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investment strategy

Investment Strategy- The Ultimate Blueprint

So, you’ve got your debt under control and you want to know what’s next? That’s great because investing is where real wealth is built.

In this guide I will explain in excruciating detail exactly what I think you should do with your money. It’s a conservative investment strategy, diversified and should clock you in at over 7% a year on average. All you need to get started is $100 and the determination to stay the course in good times and in bad.

Like all good courses, there are some prerequisites. While I can’t stop you from reading the guide now, I would like to stop you from having to read it multiple times OR misunderstanding my points and making mistakes. In order for you to get the most out of this article and plan your investment strategy, you will need have read and understand:

An Introduction to Simple Investing – Why don’t you stuff all your cash in a mattress? What’s healthy diversification? Why are savings accounts a waste of time? Why do market’s crash and can you use that knowledge to your advantage?

An Illustrated Guide to Investment Types – You should never invest in something you don’t understand. In this article we explain how things like Stocks, Bonds and ETFs work and what roles they will play in your portfolio.

The Gradual Move from Fear to Greed and How to Protect Yourself – This article will teach you how to avoid timing the market poorly and how to prevent greed from torpedoing your investments.

One last thing before we begin. If you have ANY debt that is not a Mortgage or a Student Loan you should NOT be investing. Why? Because mathematically it makes no sense. The goal of your investment strategy should be is to build wealth, not diminish it. If you do have debt it’s not the end of the world as we actually have some awesome resources to help you.

We also discuss this on the show:

The Core Components and Rules

Rules for Paradise

Before we can discuss anything we need to go over a few terms and what they mean. We’ll be using these terms throughout the guide to simplify the discussion a bit. If you have any questions or doubts about their definitions then just roll on forward to the four rules that follow which will explain the definitions and our investing mindset in a bit more detail.

Checking Account – Otherwise known as our working capital. This is the cash needed to cover your expenses from monthly purchases plus 150% extra for breathing room. So, if you spent $2,000 a month on stuff, your checking account should always have $5,000 in it ($2,000 x 2.5 = $5,000).

Until you reach your working capital goal you won’t be able to proceed into building out your investments. If you want to buy a TV you only ever take the cash out of your working capital, never your investments or Emergency Fund. So, if you need $4,000 for a TV then you must grow your working capital to $9,000 before you can do it ($5,000 + $4,000 = $9,000).

Savings Account – This account doesn’t exist because we know that interest wise there is virtually no difference between a savings account and a checking account.  If you read An Introduction to Simple Investing you would know this. Imagine that in ditching your worthless savings account you split it’s old purpose between your checking account and your Emergency Fund. That’s exactly what we’ll do and it will simplify your life while boosting your overall returns.

Emergency Fund – We consider this our “safety net”.  This will only be tapped in – wait for it – an emergency. I won’t exactly go and tell you what an emergency is but if you’re in doubt click here. How often do emergencies happen? Between 0 and 3 times for your entire life.

If you’re having frequent emergencies I’m going to go out on a limb and say you have other problems or are fishing for an excuse to spend your cash. Regardless if you’re poor or ultra wealthy you should fill your Emergency Fund up to $25,000 and then let it ride. If you do withdraw from the account, add back whatever you withdrew before moving back to contributing to your investments.

Investments – Betterment, IRAs, 401ks and ETFs to stay diversified. Maybe even some fancier stuff that we’ll discuss at the end of this guide.  All cash beyond your working capital and Emergency Fund will go into your investments. We’ll use Dollar Cost Averaging to contribute and we’ll buy and hold regardless of what the short term market looks like.

Now that we have the core concepts in place I want to go over a few ground rules. If you’re a bit confused, don’t worry, I’ve got answers after these rules.

Rule #1: Don’t Lose Your Money or Your Pants

There are two obvious goals here, don’t lose money and don’t lose everything. That means we’ll need to be vigilant about what we invest in. In order to do that we need to avoid over exposing ourselves to risky investments.

What’s a risky investment? Commodities (gold, silver, oil, etc..) are very risky just like investing in an individual company or an IPO. Buying any of these things involves tremendous amounts of research so unless you are willing to do it, you need to back away from the slot machine. You’ve been warned.

It’s even more important that you diversify your investments. We diversify so that any any single event doesn’t wipe out our wealth. Guess what, the crash of 2008 didn’t destroy my wealth because I was diversified. I both worked for Lehman Brothers and was invested in the company but I turned out fine. The big secret? Buy a little bit of a lot of stuff. Index Funds, Mutual Funds, individual companies, retirement accounts, etc…

Rule #2: Your Emergency Fund Comes First

I can not stress this enough you must always protect your emergency fund. Once your Emergency Fund reaches $8,000 you’re going to be itching to spend it. Don’t spend it, except on Emergencies. If it’s found in a store it’s almost certainly not an Emergency expense.

Without a solid Emergency Fund we’ll always be but a few steps away from the poor house. Only withdraw in an emergency.

Beyond that you’ll need to relentlessly focus on building your Emergency Fund to the proper size. Imagine the storms that you can weather with $25,000. Imagine if you were building a sky scraper that your Emergency Fund was the foundation you build one million floors upon.

Rule #3: Always Accept Free Cash

If there is a 401k, TSP, HSA or equivalent where you’ll get some free funds from an employer to match your contributions then you need to be all over that like white on rice. Employeer matches 5% of your salary? Then you need to contribute 5% of your salary to the relevant retirement account. Always, no matter what – even if you have debt. Why is that? Because even on credit card debt, a 100% return is unbeatable. Matching is at its worst, 4 times better than the worst credit card (100% return vs 25% return).

While retirement accounts with matching are the most profitable thing you can do you need to stay away from employer stock matching programs. They are often often pretty illiquid and it exponentially increases your risk. When you have stock in your company, if your company goes down so do your savings. Few exceptions may be companies like Apple and Google but even then, personally I would be nervous and stay away.

Rule #4: Give Yourself Some Respect

You’re not some chump so don’t act like one. Your future self isn’t a chump either so it’s even more important not to screw the future you. How do you do that? Don’t belittle yourself, your work or your time. Since you spend time working you need to constantly focus on being more effective.

By belittling yourself you tell yourself that you can’t meet your goals, that the road is too long and far.  Well, guess what – the road is too long and too far. So, if you’re not up for a challenge just roll up in a ball and hide. Or, step up to the plate and be the person you were destined to be. All winners started as losers.

By belittling your work you prevent yourself from getting the experience you need. You can always increase your salary through a new job but you can’t create experience out of thin air. Take pride in doing your job well, even if the job or company sucks. The first step to doing better is always to learn so if you focus on that you’ll do all right.

Finally, you can’t belittle your time by throwing away all that you’ve worked for. Want to spend your Emergency Fund? You’re just shitting on all the time you’ve spent working towards a secure future. The Emergency Fund is not for taking a vacation or buying a computer. Have some respect for your efforts, don’t be a self saboteur.

Building the Emergency Account

betterment-experiment

Until you reach $25,000 in your Emergency Fund account all you will focus on is building up your Emergency Fund. However, we will not build this account at all if we have any credit card debt or any other type of debt excluding only a Mortgage and a Student Loan. If you have a Student Loan I strongly suggest you pay that down first, however it is debatable whether it’s an emergency or not.

The process in which we build our account will be Dollar Cost Averaging. This means that we will contribute a fixed amount of dollars every month and this number will never drop. If you have $500 extra cash a month then at least $250 of that should be auto deposited in your Emergency Fund. Doing so will allow you to avoid poorly timing the market and slowly but steadily grow your Emergency Fund. Consistency is more important that the percentage of income you contribute. If all you can do is $50 than as long as you can do it every month it will still add up quickly.

What is this Emergency Fund Account we keep talking about? The Emergency Fund Account is a highly liquid medium to low risk investment account. This means that as we get about $8,000 into funding the account you’ll notice that it will start earning meaningful amounts of money on its own. It makes no sense to keep extra money in a savings account as you will earn next to nothing. We can debate this all day but the pros outweigh the cons.

What is a low to medium risk investment? A series of diversified index funds that consist of companies across the world and a certain amount of bonds to reduce your risk even further. Our personal favorite tool for this job is Betterment. I don’t want to go into it too much as we’ve already said so much on it but if you want to hear it on our podcast we talked about it in Episode #77. If you want to read about it, check out The Betterment Experiment.

All Hail Vanguard

All Hail Vanguard

So, you’ve packed a cool $25,000 into your Emergency Account? Now it’s time to further diversify your investments and take on a little risk. What we’re going to do here is build out a set of investments that attempts to grow at an even stronger pace than our Emergency Fund. Once our Emergency Fund is full we will divert our monthly Emergency Fund contributions to our Investment Account, steady as she goes.

First, why Vanguard? Two reasons, they have the lowest fees in the game and you are their top priority. Vanguard the company is owned by its funds. That means that when you invest in one of their funds, you’re also a part owner of Vanguard as well. Vanguard is a very prestigious company with a solid history of their funds growing extremely well. If you want to know why low fees are so important, check out what fees do to a 401k account as well as Vanguard’s explanation.

I’ve gone ahead and done the research for you on these funds, however I don’t want you to take my word for it so I’ve included my thoughts along with some compelling research. You can find my picks in the next section, but If you want to pick your own here are their key fund lists:
https://investor.vanguard.com/mutual-funds/target-retirement/
https://investor.vanguard.com/mutual-funds/vanguard-mutual-funds-list?&assetclass=sec
https://investor.vanguard.com/mutual-funds/vanguard-mutual-funds-list?assetclass=stk

My Vanguard Picks

I encourage you to do your own research but I think these funds are a good place to start – or at least a benchmark for better funds that you may find on you own. I’ve put the least risky at the top and the most risky at the bottom.

Vanguard Target Retirement 2050 Fund (VFIFX) (MorningStar) (Fee: 0.18% & 5 Year Return: 18.46%) – This fund will start out with mostly stocks and slowly taper into bonds over time. The point is you take on risk now while you’re young and slowly reduce risk as you reach retirement age so big market swings don’t wipe out your retirement money.

500 Index Admiral Shares (VFIAX) (MorningStar) (Fee: 0.05% & 5 Year Return: 18.38%) – This is the fund that made Vanguard famous. Invest in 500 of the biggest baddest companies around.

REIT Index Admiral Shares (VGSLX) (MorningStar) (Fee: 0.10% & 5 Year Return: 22.70%) – Why own a property and rent it when your money gets stuck in the home and there is so much work to be done? Instead invest in a REIT and take rental profit and liquidity. Have your cake and eat it too. This is not just a REIT but a fund of many REITs so you’re heavily diversified in the rental game.

Growth Index Admiral Shares (VIGAX) (MorningStar) (Fee: 0.09% & 5 Year Return: 19.27%) – Vanguard’s attempt at picking high growth companies that will knock it out of the park for you. It’s a bit riskier but the returns are generally pretty solid. Check the graphs I linked to above and judge for yourself.

Strategic Equity (VSEQX) (MorningStar) (Fee: 0.29% & 5 Year Return: 22.69%) – Like the Growth Index fund but smaller companies, potentially higher growth and a large portion of the fund’s composition is chosen by a computer. The fee is the highest here because proportionately the most amount of work goes into running this fund. 0.29% isn’t a big fee by a long shot but I do think it’s important to note. Also, again, this one’s the riskiest of the bunch. Of your Vanguard investments I wouldn’t make this one more than 10% of the total amount you invest.

Juicing Returns for the Advanced Investor

If you have $100,000 or more invested then you can start taking on some of the riskiest types of investments if you’re interested. Risky investments require a fair amount of research and a good instinct. There’s no real way of knowing how to pick good risky investments you just need to think on it as much as you possibly can.

To juice my returns I’ve been investing with Lending Club. Lending Club is a platform where you can invest in loans to individual people. Finally, a way to get in on that lucrative bank lending action. I wrote about how I’ve been personally doing in my article Lending Club: An Investors Secret Weapon. Start with $1,000 – $2,000 and play around. Learn what’s working and what isn’t. Once you think you have it figured out you can go ahead and pump more in. For what it’s worth, I’m doing pretty damn good. Wanna talk strategy on it, email me!

It Ain’t Rocket Science

It Ain't Rocket Science

Nothing I detailed here is difficult or excessively risky (aside from Lending Club). I won’t even go so far as to admit my ideas are original. Why be original when you can just do what works? I’ve stolen my ideas from the best by reading and listening to everything they have to say. Through my relentless focus I’ve been able to build quite the nest egg.

You can do it, you just need to start. The best time to start is now.

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  • Jeff Mohr

    Great article! Your guide
    is full of sound advice. I like that you
    talked about company stock being a bad idea.
    The people who worked for Enron and other failures of the time lost
    their salary and the money in their retirement plan in the same month. I don’t advocate taking money out of a retirement
    account except in the most extreme circumstances, but it would have been nice
    for those employees to have it as a last option.

    • I agree Jeff. At the time Enron was hailed as a revolutionary company that was a top 5 company in terms of the profits they “reported”. There are also plenty of other examples of great companies gone bad. Unfortunate for the employee, most are not completely aware of the going ons and thus creates a ton of risk.

      As you said, retirement accounts should stay exactly that, retirement accounts. They aren’t meant to fund a lavish lifestyle while you’re still working.

      • Vito

        I’m just curious. if you have a 401k and it has some company stocks and some vanguard stocks.. (my job uses fidelity) .. if the company i work for runs out of business that doesn’t mean that I lost my 401k? or does it? I’m confused

        • No Vito, don’t worry, your 401k will stay in tact. If you did however, have some company stock in there you might have lost just that one piece of your 401k’s portfolio.

          That my friend, is exactly why diversification is important. Weird stuff can happen and will happen but it doesn’t need to take all of you down with it.

  • Daniel Murrell

    Very incitefull and full of sound evidence to reasoning ratios. I read this 3 times lol. Company stock is a wolf in sisguise.

    • Thanks Daniel! Best be careful of stock unless you’ve done your research. Also, research isn’t one day of work unless that’s how little you value the money that you sweat to earn ;)

  • I began investing as a kid.
    After watching silly movies, etc. that showed investing as some sort of aggressive
    game to be played, I too wanted to complicated things. 14 years later, I’m doing better than ever in
    Vanguard Index Funds. I also sleep much
    better at night. You’re soooo right
    about keeping things simple. I love this
    article.

    • Thanks Will! We’re slowly trying to document our methodologies on the blog so that everyone can manage their money quickly and effectively.

      Grats on making smart decisions while you were young. I’m sure the rewards you’re reaping now were well worth the wait!

  • Thanks for the great info fellas! Great overall picture of how you should use your money! I’ve been implementing your advice for about 6 months now and it’s all part of the plan to be truly financially free and enjoy the things that I want in life. Thanks again!

    • Thanks Lane, happy to help!

      If you ever have questions don’t hesitate to email us!

  • Jochen McEvoy

    Why do you suggest starting with betterment and waiting until you get 25000 before you start with vanguard? Also what is your opinion on putting into a retirement fund like the vanguard one you suggested before you set up the emergency fund? I’m 22 years old and new to having money but I’m trying to plan when I should start putting into a retirement fund and where?

    • Great questions Jochen!

      First, there are a few reasons why we suggest reaching $25,000 first. This will be for the most part the only portion of your investing that we would expect that you may tap in case of an emergency – the rest should be considered “untouchable”. Consider it a practical segmentation of your investing by purpose with a happy bi-product of diversification.

      Also, the Admiral shares class at Vanguard requires a minimum investment of $10,000 and we highly recommend striving for that as the fees are dramatically cheaper. However, we don’t want your money to not be in the market during that time so Betterment serves as a great highly-liquid bridge that can get you there.

      As to why we recommend Betterment over Vanguard as our replacement for savings accounts, it’s mostly due to the products diversity, liquidity and flexibility. I can’t go too deep into it in the comments but for a better understanding check out our Betterment Experiment series in the Invest section of the site: http://www.listenmoneymatters.com/invest/.

  • JT

    Just discovered your site/podcast: you guys are rad.
    Just to be clear – you use Betterment for the initial $25K emergency fund, then all of your non-advanced (eg Lending Club, individual stocks, etc) investing from there on out with Vanguard?

    • JT, thanks man, glad you enjoy our muse :)

      If my income was high such that $10k was inconsequential to me then I would actually likely stick with Betterment completely.

      At $100k+ with Betterment the fee is only 0.15% (better than Vanguard’s LifeCycle fund) AND I get Tax Loss Harvesting. TLH alone will save an enormous amount on taxes. Of course Betterment also adjusts for allocation drift and re-balances accordingly another huge plus there. I write all about that goodness in my latest Betterment Experiment article: http://www.listenmoneymatters.com/betterment-experiment-august-2014-update/.

  • Tim

    Are we leaving the $25000 in Betterment and just moving our monthly deposits to Vanguard or moving the $25,000 to Vanguard also? Thanks.

    • Initially when I wrote this I was very much for redirecting extra cash above the $25k to Vanguard if you felt you were able to take on the task. Now I’m actually leaning more towards just leaving it in Betterment. They’ve dramatically improved their offerings such that any savings you’d find elsewhere would be marginal but the increase in effort required would be fairly high.

  • Hi Andrew I was just prompted to this discussion after following you. Good breakdown there. I feel that many are not well verse in the maths behind wealth building and thus it handicaps them. I can forward to some of my posts but that would be disservice to the community.

    one good example is like the image below taken from a guide i use to educate friends to show that, for conservative folks they can build wealth wisely by doing better at their job and taking less risk with their wealth building. increasing their funding to wealth machine (or saving up for your portfolio as regular people calls it) can make up for large returns.

    Knowing such maths concept lets u think about your earnings power (whether it is bond like or equity like), your risk tolerance, your funding rate to your wealth machine and find a point where you can conservatively realistically fund your wealth machine and projecting with a high probability how much wealth you will build up in 10, 20 , 30 years timeframe.

    its probably the engineers way.

    • Kyith, you called it although I’m sure you hear very similar things from your site http://www.investmentmoats.com. It’s not that people don’t “get” it, it’s more that things like exponential returns are very confusing and without working out the math it’s very hard to understand.

      This is an awesome angle that we may have covered tangentially in the whole “don’t chase higher returns, be average” discussion although I’m not sure we spent enough time discussing the value of increasing contributions consistently as a way to really amp your efforts.

      Thanks for bringing it up and attaching that sweet chart. I think we’ll have to touch upon stuff like this more because I agree that it’s incredibly important.

      • Hi Andrew I think why yourself understands these things well is because as a society (me included) we lost much of our understanding or reading and maths. what you provided here is (1) fundamentally sound (2) minimal to get you very far. So if we package them very well it helps a lot of folks. I been trying to collect these little wealth widgets. its been though.

        Btw you have one of the best minimal website theme i came across.

        • Thanks Keith, and I agree. It’s not that we’re breaking ground on new information – it’s all about putting in a nice package that will help people learn (and possibly enjoy it).

          I’m glad you like the site – it’s all custom designed/developed. If you ask my wife she’ll tell you I spend way too much time tweaking and not enough time writing ;)

          • Tell her its well worth it… well perhaps for CSS geeks like me haha!

  • jb1907

    the only issue with the target funds is that if you are going to put money into a target fund, that should be the only fund you use. Other than that, you can build the same structure with a equity fund and a bond fund in the same ratios.

  • Gene Short

    Good article. I’m curious about the “Safety Net” amount. Why $25,000? What’s the science behind that number? Is it more if you’re self employed, less if your single, etc?

    • $25,000 represents the amount necessary to get through most typical emergencies often without wiping out your account. The money can also double as living expenses for a family when the primary (or only) breadwinner loses their job. The number is meant to be universal.

      It’s an excellent goal to strive for and if you let it sit there for 30 years untapped it will approach $190k in value which is about 1/4th to 1/3rd of what a typical person needs to retire.

      • Gene Short

        Thanks Andrew. One more question – what do you recommend as an allocation for bonds/stocks in the safety net? I think I heard on an early episode of the podcast that it should be 90 stock/10 bond, but on the surface that seems a touch risky for a “Safety net”. I’m thinking the primary focus here is safety and stability – mentally this feels more like a 60-75% stock allocation. Thoughts?

        • Woah, sorry for missing this one Gene!

          Betterment by default suggests a 60/40 stock/bond split for an emergency fund. That’s fine for someone just starting out that really doesn’t have a solid footing financially but for someone a bit further along in the process I believe it pays to be more aggressive. Personally I’m at 90/10 but for most people 75% stock should be pretty solid.

          • jb1907

            60/40 is way too conservative. Have lots of cash for emergencies and buy on large dips. Your safety net should be in cash, not in the market.

  • Rob Lehner

    Thanks for the advice. I have one question. I have always thought of an emergency fund as idle money for an emergency not an investment. After listening, I am debating going 20-40% stocks and the rest bonds for this fund (instead of ally at 1%). Why do you choose betterment over vanguard for the emergency fund? Vanguard has life strategy funds with a lower expense ratio and in my opinion is more reputable. Is it because betterment does a better job at TLH?
    Thanks
    Rob

    • Rob, TLH is certainly a reason I use Betterment, among many others I dive into detail here:
      https://www.listenmoneymatters.com/betterment-review-experiment/

      That said, the main reason I use Betterment for my emergency fund is that I have control over my stock/bond split. A Vanguard lifecycle fund slowly tapers into bonds over time so while you can pick something like Lifecycle 2010 to be heavier in bonds, at the end of the day the fund is going to follow its predetermined trajectory. So, in order to not continually move to all bonds you’ll need to switch funds occasionally.

      I opted for the easier route with more control but if you did use lifecycle funds it certainly wouldn’t be wrong and would achieve pretty much the same thing.

  • Bryan

    Great post, I love the breakdown here. My only comment is that you really don’t discuss retirement accounts. Do you not put any of your money into Roth/Traditional IRA’s? Is all of it in taxable accounts? My plan was finish building my emergency account, then load up on Roth IRA’s. After max out my IRA’s each year then start to invest into taxable accounts with the remainder of my money. It seems counter intuitive not to use the tax sheltering that IRA’s provide you. I guess I would like to hear a breakdown on how much you put towards retirement accounts vs. taxable accounts.

    • It’s a good point Bryan. I don’t go that far in this post, it’s meant to be more of an initial approach for someone starting with almost nothing. It also highly depends on your situation and I tried to keep it a bit more agnostic focusing more on “taking the free money” in retirement matching above tax optimization.

      I’ll admit that personally I focus less on IRAs as I’m looking to actively build income sources. LMM, rental properties, etc… and if I locked it away in an IRA/401k I wouldn’t be able to do that. I do have IRAs and 401ks, they’re just not a major focus for me.

      I’m adding a more detailed, nuanced update to my “to write” list where we get into this in depth.