Investment Recommendations

The proper investments for an individual vary based on his/her specific situation with many factors to consider in addition to those mentioned in the previous post, Investment Considerations. None of the recommendations here are taking into account your specific situation and should not be considered investment advice. Investing carries a large chance of losing money and no investment advisor (which I am not) can save you from that. Following are some general guidelines for what I would do in different situations.

First, in all situations, you need to consider tax and fee implications because they will eat a significant proportion of your investment returns if you are not careful. There is a high degree of factors outside of your control when you invest. You can’t control or predict the future. The only things that are 100% known are the taxes and fees you will pay.

To reduce taxes, I recommend putting as much money into tax-advantaged accounts as possible. Ideally, you will want to reduce your current tax obligation with traditional IRAs and 401ks. This reduces your taxes at your marginal rate (highest tax rate) so that you will pay taxes at your effective rate (much lower tax rate) when you retire.

To reduce fees, I recommend investing in the lowest cost mutual funds and brokerage account combos you can find. The lowest cost place to invest is almost always Vanguard when available because it is the only not-for-profit brokerage firm. Passive index funds are also generally the lowest cost mutual funds to own.

To reduce risk, I recommend diversifying as broadly as possible. Buying individual stocks is one of the worst deals in investing because you add an additional risk of your specific company losing business or going bankrupt but still can only expect the market return—higher risk for equal reward. This is why you should get an index fund that buys a small piece of every company, or bond in the asset class you want to invest.

Following are general categories of investors and how I would invest if I were in them. Even if you match one of these categories, I have no idea the other things going on in your life, so any investment decisions are solely your own. This is not investment advice for you.

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Working and Tolerant of Volatility

This is the situation that I am currently in. I have an income significantly higher than my expenses and I want to load up on stocks when the market goes down. I have invested through two market crashes and am confident I will not sell during the next crash.

In this situation, you are free to maximize your returns by putting 100% of your money into the highest expected return asset class. I find this by looking at my prediction of earnings and dividing by price. For example, Vanguard’s total bond market fund, VBMFX has a current yield of 2.21% and I expect it to earn that same amount. I would compare that to Vanguard’s total stock market fund, VTSAX has a Price/Earnings ratio of 21.5 so I will take 1/21.5 to find the earnings to price ratio, 4.65%. I also think the earnings will grow at the pace of GDP growth at 2-3% for a total expected return of ~7%. If these were the only two investment I looked at, I would put 100% into VTSAX and 0% into VBMFX because 7% > 2.21%. I also consider REITs as a gauge of the returns investing in housing might return. I am currently 100% invested in stocks, but I do have some money in stocks which I do not recommend (it is a bad habit and a function of enjoying researching stocks. I am still working on my ego to end this habit).

For the average investor that does not enjoy spending this time, you have the exact same returns by assuming the VTSAX (stocks) will have higher expected returns than bonds or real estate and putting 100% of your money in VTSAX (stocks). VTSAX (stocks) almost always has a considerably higher expected return than any other asset classes and is well diversified without specific company risks. Historically investing 100% in a total market passive index fund would outperform any other asset allocation. The idea is to have as much of your money working for you as possible at all times. The reason that I specify that you have a job, is that when the market crashes, you will be able to invest new money from your work into the market at bargain basement prices.

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Retired and Tolerant of Volatility

You have also seen market crashes and wanted to buy more instead of sell. The only difference from the above scenario is that you are no longer working and will be drawing living expenses from your portfolio. This introduces a new risk called sequence of return risks—when the timing of market returns affects your overall return.  A drop in stock prices early in retirement will force you to sell stocks at a discount price which eliminates the gains you would receive from those stocks in the subsequent years. To avoid this you will want to include some bonds to spend from during a stock market downturn. The sequence of return risk decreases the further you get into retirement and becomes insignificant by around 10 years. To account for this, I would start with 60% stocks and 40% bonds at retirement and then increase my stock percentage by 0.3% each month the stock market doesn’t make a new high—this prevents buying at peak prices. I will keep doing this until I reach 100% stocks in 11 or 12 years. I care more about having my living expenses covered in bad times than I do having slightly more money to spend in excellent times. I like this strategy because it reduces the harm of worst case scenarios in exchange for a reduced benefit in the best case.  This keeps my returns closer to my expectations which makes retirement planning easier.

I know this is slightly more complicated and requires more effort than some care to put toward their finances so I also have a less beneficial option if I didn’t enjoy thinking about this stuff. Instead of adjusting my asset allocation each month, I would make a one time change from 100% stocks to 90% VTSAX (stocks) and 10% VBMFX (bonds) at retirement. 

In both cases, I would pull my living expenses out each month in a way that resets the allocation back to my target. I would avoid doing additional rebalancing unless the stock market moves your allocation significantly due to transaction and tax costs.

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Volatility Adverse

This investor worries about losing money and will not be able to focus on living their life when the market goes down. This investor gets scared when the market gets cheap and wants to sell to prevent further declines in his/her portfolio. Selling at the market lows has negative impacts that far outweigh any benefits of investing in stocks. This needs to be avoided at all costs!

Ideally, this investor should work on their mindset so that they are able to view market crashes with equanimity. The should work to view the lower prices as a discount and opportunity to pick up more shares at a cheap price. That said, it may take some time to get their mindset right.

In the meantime, the goal for these investors is to have a smooth path that does not lose too much money toward inflation. This investor may be tempted to be 100% in cash, but they need to realize that they are almost guaranteed to lose 3% in buying power each year. To introduce inflation-beating returns while minimizing risk, these investors need to diversify their asset classes. The best mix I have found to accomplish this using historical data is 25% VTSAX (stocks), 35% VBMFX (bonds),  25% VGSLX (real estate), and 15% VGPMX (precious metals). This asset allocation has produced solid returns for the amount of volatility in the past, but you can look at how other asset allocations have performed at https://www.portfoliovisualizer.com/backtest-asset-class-allocation. Remember, this is based on past results so do not choose an asset allocation that goes right up to your risk tolerance. Whichever asset allocation you select can and likely will perform worse in the future.

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Summary

These are the investments I would make in each situation described, but please remember that nobody including me can see into the future. Luckily, I have no incentives to give you bad advice unlike most financial advisors (commissions, kickbacks, business relationships, etc…), but my ignorance of the future means my recommendations could perform terribly. The thing that makes me okay with this uncertainty is that I am flexible. I can/do enjoy working, I don’t need much to be happy, I have valuable skills, and I take care of my health, so even if the economy collapsed, I would be fine. I hope that you put yourself in a similar situation where the highly likely (IMHO) positive outcomes of following my investment recommendations are just adding to an already happy life.

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