and reports, analyzing debt-to-asset ratios, and comparing the 12-month trailing P/E to the increase in dividends paid each quarter …
(Eyes glaze over).
… but if you go this route:
- You’ll take larger risks
- You’ll be unlikely (over the long run) to make better returns than the market average
It’s a lose-lose-lose situation.
Which makes my job simple: to teach you the most critical basics, so your money can make money.
Then you can move on to more important things in your life.
Divide Your Money Between Stocks and Bonds According to Your Age.
Here’s a simple rule of thumb:
110 minus your age = the percentage of your portfolio that should be in stocks.
If you’re 35, this means 110-35= 75% of your portfolio in stocks, and 25% in bonds.
If you have a high risk tolerance, increase that to number to 120 minus your age. If you’re 35 and you have the stomach to withstand more volatile returns, and you’re 35 years old, put 120-35 = 85% of your portfolio in stocks, and 15% in bonds.
If your risk tolerance is low, drop the number to 100. If you’re 35, 100-35 = 65% of your portfolio goes to stocks, and the rest to bonds.
Figure out your risk tolerance here: Take this quiz.
Avoid Individual Stocks
Remember that nonsense I was babbling about in the intro … SEC filings, debt-to-asset ratios?
Yeah, I’m trying to forget it too.
Avoid buying individual stocks (Apple, Google) unless you’re willing to spend your Saturday afternoon researching that information.
When I tell you to “buy stocks,” I don’t mean individual stocks … I mean baskets of stocks, such as mutual funds, index funds, or ETFs.
Which leads perfectly to my next point …
Avoid High-Fee Funds.
Pop quiz: What’s one of the biggest investment mistakes investors make?
Answer: Ignoring the fees associated with a mutual fund.
This money silently, quietly seeps out of your portfolio. You never get a bill in the mail. You never pay it upfront. And so you never realize just how many thousands of dollars you pay for a high-fee fund vs. a low-fee fund.
Scenario 1: Let’s say you have $50,000 to invest in your account. You put it in a mutual fund and leave it there for 20 years. But you don’t check the “expense ratio” (a fancy word for “fee”), and as a result, you’re in a fund that charges a 1.19 percent fee — the industry average, according to Vanguard.
At the end of 20 years, you’ve paid a whopping $49,621 in fees.
Look closely at that number — that’s almost the same amount you invested to begin with!! (But you don’t know you’re losing it, because you never have to write a check … this fee is just silently, quietly deducted from your overall portfolio, in small amounts at a time.)
Scenario 2: Now, let’s say you have $50,000 in your account. You put it in a mutual fund and leave it there for 20 years. You DO check the “expense ratio” and find a fund that charges only a 0.23 percent fee.
After 20 years, you’ve paid $10,489 in fees. You’ve saved $39,132.
Stick with Passively-Managed Funds, not Actively-Managed Funds.
There are two types of mutual funds: active and passive.
An active fund is managed by a group of (usually) Ivy League MBA’s who have convinced themselves that they can do what no human being has ever done: consistently beat the broad market average.
In fact, active fund managers are so convinced that they’re smarter, stronger and better than everyone else they’ll charge you a hefty premium to manage your money. (This is where the high fee comes from).
Then — this is where it becomes a horrible deal for you — they collect their hefty premium whether or not they actually beat the market average.
(And, statistically, they don’t).
Put your cash in a passively-managed mutual fund. This is a fund that tracks a broad market — like the Total World Stock Market, or the S&P 500, or the Russell 2000 — without charging you high fees.
What’s an Index Fund?
The king of all passively-managed mutual funds are called Index Funds.
Index funds track an index within the market and deliver returns that mimic the overall market performance.
“They do wha??”
They make sure that your investments perform AS WELL as the overall stock market. No better, no worse.
“Cool, got it. Thanks!”
Want to invest in the entire U.S. stock market at once? There’s an index fund for that. Want to invest in the entire globe? There’s an index for that too. How about investing in the small companies of the U.S.? Yep, there’s an index for that.
If you’re invested in a U.S. stock market index fund, and the U.S. market rises 8 percent, your portfolio rises 8 percent.
With one caveat, of course. You’ll have to subtract a small fee.
This fee — the “expense ratio” can be anywhere between 0.05 percent to 0.20 percent.
Sound bad? No one likes these. But 0.05 percent is much better than paying those hefty 1.01 percent fees that actively-managed funds charge.
What’s an ETF?
Index Funds became so popular that they spawned Exchange-Traded Funds, or ETFs.
This type of fund has grown more in popularity over the last decade than any other fund.
It’s done so for good reason: functionally, it does exactly what an Index Fund does (track a broad index of the market), only it has even lower fees than index funds.
Better yet, ETFs have no minimum requirement (if it’s trading at $25 per share, and all you have is $25, you can buy one share). Index funds, by contrast, have a minimum requirement to get started — usually around $2,000.
The low fees, and the lack of a minimum opening amount, is because ETFs are technically not mutual funds — they’re registered, under the SEC, as baskets of stocks that can be traded real-time throughout the day.
This means that day-traders out there are buying and selling ETFs multiple times a day, hoping to “beat the market” (the greatest delusion in the history of Wall Street).
Those guys who are day-trading, paying fees and commissions with every transaction, subsidize ETFs for the rest of us. That’s why ETF’s have the lowest fees of all. Thanks, dudes!
Here’s the takeaway lesson: The best way to invest in the market is to buy commission-free ETFs. These have low expense ratios, they perform at the market average, and they’re free to buy and sell.
Which ETFs Should I Buy?
This brings us to the topic of asset allocation (otherwise known as “The ONE Thing You Should Know In Order to Get Filthy Rich.”) Click that link to read more …