Chapter 10
Keeping it simple: Considerations
and tools
Simple is good. Simple is easier. Simple is more profitable.
That’s a key mantra of this book and what I’m going to share with you in these next couple of chapters is the soul of simplicity. With it, you’ll learn all you need to know to produce better investment results than at least 82% (per the Vanguard Study referenced in Chapter 8) of the professionals and active amateurs out there. It will take almost none of your time and you can focus on all the other things that make your life rich and beautiful.
How can this be? Isn’t investing complicated? Don’t I need
professionals to guide me?
No and no.
Since the days of Babylon people have been coming up with investments, mostly to sell to other people. There is a strong financial incentive to make these investments complex and mysterious.
But the simple truth is this: the more complex an investment is, the less likely it is to be profitable. Index funds outperform actively managed funds in large part simply because actively managed funds require expensive active managers. Not only are they prone to making investing mistakes, their fees are a continual performance drag on the portfolio.
But they are very profitable for the companies that run them, and as such are heavily promoted. Of course, those profits and promotional costs arise from all those juicy fees that come directly out of your pocket.
Not only do you not need complex investments for success, they actually work against you. At best they are costly. At worst, they are a cesspool of swindlers. They are not worth your time. We can do better.
Here’s all you are going to need: Three considerations and three tools.
The Three Considerations
You’ll want to consider:
In what stage of your investing life are you? The Wealth Accumulation Stage or the Wealth Preservation Stage? Or perhaps a blend of the two?
What level of risk do you find acceptable?
Is your investment horizon long-term or short-term?
As you’ve surely noticed, these three are closely linked. Your level of risk will vary with your investment horizon. Both will tilt the direction of your investing stage. All three will be linked to your current employment and future plans. Only you can make these decisions, but let me offer a couple of guiding thoughts.
Safety is a bit of an illusion.
There is no risk-free investment. Once you begin to accumulate wealth, risk is a fact of life. You can’t avoid it, you only get to choose what kind. Don’t let anyone tell you differently. If you bury your cash in the backyard (or in an FDIC insured bank account at today’s near zero interest rates) and dig it up 20 years from now, you’ll still have the same amount of money. But even modest inflation levels will have drastically reduced its spending power. If you invest in stocks, you’ll likely outpace inflation and build wealth but you’ll have to endure a volatile ride.
Your stage is not necessarily linked to your age.
The Wealth Accumulation Stage comes while you are working, saving and adding money to your investments. The Wealth Preservation Stage comes once your earned income slows or ends. Your investments are then left to grow and/or are called upon to provide income for you.
You might be planning to retire early. You might be worried about your job. You might be taking a sabbatical. You might be accepting a lower paid position to follow a dream. You might be launching a new business. You might be returning to the workforce after several years of retirement. Your life stages may well shift several times over the course of your life. Your investment stage can easily shift with them.
F-You Money is critical.
If you don’t yet have yours, I suggest you start building it now. It is never too late to start. Be persistent. Life is uncertain. The job you have and love today can disappear tomorrow. Remember that nothing money can buy is more important than your fiscal freedom. In this modern world of ours, no tool is more important.
Don’t be too quick to think short term.
Most of us are, or should be, long-term investors. The typical investment advisor’s rule of thumb is: Subtract your age from 100 (or more aggressively 120). The result is the percentage of your portfolio that should be in stocks. A 60-year-old should, by this calculation, have 40% (or 60%) in stocks and 60% (or 40%) in conservative, wealth preserving bonds.
Nonsense.
Here’s the problem. Even modest inflation destroys the value of bonds over time and bonds can’t offer the compensating growth potential of stocks.
If you are just starting out at age 20 you are looking at perhaps 80 years of investing. Maybe even a century if life expectancies continue to expand.
Even at 60 and in good health you could easily be looking at another 30 years. That’s long term in my book.
Perhaps you have a younger spouse. Or maybe you want to leave some money to your kids, grandkids or to a charity. All will have their own long term horizons.
The Three Tools
Once you’ve sorted through your three considerations, you are ready to build your portfolio and you’ll need only these three tools to do it. See, I promised this would be simple!
1. Stocks: VTSAX (Vanguard Total Stock Market Index Fund). Stocks provide the best returns over time and serve as our inflation hedge. This is our core wealth-building tool. (See Chapter 17 for variants of this same fund.)
2. Bonds: VBTLX (Vanguard Total Bond Market Index Fund). Bonds provide income, tend to smooth out the rough ride of stocks and serve as our deflation hedge.
3. Cash. Cash is good to have around to cover routine expenses and to meet emergencies. Cash is also king during times of deflation. The more prices drop, the more your cash can buy. But when prices rise (inflation), its value steadily erodes. In these days of low interest rates, idle cash doesn’t have much earning potential. I suggest you keep as little as possible on hand, consistent with your needs and comfort level.
We used to keep ours in VMMXX (Vanguard Prime Money Market Fund). At the time interest rates were higher and money market funds typically offered better interest rates than bank savings accounts. But with interest rates currently at historic lows, money market funds pay close to zero percent. Bank interest rates are now slightly higher. Plus they come with FDIC insurance on accounts up to $250,000.
For these reasons, we now keep our cash in our local bank and in our online bank, which happens to be Ally. Should interest rates rise and money market funds again offer better rates, we’ll switch back.
So that’s it. Three simple tools. Two index mutual funds and a money market and/or bank account. A wealth-builder, an inflation hedge, a deflation hedge and cash for daily needs and emergencies. As promised, it’s low cost, effective, diversified and simple.
You can fine-tune your allocation in each investment to meet your own personal considerations. Want a smoother ride? Willing to accept a lower long-term return and slower wealth accumulation? Just increase the percentage in VBTLX and/or cash. Want maximum growth potential? Hold more in VTSAX.
In the coming chapters, we’ll talk about index funds and bonds. Then we’ll explore a couple of specific strategies and portfolios to get you started, and take a look at how to select the asset allocation best suited to your needs and temperament.