How I’d Do It Today: A Short Path to Financial Security
A Case Study and a Commitment
Allow me to begin this post with a thank you! My series on ROI in personal finance has been by far my most read to date. This topic seems to have struck a chord with folks, and I really appreciate the feedback I’ve been receiving. Keep it coming!
The biggest piece of feedback I’ve gotten is that the case study was an exercise in “was it easily done?” which is interesting, but not as actionable as it can be. It’s my commitment to you, the reader, to make sure that every technique on this site is actionable so that you can get results.
Thus, today, we’re going to spin back the clock for a brief, focused discussion of how I’d handle my investments if I were just starting out today. All killer, no filler.Let’s get started.
First Thing’s First – Get Started Now
I started investing when I was 18. If I had it to do all over again, I would have started even earlier. I reckon that starting at 18 gave me half of my overall investing results vs. starting at 30. Even a few years of extra compounding can make a big difference.
The only trick here is starting with an easy investment that is not too much of an emotional roller coaster. Let’ break it down:
You’ll need an account to invest in. It’s preferable to use a tax advantaged account, if you can. In the U.S., an IRA fits the bill. I would set one up somewhere low cost: my favorite is Vanguard but Fidelity is also a reasonable option. Note that these companies want you to invest with them, so they will make it easy to set up an account and even to transfer the money from elsewhere if you’re doing a rollover.
You’ll have a choice between a Roth and a Traditional IRA. For most people starting out, a Roth makes more sense, but there is some nuance to consider here. Also, make sure that the account is a “brokerage account” rather than just a “mutual fund accounts” because you’ll need it for later optimizations. Finally, note that your job may have a 401(k) plan. If it provides at least one diversified, low cost fund like we’ll discuss below, it can work in lieu of the IRA, at least for now.
Not an Emotional Roller Coaster
When you get started isn’t the time to get fancy. Asset allocation, leverage, etc. can wait. What you want right now is a well-diversified mutual fund or ETF. You can’t get more diversified than the entire world stock market as represented by something like VT or ACWI.
Many advisors recommend a “lifecycle” fund that is a combo of stocks and bonds. I don’t recommend that. Per my case study, lifecycle leverage is the third most impactful thing you can do (after starting early and ramping up your contributions), so stick with 100% stocks right now. We’ll talk about how to go higher than 100% below.
Your Actions for Today
- Open an IRA ( Vanguard or Fidelity is a good choice)
- Put some money into a total world fund like VT or ACWI
Now that you’ve started and you know how to put money into the account, how do you know how much to put in? The math here is clear: the more the better. I suggest aiming for 10% starting out. If you can’t do that, any amount greater than $0 is good, so long as you set up automatic deposits to invest the money every paycheck. Set up the systems now when your willpower is high and you’ll learn that you don’t miss money that never hits your checking account. It’s not so tempting to spend what was never there.
Whether you’re investing 10% or not, try to ramp up over time and defeat lifestyle inflation. Any time you get new regular income (e.g. a raise or starting a new job), up the amount that you are investing each month, ideally by 50% or more of the new income. If you do this right away, you won’t be tempted to increase your expenses and you’ll push up your investment amount well above 10%! You can also do this with irregular income, like a bonus; just invest a healthy chunk when you get it.
Your Actions for Today
- Use auto-deposit to invest, targeting around 10% of your paycheck if possible
- Up the amount you are investing each time you get new income
- Consider investing bonuses and other irregular income as well
Take Advantage of Your Risk Tolerance
Following the above steps puts you way ahead of most people and by my calculations gets you roughly 60% of the way to optimal results. I followed most of the above advice myself over my first decade of investing and ended up quite happy with the results. It’s pretty straightforward if you automate your investments.
The next step is lifecycle leverage, which gets you to around 80% of optimal, but is tougher psychologically. Here’s how I would do it.
First, you shouldn’t use leverage if you can’t stick with the plan because you can’t tolerate risk. There are risk tolerance questionnaires you can take to get a rough idea, but they’re not very good. My suggestion is to slowly increase your leverage over time and see how you react to market corrections and recessions. If you panic and can’t sleep at night, more than 100% leverage isn’t for you. If you’re disciplined and keep adding funds according to plan, ramp it up.
High leverage that ramps down over time is mathematically optimal and 200% is about the limit where you begin to run into implementation problems and volatility drag, so that is where I would stop. The most straightforward way to get low cost leverage is with a taxable margin account at Interactive Brokers. After a few years of maxing out your IRA and 401(k) if you have one, this can be a good option, but you need a minimum account size of $100k to avoid monthly fees.
If Interactive Brokers isn’t a good choice for you, you can also get leverage in an IRA through leveraged ETFs such as SDYL, but note that there are a variety of downsides (e.g. fees, beta slippage), so you shouldn’t just use these on a whim without doing a bit of research. Unfortunately, there is no perfect solution to obtain leverage, but if you have the risk tolerance to leverage early on, I still believe it’s worthwhile.
Your Actions over the Next Few Years
- Keep a close eye on how you react to having 100% stocks
- Assuming you stick to your plan, consider adding leverage via margin or leveraged ETFs until you hit 200% leverage
To Everything There Is a Season
So now you are investing, upping your contributions, and testing out lifecycle leverage. What’s next? Based on my case study, this gets you 80% of the way there. Per the Pareto principle, everything else is optimization. In my case studies, I looked at more elaborate diversification (e.g. factor investing) as well as trend following and time series momentum, and if you’re so-inclined please do so. They are worthwhile tools to squeeze that last bit of performance out of your portfolio.
Otherwise, just keep an eye on your portfolio. I recommend a quarterly look just to make sure that everything seems reasonable (monthly if you are using leverage) and a yearly review where you:
- Adjust the amount you are investing based on current income
- Adjust your leverage targets based on your lifetime risky investment amount calculation
- Rebalance the portfolio to your target allocations (if you’re diversifying across multiple funds)
Your Actions until You Hit Your Goal
- Do quarterly or monthly reviews of your portfolio to make sure everything is on track
- Revisit your investment and leverage amounts each year
So that’s what I would do if I had it to do over again.
In a nutshell:
- Open an IRA and start investing in VT right away
- Set up auto-deposit of 10% of my salary and ramp up with each raise
- Keep an eye on my risk tolerance and use margin and leveraged ETFs to move to 200% leverage as I stick to my plan
- Test out other ideas like factor investing and time series momentum
- Do regular reviews as I learn and grow as an investor
Like Blaise Pascal said, “I would have written a shorter letter, but I did not have the time.” I hope this shorter primer on investing helps you to do it more easily. Let me know how this shorter format worked for you. We’ll keep learning together.