Let's Talk About Money Part 1

Mar 03, 2015

Thoughts on what to do with your money

Almost nine years ago in 2006 I took my entire life savings - $5,500 - and invested it in 4 mutual funds wrapped up in a product called a variable annuity. A variable annuity is kind of like an insurance contract that promised to pay a stream of payments after I retire. The guy who sold it to me worked out of this small, scrappy office 15 miles away from where I lived. He was referred to me from a high school friend who I sorta knew but didn’t know too well but the dude was eloquent and had lots of praise. When I signed the contract and handed over the check he said that I was on my way to being a millionaire.

1.5 years later, I closed the variable annuity and cashed out of the funds, part of my consolidation. The funds had done alright but the total value of the annuity had not gone anywhere. In fact it had gone downwards from $5,500 to the mid $4,000s. I was frustrated and paid another 1-2% fee to close it down. I was angry at both myself and the joker who talked me into this horrible financial mishmash.

I pursued the investment banking and finance track while I was in college and though my career there never took off (thanks to 2008), I came away from it with a sense of financial literacy. Then years of muffled attempts to handle my own finances and portfolio left me tired and cynical.

I figured I would spend some time today to write about finances. A long time ago I heard a nutritionist boil down the rules of eating healthily into a few simple sentences

  • Eat vegetables (leafy greens are best) and fruits
  • Avoid processed foods
  • Don’t eat carbs and sugars are the worst

Really simple and broad, and in their simplicity people can stick to them. I have in the next section the really really simple one, and then in the section after that, a slightly more nuanced one.

Deadest of Dead Simple

I’ll start with the advice that Warren Buffett gives to his wife about what to do with her inheritance:

My advice to the trustee couldn’t be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)

Let me break it down for you as simple as I can:

There are two types of securities that are freely available to people out there in the investment world. Stocks and bonds. Bonds are where people lend money to others and it gets paid back with interest. There is a high likelihood you get your money back when you are dealing with bonds. Stocks are where people buy portions of companies. You own 1 share of Wells Fargo, you own one small fraction of the entire company and thus are entitled to its profit.

You probably already know this. But here is the confusing part. You usually don’t want to own the shares of just 1 company. Instead, people package them up into things called “funds”. There are a lot of types of funds out there:

  • Mutual funds are companies that own stocks. They are managed by a manager who gets paid for his performance against the overall market. Mutual funds try to beat the market, and they are paid fees for doing so.
  • Index funds are companies just the same but the manager is not really a human being trying to beat the market. The manager is just a list of stocks based on some quantitative set of criteria. The most popular is the SP500. Index funds have smaller fees than mutual funds because it’s a lot cheaper to match up with the market than it is to beat the market

Mutual funds and index funds have shares that can be purchased through brokers but they can also be packaged up into stock-like entities that are priced on the open stock market just like any other stock. For example, the Vanguard S&P500 is traded on the stock market under the ticker symbol VOO. When they are like that, they are called ETFs (exchange traded funds). If the ticker symbol has more than 4 symbols, it is likely it is a mutual fund selling in a non-ETF structure. For an example, look at the American Funds Growth Fund of America on Google Finance and note that weird ticker setup: MUTF: AGTHX.

Generally index funds that are wrapped up as ETFs have the lowest fees, usually under 0.5%. Anything under that is favorable. Fees like the one I got with my variable annuity are the number one reason why people underperform. Tiny little fees accumulate over time and choke your portfolio to death. Vanguard is like a credit union in that it is not a publicly held company and all profits that their company makes from fund fees are returned to the funds themselves.

Slightly Less Dead Simple

While the portfolio above is a fine choice, the truth is that it’s not comprehensive. The S&P500 covers only the largest 500 American companies in the world. The truth is that there are a whole bunch of HUGE companies outside of the USA that make fine investments. Examples include Royal Dutch Shell, Nestle, and Samsung Electronics. These are companies you cannot own if you own the S&P500, and in general you want to own these companies to shore up against risk of a downturn in the American markets.

In addition, you want to own a larger allocation of bonds. I have heard some people saying that younger people want to own almost all equities and ideally yes, that is the case. However, I feel like it is psychologically necessary to have a larger allocation to bonds. It feels a lot better to have those bonds when the stock market is crashing like it is in 2008-09.

So I would take up a portfolio that looks a lot like what the world’s largest fund has. The country of Norway has been rich off oil, but instead of wasting their oil money, they have been putting into stocks. As a result they have the biggest wealth fund in the world - projected to grow to around $1.1 trillion in a few years. It is invested basically 70% stock/real estate, 30% bond. I would recommend something similar. Take 25-30% of the portfolio and put it into bonds - the iShares Bond fund would do fine. Then take the rest and allocate it between the SP500 (VOO does fine, but in a previous blog post I talked about VYM and I still fully stand by what I said there) and the international stock market (IXUS does a fine job because it has a low fee charge). If your online brokerage allows you to purchase these ETFs without having to pay a $7 transaction fee, that is all the better. I would opt for whatever fund that might be. Saving money on those transactions is a life saver over time especially you intend to invest frequently, which is what you should do because that is the best way to set good lifetime habits. And saving should be a lifetime habit.

Set It And …

Forget it. I feel like that truly is the way to go.

When people talk about the hot stock on the block around the BBQ, listen and chat it up but don’t go home and buy it yourself.

When CNBC posts an article titled, “The One Stock You Must Buy This Year”, well you can read it fine but don’t go home and buy it yourself.

When your father in law tells you over enchiladas and pinto beans that you just have to buy this one thing or else so help you God, well then nod and smile but don’t go home and buy it yourself.

It has nothing to do with how dumb or smart you are. It is about what you would rather be doing in your life. Do you want to go ahead and spend hours and hours studying and researching stocks until your brain goes to mush? If you want to think about what could happen with this sort of obsession, read the post that I wrote about my experience trading stock options. Spoiler alert: I was miserable, obsessed and a horrible person. I doubted myself. I ignored my friends. I hated myself. (I will talk more about this in the follow up to this post.)

Stocks are cars. You can buy the big honking expensive Ferrari or the Corvette and let everyone know that you have a Ferrari or Corvette. Or you can blow a whole lot less, get the Toyota, and get to where you wanna go.