A number of people have asked me to share some different investment strategies for different life stages. What I’ll do is highlight the various investment strategies I think make sense for most people, discuss a couple more alternative investment strategies, and round up what strategy I think is most appropriate by life stage.
We all know that step one to building financial wealth starts with saving. What really widens the wealth gap over the years is HOW one invests. Before investing in anything, I encourage everyone to tell themselves five things out loud.
1) I will lose money.
2) I will feel like a complete idiot when I lose money.
3) Nothing goes up forever.
4) There are plenty of exogenous variables outside of my control.
5) No risk, no reward.
Now that you’re mentally set to invest your hard-earned savings in the stock market where one change in government law, a corrupt CEO, a terrorist attack, a natural disaster, or a declaration of war could instantly wipe out half your gains, let’s begin!
DIFFERENT INVESTMENT STRATEGIES FOR EVERYONE TO CONSIDER
1) Indexing. A simple, low-cost strategy where you pick a particular stock index to purchase through an ETF or mutual fund. The most common US index to follow is the S&P 500 index. You can buy the ETF, SPY or buy a Vanguard S&P 500 Index fund, VFINX. Given its been shown that active fund management can’t outperform their index benchmarks over the long-term, saving on fees through an ETF or index fund is a prudent way to go for everyone.
2) Smart Indexing. The S&P 500 is a market-cap weighted index. In other words, if we go through a three year bull market in technology, technology stocks will account for a greater weighting of the index than other sectors. This can be good for momentum investors, or bad as the tech sector tumbled by 80% in 2000, and the financial sector corrected by a similar amount in 2008-2009. Smart Indexing aims to keep all sector weightings equal, through constant rebalancing so that no one sector can dominate. I wrote an entire post about my discovery of Smart Indexing.
3) Target Date Funds. Target date funds are a smart invention by the money management industry that allows retail customers to allocate all their money into one specific target-date fund and forget about things until they reach that target date for retirement. For example, you could be 40 years old and have a target date to retire in 20 years. You’d therefore choose the XYZ 2034 Target Date Fund. The fund will already be diversified for you in terms of stocks and bonds. It’s up to you to read the fund prospectus and understand the allocations, holdings, and decision making process. You should also examine the fund for fees, as they will be much higher than index funds.
4) Actively Managed Funds. As a whole, actively managed funds underperform index funds. That said, there will certainly be long term winners who do outperform. Otherwise, there wouldn’t be titans in the money management industry like Capital, Fidelity, Wellington, Dodge & Cox, Oakmark, Artisan, and so forth. I used to cover many of these fund managers in my previous life-time, and am friends with many of them now. What you need to watch out for is Portfolio Manager turnover. You’re really betting on the money management skills of the portfolio manager and his/her analysts. Many of these large money management firms will lose their PMs and analysts to competitors, and try to utilize their existing brand to prevent defection. To see how actively managed funds are rated, pick up your latest Money Magazine issue and look to the back, or check out MorningStar, whose business is to rate all different types of funds for performance.
5) Combination Index + Actively Managed. In general, you shouldn’t really be thinking about how to beat the markets, because it’ll cause you a lot of stress and you’ll probably lose in the long run. What you should be thinking about is market exposure, since we can get a good idea of future equity performance based off historical performance (6%-8%). Let’s say you are comfortable with a 100% equity exposed portfolio. You can consider allocating 70% of your portfolio in an Index fund, and allocate the rest of your money in your favorite actively managed funds. Many people will like this approach because people want to feel that they are making a positive difference with their investment choices.
ALTERNATIVE INVESTMENT STRATEGIES TO CONSIDER
The above five investment strategies are appropriate for everybody who wants to invest in the stock market. We are primarily talking about the domestic stock market, but you can clearly gain exposure to international stocks through international ETFs, international index funds, and international actively managed funds as well. The following investment strategies can be considered for people with different circumstances.
1) Hedge fund. A hedge fund is supposed to bring you absolute dollar returns in a bear market or a bull market. They are actively managed funds that use leverage to juice returns, and go short to hedge or make money on the downside. Some of the wealthiest people in the world are hedge fund managers due to their performance. Names like Ray Dalio, David Tepper, and Ken Griffin come to mind. The problem with hedge funds is that they often charge 1%-2% of assets under management, and 20% of profits. Many hedge funds also severely underperform on the way up and on the way down as well. Furthermore, you often need at least $100,000 minimum, if not $1 million minimum to invest with the fund. Some funds have two or three great years and shutdown after a bad year because they know it’ll be too difficult to get back to their high water mark. If you are going to invest in a hedge fund, I would look for a fund with roughly ~10% annual returns, and a fund who looks for 10% annual returns as an easy screen. (See: How Do Hedge Funds Make So Much Money).
2) Do It Yourself Cowboy. If you just love investing your own money and picking stocks, you’re welcome to go through the entire stock picking process yourself. I just wouldn’t investment more than 25-50% of your net worth yourself in case of a blow up, which happens more often than you think. If you have several hundred thousands of dollars in assets and it takes up more than 50% of your net worth, you’re going to be very stressed out to the detriment of your relationships with loved ones. The likelihood that you will underperform is high due to the emotional nature of investing. If you insist on doing all the investing yourself, I would at least sign up with Personal Capital and run your portfolios through the free 401k/Portfolio fee analyzer to see how much you’re overpaying in fees, and the new Investment Checkup tool to ascertain your portfolio’s exposure and risk.
3) Private Equity Investments. Private equity investing is where you invest your money in private companies who you think will grow and either pay you a future dividend or have some liquidity event that will make you a solid return. Venture investing is investing in the earliest stages of company’s growth. Massive returns, but also much higher loss occurrences. Most private equity investments fail (9+ out of 10 they say), so it’s best you really know what you’re investing in before cutting a check. Seven years ago I invested about $75,000 in Bulldog Gin. They have grown very well in Spain, the UK, and NYC. Only recently have they partnered with Campari to distribute across the entire United States. It probably won’t be another five years before I get any of money money back.
4) Hire A Financial Advisor. After you achieve a certain amount of wealth, there is this mental shift that occurs where you’re no longer seeking to make maximum returns on your money. Instead, you’re happy with more conservative returns because you want peace of mind and protection of principle. The point of having money is so that you have freedom to do something else more meaningful, like spending time with your family, traveling around the world, working on your business, or volunteering. The last thing you want is to get stressed out by having so much money. Hiring a financial advisor allows you to offload your money worries on someone else for a fee. Thanks to technology, fees are under 1% a year on assets managed, and the advisor is a Registered Investment Advisor who has a fiduciary duty to look out for your best interests, instead of trying to earn a commission by selling you products. Although this is a personal finance blog, my goal is to not let money negatively affect my life. Money will make your life miserable if you cannot control your money habits. (See: How Experienced Investors Can Use A Financial Advisor)
INVESTMENT STRATEGIES AT DIFFERENT STAGES OF LIFE
My philosophy is that one should be more risk-loving up to the age of 35, risk-neutral from ages 36-60, and risk-averse from ages 61-death. Of course everybody is going to live different types of lives and have different types of risk tolerances. But for the most part, I think it’s a good idea to think about our lives in three different segments of risk.
Risk-Loving Up To Age 35
When you graduate from college, you either have very little or are in debt with student loans. As a result, there’s really nothing to lose. You can afford to pick 100% of your stocks and allocate 100% of your money into equities. If you lose half of your $10,000 portfolio, you’ll likely make it up after several months of work. If you lose half of your $500,000 portfolio, you will probably start hitting the bottle.
People in this stage should feel free to take risks not only with their investments, but with their careers. The greatest asset you have here is time. Of course, someone who is 35-40 should be more conservative than someone who is 20-30. Related: Don’t Stop Fortune Hunting
Options: All of the above.
Risk-Neutral From Ages 36-60
This is a time where you might have dependents, a mortgage, and a lot of desires because you’re finally making decent money and accumulating a sizable amount of wealth. You don’t want to go back to living like a college student, so you tone down your risks so that you’re able to just rise and fall with the markets and the economy.
A stable job with a stable income becomes more important than ever. Losing a job is therefore more devastating due to a higher wage loss, and the need to start over to prove your abilities.
I’ve omitted DIY from this stage because of the risk of trading your now larger portfolios into money losers. It was OK to whip around your portfolio when they were smaller and when you had much less responsibility, but not now. Based on my own experience, the experience of many other personal finance consulting clients, and the fact it’s impossible to beat the markets consistently over time, I do not recommend DIY and trying to be a stock picker to fund your retirement. Focus on the idea of managing your stock market exposure through low cost index funds or ETFs instead. That way, you can spend your time enjoy life instead.
Options: Index investing, Smart Indexing, target date funds, hedge funds, hybrid, private equity, hire a financial advisor.
Risk-Averse From Ages 61-Death
Hopefully there’s no longer a need to work for a living once you’re in your 60s. You’ve either saved up a sizable nest egg in which you can comfortably withdraw funds indefinitely to survive. Or, you have Social Security or a pension.
There’s no need to risk anything at all because you’ve already made it. To lose everything now would be a disaster, so stay away from “hot investment opportunities” and investments that just seem too good to be true. You are a target for scammers galore, and your number one priority is to protect your money like Sparta!
Options: Index investing, Smart Indexing, hedge funds, hire a financial advisor.
INVESTMENT STRATEGY CONCLUSION
The only three really risky moves are: 1) Doing all the stock picking yourself, 2) Over allocating your net worth towards equities, and 3) Private equity investing / venture investing.
Investing in a hedge fund or hiring a financial advisor aren’t risky moves at all if you really think about it. A hedge fund is there to hedge against downturns and make you money in bad years and good years. You just have to choose the right hedge fund for you. A financial advisor is incentivized to do what’s best for you and grow your investments. If you start underperforming badly, clients will simply withdraw their funds and go somewhere else.
“The Proper Asset Allocation Of Stocks And Bonds By Age” provides a framework of what I think is an appropriate mix as we get older. The one thing we do know is that leaving all our savings in a money market account paying 0.1%-0.2% is not going to help us build wealth. At least keeping your money in savings won’t lose you any money. The only sure money maker is working for a living. But who wants to do that for the rest of their lives?
RECOMMENDATION FOR BUILDING WEALTH
Manage Your Finances In One Place: The best way to become financially independent and protect yourself is to get a handle on your finances by signing up with Personal Capital. They are a free online platform which aggregates all your financial accounts so you can see where you can better optimize. Before Personal Capital, I had to log into eight different systems to track 25+ difference accounts (brokerage, multiple banks, 401K, etc) to manage my finances. Now, I can just log into Personal Capital to see how my stock accounts are doing and how my net worth is progressing. I can also see how much I’m spending every month. The best tool is their Portfolio Fee Analyzer which runs your investment portfolio through its software to see what you are paying. I found out I was paying $1,700 a year in portfolio fees I had no idea I was paying! There is no better financial tool online.
Pic: Hot tub, tennis, beer, San Francisco.