The Basic, All-Purpose, Master Mutual Fund Investing Portfolio


(This is part of a series of articles to teach those who are new to investing how to invest.  To find other articles in this series, choose “Beginner Investing Class” under “Investing” in the menu at the top of the page.  If you have questions or you’d like a topic to be covered, please leave a comment at the bottom of the post.)

Perhaps you’ve tried baking and found an all-purpose, master bread dough recipe.  This is a basic recipe that can be shaped in a variety of different ways, perhaps to make loaves of bread, cinnamon rolls, dinner rolls, and maybe even morning pastries.  Perhaps this master dough could even be used to create the crust for a pizza.

To start out our lessons on learning to invest, we’ll begin with a basic mutual fund investment portfolio and build from there.  Think of this as a master dough for your investing needs.  This is a general portfolio that would be suitable for almost anyone who was planning to invest for at least five years before needing the money.  Once we introduce the basic portfolio, we’ll then talk about why it is designed the way that it is, then tweak it a bit to show how you can adjust it to meet your particular needs.

So what about people who need the money in less than five years?  Investing involves taking a calculated risk with your money to get a higher return than you could with things like bank CDs and savings bonds.  In our case, we’ll be investing in stocks, corporate bonds, and real-estate portfolios.  Part of investing is to put the odds well in your favor.  One of the easiest ways to do this is to invest for long periods of time.  Over less than a five-year period, history has shown that stocks, bonds, and real-estate can produce a positive or negative return, and these returns can vary widely.  Over a period of at least five years, there has almost always been at least positive return.  Over periods of fifteen years or longer, there has always been a positive return and a return averaging about 12-15% per year for stocks.  Because we’re talking about investing, holding periods of at least five years are expected.  If you need the money before that, bank CDs or some sort of government bonds are the way to go since their returns are predictable, if also boring and low.

Before we go too much further, let me highly recommend that you pick up a copy of The Bogleheads’ Guide to Investing.  This book will go into a lot of the details behind how mutual funds work and why you should buy certain types funds (index funds).  It also gives great advice on things like life insurance.  If you buy a copy by clicking on the book cover below and going through Amazon, it won’t cost you anything more than it would if you bought it elsewhere, but I’ll get a couple of dollars from Amazon.  If I get enough of these commissions, it keeps me wanting to write more great articles like this one instead of going fishing, so it is really in your best interest too if you like good free web content.  Just saying.

The Basic, Master Portfolio

As promised, we’ll start out by providing the investments in the basic, master portfolio.  This is the “what,” given before the “why” and the “how.”  Those details will come later.  Please don’t confuse the portfolio (which is a set of investments) with an investment account (which is the wrapper that holds the portfolio).  The basic, master portfolio could be a portfolio held in a standard brokerage account, in a retirement account such as a 401k, 403B, or an Individual Retirement Account (IRA), or it could be held in an Educational Savings Account (ESA) or a Health Savings Account (HSA).  Each of these accounts is just a place to hold the investments.  It is not an investment itself. 

If this is confusing, think of the accounts like types of automobiles and the investments like passengers.  The investment account functions in some fashion and has certain rules for its use, but you can put any assortment of investments into the account, just as you could put any combination of passengers into a given car, truck, dune buggy, or minivan as long as they would f0it.  Different types of accounts are generally suitable for different purposes, just as different vehicles have different uses.  You would not use a retirement account when you were 23 years-old, for example, to save up money you want to use to buy a house in ten years just as you wouldn’t use a sports car to drive down a jeep trail to a campsite.  Certain accounts are also more suitable for certain types of investments.  You might not want to put a high-yield bond fund into a standard brokerage account because of the taxes you would pay, for example, just as you might not want to put your toddler with a box of nuggets and a milkshake in your Corvette.

The basic, master portfolio is composed as follows:

20% General Large-Cap US Stock Index Fund

20% General Small-Cap US Stock Index Fund

20% International Stock Index Fund

20% General US Bond Index Fund

20% US Real-Estate Investment Trust (REIT) Fund

Each of these investments is what is known as a mutual fund.  With a mutual fund, a group of people pool their money together and have a professional investment manager invest the money for them, with everyone in the mutual fund owning a portion of the investments in proportion to the amount of money they invest.  For example, let’s say that you and the 500 people at your work each put money into an envelope and then hired someone to buy a set of investments with the money.  If the envelope contained $100,000, perhaps the manager would buy a portfolio consisting of ten different stocks with $10,000 invested in each.  If you had put $1,000 into that envelope, you would own 1% of the portfolio, meaning you would have $100 invested in each of the stocks.  If the stocks in the portfolio then went up and the portfolio was now worth $150,000, your portion of the investment would be worth $1500.

Furthermore, each of these is an index fund.  We’ll get into what index funds are and why you want them in later articles.  Let’s just say for now that with an index fund, rather than having a manager choose investments for you, he has a specific list of what she is supposed to buy.  This makes it really easy since the manager doesn’t need to spend time picking stocks and doing all sorts of research to do so, which makes the cost to the investors low.  Realize that the salary for the mutual fund manager and all of the travel and things she needs to buy to do research comes out of the fund, so the more you need to pay the manager, the more money gets sucked out of the fund each year.

So What’s in this Basic, Master Portfolio?

The master portfolio is made up of five different funds, each investing in different things.  We’ll get into why we spread the money out like this later, but for now let’s just say it is for something called diversification, which is a way of reducing your risk.  Investing is all about maximizing your returns while making it very unlikely that you will lose money.

The large-cap US stock fund invests in big companies headquartered in the United States.  These are household names like Apple, Alphabet (Google), Amazon, Procter and Gamble, Home Depot, Wal-Mart, and McDonald’s.  Some large-cap funds have the words “large-cap” right in their titles.  An S&P 500 fund, which invests in a list of stocks called the “S&P 500,” is a very common large-cap US stock fund.

The small-cap US stock fund invests in little companies that you’ve probably never heard of, but some of which you will hear lots about in a few years.  These are the little, fast-growing companies.  Some of these companies will make you a lot of money (think if you’d bought Amazon and Ebay back in the early 1990’s).  Many others will disappear and never be heard of again (think of Pets.com and WebVan, also from the mid-1990’s).  On average, you’ll make money by investing in a whole bunch of these small companies since those that become Amazon will make up for those that become WebVan.  The Russell 2000 is a commonly used list of small-cap US stocks.

The international stock fund buys stocks in non-US companies.  This could include companies based in countries in places like Europe, Asia, and South America.  (Yes, for our neighbors to the north, it could also be Canadian companies.)  It might also mix in a few developing countries in Africa or Central America where there is a bit more risk because the political system is a bit unstable, but there could be a huge reward if things work out.  For example, there are a huge amount of valuable resources in the Congo, but there have been many civil wars and coups in the past.  You might have a company there that is very profitable, but then a group of rebels take over the headquarters and take all of the equipment, making your investment worthless.

The bond fund buys bonds, which are loans made to companies and government entities.  Because you receive interest payments from these loans, and because most of the loans will be paid back if you wait long enough, bonds are generally less risky than stocks if you hold them for a long period of time.  Because they are less risky, however, your potential returns will be less than they will be for stocks.  You, therefore, want to have some bonds, but not all bonds.  20% of your portfolio in bonds is a good starting point that can be adjusted up or down, depending on the amount of risk you are willing and able to take, plus the amount of time you have before you’ll need the money.

Finally, the REIT buys a set of properties.  For example, REITs buy groups of office buildings, apartment buildings, malls, and even storage sheds and cell phone towers.  Chances are, the shopping mall near you and that big office building in downtown are owned by an REIT.  REITs both collect rents and sell properties for a profit as the land and buildings increase in value.  Because they are radically different from stocks or bonds, they provide yet another leg to your portfolio.  (Again, we’re doing that “diversification” thing.)

So there you have it – the master portfolio.  In the next article, we’ll break it down a little more and explain why we’ve made the choices we’ve made.  We’ll then talk about ways that you can adjust this basic portfolio to meet your risk tolerance and your needs.

Want all the details on using Investing to grow financially Independent?  Try The SmallIvy Book of Investing.  

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Avoiding Bad Investing Advice


I am a big fan of the financial independence, personal finance movement and all of the great people trying to help others not be “normal,” as Dave Ramsey would say.  It is great to hear about others’ experiences, both to learn new ways to do things and also see that others aren’t perfect either.   People who reach financial independence don’t do everything perfectly.  They buy a latte once in a while.  They sometimes buy something on vacation they later regret buying.  They maybe miss making a budget some months (very guilty, but I’m hoping to do better in May).  It is good to see that you don’t need to be perfect to make your life better and more secure in ten years than it is today.

One area that concerns me, however, is when people start to get into investing advice.  I don’t mind when people say what they are doing with the caveat that they are learning.  Just as with personal finance, hearing stories of what people are doing to invest and their results is good for all.  In particular, if someone does a boneheaded move and tells people about it and the money they lost, that is helpful.  Maybe others won’t do the same. (Although I’ve found you need to lose money sometimes before you’ll accept a lesson.  I call this “paying tuition to the markets.”)

What I don’t like is for someone who has little or no investing experience trying to tell others how they should invest.  Investing is a craft which takes years of experience to really master.  You need to have gone through up markets and down, made and lost money, and read a lot before you can really know where the pitfalls are and learn what works and what doesn’t.  This isn’t to say that you shouldn’t start to invest until you have a huge amount of experience, because you can’t get experience without actually investing.  This is to say that you shouldn’t be recommending that people put all of their money into XYZ stock when you’ve just opened a brokerage account yourself and have been investing for a year or two.

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Note that just because a person is “in the industry” does not mean that they know how to invest either.  There are a lot of people in the financial planning business who maybe have some sort of certification, meaning that they’ve passed a test on things like tax planning and life insurance with perhaps a few questions about what a stock and a bond are thrown in, but without any real experience investing.  They’ve never felt what it was like when your portfolio has declined by 40% in a month and it seems like the whole world is crashing down.  They also are often on commission to sell the high-priced mutual funds that their firm pushes so they may not have your best interests at heart.

Someone with a finance degree, or a business degree, is also not necessarily the person you want to be taking advice from.  These degrees might give them some good insight into how the financial system runs or how to run the payroll at a business, but they do not make them good investors.  In fact, there really are no college degrees that make people good investors, just as there are none that make people good salesmen of woodworkers.  It all comes from experience.

The manual on how to make money by investing.  Read The SmallIvy Book of Investing.  

Having said that there is a lot of bad advice out there, obviously, there is a need for good advice.  If you want to reach financial independence within your working lifetime, investing is almost a must.  You should be investing a portion of your paycheck and building up a portfolio that will provide income to you.  This is the way that you become financially independent.

To fill that void, you’ll see a change in the articles and organization of The Small Investor going forward.  We want to become the go-to site for people who want to learn how to invest, both complete novices and those who have been investing for a while and want to do things better.  We’ll also keep a personal finance flair as well, since managing your income correctly is the way that you free up cash to invest.

It will take a little while to rejigger things, but you’ll soon see a shift in the way The Small Investor is laid out and the kinds of articles we publish.  Most articles will be placed within two focuses – investing and personal finances.  With investing in particular, we’ll have very basic articles designed for those who know nothing about investing organized in such a way that you can go from square 1 to being knowledgeable in what you’re doing if you keep reading.  We’ll also seek out good articles from others and link to those so that readers can gain from some of the great stuff that is out there.  Finally, we’ll have a reading list that you should take advantage of if you want to really get good at investing.

So, please check back often, or better yet, subscribe so that you’ll get notified as content is added.  Also, please let me know your questions about investing and comment on what is helpful and what is not.  Let’s build a generation of investors.  Society will be better when more people are standing on firm financial footing.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Privileged Argument – An Evil Cycle Repeats


They say that if you don’t learn from history, you’re doomed to repeat it.  We’re seeing a dark history start to repeat in its newest form, the Privilege Argument.  The cycle goes something like this:

  1.  People are unhappy because they don’t feel they make enough money.
  2. People wanting to gain power tell the unhappy people that the reason they don’t have enough money is that some other group of people are wealthy and keeping them down.
  3. Other people, who think that the people who want to gain power are super cool and really smart with all of the answers, repeat their rhetoric.  The term, “useful idiots,” was coined for this group of people since they have been fooled by the people who want to gain power and are therefore useful for obtaining their aims.
  4. The people who think they don’t have enough money rise up against the group of people who have been demonized, either physically through riots or by electing the ones who want to get power because of their promises to take the money from the demonized group and give it to the poor group.
  5. The demonized people are imprisoned, banished, or killed in gruesome ways and their property stolen.  Much of their wealth is destroyed very quickly, making everyone poorer.
  6. The people who wanted power become dictators, oppress the people, and lots of people are shot or starve.

Examples of this pattern are:

The Bolshevics, Russia, early 20th century:

The Marxists, under Lenin, convince the Russian people that the Czars and Russian Elite are the cause of their problems.  They rise up against the leaders with violence and put the Bolsheviks in power.  Lenin isn’t too bad to start, but eventually Stalin rises to power and kills millions of people.  The Russian people live a sad life with long lines for necessities and scarcities of things like toilet paper.  Eventually, the USSR falls, but the corruption left from the remains of the old Soviet party remain today.

The Nazis, Germany, mid-20th century:

The German people are unhappy after the loss of WW1 and the severe restrictions placed upon them by the nations who conquered them.  Inflation is rampant with wheelbarrows full of cash being needed to buy groceries.  The Nazis, under Adolf Hitler, convince the people that the Jewish people, who run many of the shops and banks, are the cause of their plight.  (Note, the Nazis were Socialists, not right-wingers.) The people put Hitler in charge, who proceeds to try to take over the world.  Millions of Jews, Poles, homosexuals, and Gypsies are put to death in concentration camps.  Millions of people are killed in WW2.  Today some neo-nazi groups remain, still spreading a rhetoric of hate.

Hugo Chavez, Venezuela, Early 21st century:

Hugo Chavez convinces the population of Venezuela that the wealthy white farmers and foreign oil companies are the cause of their problems.  The people rise up and put Hugo Chavez in power.  The farmers are chased off of their land and the farms are given to squatters who have no idea of how to run a farm or have any desire to do so.  The foreign oil companies are chased away and the wells taken over by a corrupt government-owned oil company.  Today the country is starving to death and those who oppose the dictator in charge have their meager food rations withheld.  One of the effects of centralizing distribution of necessities is that those who oppose the leaders can have necessities withheld.  No need to send in troops with guns to control the population when you can just turn off the supplies to them.

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The sad thing is that despite these examples (and there are a lot of other examples), the cycle keeps repeating.  This is because this philosophy, take money from the wealthy (who must have become wealthy by oppressing others) and give it out to people who aren’t wealthy (because it must be that they are being oppressed), sounds good to people.  Often a government is put in between since that insolates the people who are taking the money from the ones that they are robbing:

We need the poor to have food.  Let’s have the government provide food. 

The government is seen as a limitless source of funds that can be used for whatever social good is needed.  This is separated from the other side of the coin, which is required for the “government” to provide the food since the government itself produces nothing:

The government is running out of money.  We need to raise taxes so that the government doesn’t run out of money.  Wealthy people can afford to pay more since they don’t need all of that money.  In fact, the wealthier you are, the greater the percentage of your wealth you should pay since you have obviously done evil to become that wealthy.

Even if the taxes become burdensome to the point where less food (and everything else) is being produced since those who are most productive decide to leave the society or simply do less, taxes are held high because the goal has gone from feeding people to punishing the wealthy.  If you try to cut programs back, you get the argument:

 How dare you not support programs that are providing food to the poor.  You’re taking food away from poor people.

For some reason, these ideas tend to be promoted not by the poor but by individuals who have been successful.  Perhaps this is out of a sense of guilt because they have succeeded while others have not.  They do not feel guilty enough to take on the whole problem by themselves, however, by giving away a good share of their wealth.  Instead, they demand that others give away their wealth and use the force of government to cause this.

There also seems to be a feeling of superiority by this group of do-gooders over the people they want to help.  It is true that many of the do-gooders are highly educated and very intelligent, but they lock themselves into an echo chamber and never allow their idea that “government” can just do it all to be questioned.  (Many of the useful idiots tend to be highly educated and taught by professors who themselves have been isolated from the need to work in a real economy where costs must be balanced by revenues and where raising prices reduces the amount of revenue collected.  Because they have tenure, they are isolated from economics, so they are free to advocate for their theories without any real effects coming to them.)  The do-gooders, because they believe they are superior to those they wish to help, believe that others cannot make a better life for themselves through the path that the do-gooders themselves have taken – education, learning of skills, hard work, seeing to the needs of others – because others are inferior and not capable of taking their path.  Racism also often enters in here, with the do-gooders telling themselves that those of other races can’t make it due to racism by others (even though the do-gooders control most of the necessities for success like at least half of corporate board seats and all of university admissions), but deep-down the do-gooders believe that those of other races cannot make it due to a defect in their race.

Today the argument has resurrected itself in the idea of privilege.  The idea is that certain individuals have privilege, and therefore are able to be successful.  Those who are not privileged cannot improve their lot.  If someone does not have privilege but succeeds anyway, it is chalked up to blind luck that could not be replicated.  White males, in particular, have been singled out as privileged, although virtually anyone whose family has saved and worked to earn money to provide things like a college education or a stable home-life is seen as privileged.  Nevermind that the reason they are “privileged” is usually that their parents sacrificed and worked hard, spending a great deal of time providing things of need to others, to put them in that position.  Those who are seen as privileged are the ones being demonized in this journey through the old cycle of demonize, take, then oppress.  This is the way in which those who want to gain power this time are trying to convince the poor and middle class to put them into power:

People who are privileged have an unfair advantage and there is no way someone who is not privileged can succeed.  Put me in office and I’ll tax and punish the privileged to level the playing field.  If you have succeeded, you must have been successful or lucky, so you should feel guilty and support the righting of this great wrong.

To see an example of this philosophy, read The Funnel of Privilege by Bridget Casey.  Note that she talks first about how some are privileged and her envy of them when she was younger (envy is a powerful tool used by those seeking power), then describes how she was able to make it and get a degree despite not being privileged.  One would think that this would negate her whole argument and she would be advocating for free markets and encouraging others to follow her path.   Instead, she inexplicably concludes that others who are not privileged probably won’t be able to make it without special assistance.  For some reason she thinks that the path she chose is closed to others, either because things have changed or because she was somehow special – maybe she had the privilege of intelligence or just good fortune or something.  Note the arguments that emerge when I challenge her on this on Twitter, suggesting that others could improve their lives and move into the middle class and even the leagues of the wealthy by spending time trying to serve the needs of others through education and work like she did:

Notice that she first demonizes me, saying that my secret goal is to keep those in the middle class and those who are poor working as slaves for the wealthy.  (Somehow I’m part of this secret society trying to keep the poor down because I’m not for large, incentive robbing government programs that encourage people not to produce and thereby make society as a whole poorer.)  Again, the wealthy are seen as oppressors of the poor, only becoming wealthy because they took advantage of the poor.  My personal observations are that those who become wealthy tend to be very giving people who spend a great deal of effort creating businesses and things that greatly improve our lives.  They also make great sacrifices in order to build their businesses and provide for others.  I don’t know of anyone who became wealthy through a business who didn’t spend 12-hour days in the office at least.  (If you want to learn how to become wealthy without starting a business, but through investing, pick up a copy of The SmallIvy Book of Investing where I lay out the game plan needed that anyone with a middle-class income can follow.)

She also can’t understand why those in the middle-class would be against things like universal healthcare.  The reason if you use a little bit of logic is simple:  It is because those who aren’t wealthy can’t afford to pay for other healthcare if the public healthcare is of poor quality, so they lose their ability to choose their healthcare if they are taxed to pay for a public system.  Those who are wealthy can just buy better healthcare, education, etc… if they don’t like the public system.  They are free to travel the world if needed to get better things.  Those in the middle-class and the poor are not.

Certainly, those whose parents worked hard and put money away so that their children could go to college debt-free start out their adult lives on a better footing than those who didn’t and therefore start with a large student loan.  Certainly, those who grew up in a home where their parents made sure they did their homework and helped teach the lessons they didn’t understand from the classroom had an advantage over those who came home to an empty house.  Certainly, those who grew up in a mansion and were given a car when they turned 16 had an advantage.

But the things that will make those who were disadvantaged successful is the same things that will make those who are advantaged successful:  Gaining skills, working hard, choosing a good career path, meeting the needs of others, and spending less money than they make so that they can put money away and invest.  To do otherwise would make those who are advantaged fail just as it will make those who are disadvantaged fail.  If advantage were a guarantee of success, the wealthy families would always be wealthy, but more than half of second-generation wealthy lose their wealth and more than 80% of third-generation wealthy do.  It is behavior, not your starting point, that is the greatest factor in your success or failure.

Want all the details on using Investing to grow financially Independent?  Try The SmallIvy Book of Investing.  

The post also draws comments from others who question their own success, thinking that maybe it is only because they are privileged.  (See Krista G’s comment below, where despite her coming from a modest background and working hard for her success, believes now that she somehow must have been privileged or she would not have been successful.)  Note also that they attack my narrative, that people who work to improve themselves and commit themselves to doing useful things for others can better their position in life.  My narrative is seen as keeping us from “making reforms that will make life better for EVERYONE,” where “making reforms” mean they wish to give the government more control and allow them to take money from the wealthy to fund public programs and my ideas are standing in their way.  Again, the demonization of those who object to their plan.  This is the useful idiots pushing the agenda of those who want to seize power by centralizing authority:

Hopefully, people won’t be fooled again this time.  People who are free are able to improve their lives.  There are thousands of people who are first-generation wealthy in free countries like the US.  There are millions of others who have entered the middle class despite a meager start.  The secret is spending time providing for the needs of others, spending less than you make, and investing to increase the rate of your wealth growth.  The way to do this last item is covered in The SmallIvy Book of Investing   for those interested.  The way to stay where you are is to become obsessed over things like privilege to the point where you give up and don’t try to succeed.  People who are successful will tell you, the harder you work the luckier you become.  

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How A Target-Date Fund Works


A target-date fund is a great choice for those who want to invest for retirement but don’t want to spend time learning to invest.  In fact, it is better for you to use a target date fund if you don’t know what you’re doing than it is to not know and not try to learn, yet try to manage your retirement plan anyway.  Unfortunately, many people try to do so and end up jumping from fund to fund (trying to chase returns), staying all in cash (because of fear of loss), or staying all in stocks too long (trying to maximize account balances before retirement).  Each of these mistakes could leave you far short of your monetary needs in retirement.

If you are putting at least 10% of your gross pay into a 401k or similar retirement investment plan, before any employer match, you should be set for retirement.  The main reason you would not be is because you make one of the mistakes mentioned above.  Chasing returns normally means that you are buying stocks high and selling them low, resulting in returns way below those that you would have gotten if you had just stayed in the markets and rode out the ups and downs.  Staying all in cash may seem safe, but it actually guarantees that you will end up with a negative return if you include the effects of inflation and denies you all of the benefits of investing.  Being invested entirely in stocks too long, hoping to make a big score before you retire, can lead to a huge loss right before you need the money.

Hey – if you like The Small Investor, help keep it going.  Buy a copy of the SmallIvy Book of Investing: Book1: Investing to Grow Wealthy or just click on one of the product links below, then browse and buy something you need from Amazon’s huge collection.  The Small Investor will make a small commission each time you buy a product through one of our links.

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So why is a  retirement date fund a good way to avoid these issues?

Think of a target date fund (TDF) like an automatic transmission in a car.  While someone who is skillful with a manual transmission can get better gas mileage or get from 0 to 60 faster than someone using an automatic transmission, someone who doesn’t know what they are doing can easily break something or get worse performance.  Someone who is skillful at investing can do better choosing funds than someone who uses a TDF, but someone choosing funds who is not willing to do the (small amount) of extra work involved or who just guesses blindly can end up breaking their retirement fund.  A decent TDF will get you 90% of the way to your retirement goals.  Choosing funds can get you that extra 10%, which could be millions of dollars, but might just mean that you retire with $4 M instead of $2 M.  Someone managing their account badly could retire with $0.4M instead, which could be a very meager lifestyle.

A TDF does several things automatically for you.  Specifically it:

  1.  Diversifies your investments among different asset classes.  In simple terms, it spreads your money around so that you’ll always have some of your money in whatever is doing well and not have all of your money in whatever is doing badly at any given time.
  2. Adjusts your investment as you get closer to retirement.  As you get closer to the time when you’ll need the money, it shifts from growth investments, which have a great long-term return but have very unpredictable returns over periods of a few years, to fixed-income assets, which return less but are more predictable.
  3. Rebalances your portfolio, selling what has done well (selling high) and buying what has not done as well (buying low).

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How to Use a TDF

Inside your retirement plan (or on the website for a mutual fund company if you’re using a private IRA to save for retirement) you’ll probably fund several TDFs with names like “Retirement 2060”, “Retirement 2070”, and so on.  The number refers to the retirement year for which it is designed.  For example, a 2060 fund would be designed for people who are planning to retire around the year 2060.

To use a TDF, just:

  1.  Figure out your retirement age (pick when you’ll be about 65 or 70 – more on that in a minute).  For example, if you’re 25 today, you’d be retiring around the year 2058, so you would select the 2060 fund.
  2. Once you find your fund, direct all of your investments there.
  3. Don’t touch anything – you’re done.

Let’s go through the reasons for each of the steps above.

Why pick 65 or 70?  What if you’re planning to retire at age 50?

Even if you’re planning to retire 15 or 20 years early, you won’t want to invest like you’re 15 or 20 years older than you are.  TDFs invest more aggressively while you are far away from retirement, then get more conservative as you start to get near your retirement date.  If you invest in a fund designed for 40-year olds when you were twenty, you would not be taking on enough risk to get the returns you need to grow your retirement savings early.

Instead, choose the fund appropriate for your normal retirement age.  If you save like crazy and do really well in the TDF in the first couple of decades, such that you think you’ll be able to retire within five years or less, shift to a TDF designed for someone five years from retirement at that point.  If the markets do not do well or you aren’t able to save like you think and you end up not having enough to retire at age 45 like you planned, you might just need to work another five or ten years.  Eventually, there will be a good streak in the stock market that will raise your returns.  If you invest too conservatively early, you’ll virtually guarantee that you will have sub-par returns and need to work that much harder to meet your goals.

Why not supplement your TDF investments with other funds?

You might be tempted to add a bond fund, small-cap fund, or specialty fund to your TDF to up your returns.  But remember what you’re doing – you’re using the TDF to automatically get you to your goals.  Adding other funds to your TDF would be like adding a clutch and gearshift option to your automatical transmission.  You might shift up into 4th gear when your automatic transmission was trying to shift down into 2nd.  A TDF fund is designed to work alone, so adding other funds makes things not work as designed.

Why not touch anything?

Let’s say that your coworkers or CNBC commentators start talking about how overpriced the markets are and how stocks are ready for a fall.  You might be tempted to sell your TDF and go to cash for a while.  The truth is that your coworkers and CNBC don’t know anything more about where the markets will go next year than anyone else.  Just because stocks are pricey doesn’t mean that they won’t go up more.  Just because stocks are cheap doesn’t mean that they won’t go lower.  If you sell out because you’re worried, you might miss a big rally that adds another couple of million dollars to your retirement account over time.  If you shift to all stocks because you think that the markets are ready to rally, you might go all-in right before a 40% bear-market decline.  It is better to leave things alone and let your TDF do its job.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

If You Think Investing is Gambling, You’re Doing it Wrong


 

I often hear people talk about how stock investing is gambling.  “It’s no different than Vegas when you put your money in the market,” they’ll say.  When I hear this sentiment, I know that the people I’m talking to have no idea how to invest.  They either don’t invest or use the markets as a casino, betting on red and black.  People who know how to invest understand risk and reward and use this knowledge to put the odds totally in their favor.  They know they will make money and can estimate about what return they’ll get, the only uncertainty is their rate-of-return during any given short time period.

It is true that if I were to put $1000 into XYZ stock and plan to sell within a year, I would be gambling.  I’ve spent over 30 years in the markets and I have no earthly idea what any individual stock will do during the next year.  I don’t even know what the markets in general will do, which is easier to predict because the action of no one person will move a whole market, but a single company can be moved by the actions of their CEO or even a single line employee.  But I can pick out a set of ten stocks and be fairly certain that I’ll make somewhere in the range of 10-15% annualized if I hold them for 10-20 years, only selling if something about the company drastically changes or a single position gets too big.  If you’d like to find out more details on how this is done and why it works, check out my book, The SmallIvy Book of Investing.  

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It would also be gambling to buy a mutual fund or even a set of mutual funds using money that you need at the end of the year.  For example, if you were planning to retire next year and decided to put your life savings into the Investment Company of America Class A fund with hopes of doubling it so that you could go live on the beach, you would be gambling.  You would just as likely be down 30% as be up 30% next year.  Most likely you would have between 90% and 110% of the amount you invested when the year ends.  No one can predict where the markets will go over a short period of time.  To take a position thinking that you can is gambling.

You see, as long as everyone is trading with the same information, which is largely the case since financial news gets distributed so quickly and insider trading is illegal (but still does happen, and is legal for members of Congress – go figure), everything known is already priced into the price of stocks in the markets.  If it is expected to be a cold winter, the shares of companies that sell coats and heating oil have already risen.  If a tsunami were to wash over Florida and wipe out Disney World, the shares of Disney would have already fallen by the time you heard the news.  If you think that stocks are overpriced, so do a lot of other people and they have already adjusted the prices accordingly.  

 

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Because stocks are already priced to include everything already out there already, where they go next over the next week or the next year is all a matter of chance.  Maybe someone in one of the company labs will find a cure for cancer and the shares will shoot up 1000%.  Maybe the CEO will get indicted and the shares will fall 50%.  Maybe someone who owns 30% of the company will decide to throw a big party for his daughter’s wedding and sell half of his stake, causing the price to dip.  Maybe some people will just see that the price of the stock has gone up and buy more, figuring that the price will go up further.  With all of these individuals making independent decisions in the marketplace, what the stock price will do next is anybody’s guess.

So if it is all random, how can you put the odds in your favor?  You do so by looking at the past and finding the things that were true then and will likely be true in the future.  While I cannot predict whether the market will be higher this year or lower, I do know that the market is up about three years for every one that it is down.  This means that if I hold stocks for 20 years, I will probably have somewhere around 15 up years and four down.  I can also see that the returns for long periods of time (20 years or more) average around 10% before inflation.  I, therefore, know that if I hold stocks for long periods of time, while I don’t know what will happen and when it will happen, I can be fairly certain that I’ll make about 10% annualized per year before inflation.

So, if I buy a mutual fund and hold it for a year, then shift to another one or pull money out of the market, I’ll be gambling and the odds will be about 50-50 that I will make money in any given year.  This means that I’ll probably break even over long periods of time.  If I include trading fees, taxes, and the fees that the fund charges, I’ll be slowly losing money over time.  This would be like playing baccarat in a casino.  If I hold for a long period of time and don’t mess with things, the odds are very strongly in my favor (like 99 out of 100 or more) that I’ll make money, and I’ll probably make around 10% annualized.  This means that my money will double, on average, about every seven years.  It’s not like putting money into a bank CD, but it sure isn’t gambling.

So, are you investing, or are you gambling?

 

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

If You Really Want to Close the Wage Gap, Here’s How


We’ve all heard the statistics, that women only earn 81 cents for every dollar that a man earns or some such number.  Progressives argue that this is due to sexism and discrimination, so we must have the government go in and set salaries, have affirmative action in promotions and hiring, and probably remove some men from CEO seats and insert women.  But these solutions are neither fair nor will they be effective at both creating an equal society and one at maximum productivity.  As usual, Progressives can make us all equal but they do so by making everyone broke (except for a few progressive oligarchs).

I was reading a really interesting post on Money After Graduation called The Impossible Price of the Motherhood Tax.  In this post, Bridget Casey really nails it when it comes to the reason for the wage gap, at least when it comes to men and women of equal education and vocations.  On average, women and men make similar incomes coming out of college and through their early twenties, but then they diverge.  The reason that men make more than women after this point comes down to one obvious reason:  children.

In Canada, where the author resides, new mothers can use the unemployment system to take either a year or a year and a half off (depending on where you live) when they have children and receive a little over half of their pay while they are off (they can actually start a couple of months before they have children).  (Dads can take some time off as well, but it starts after the baby has been home a few months.)  Their employer is required to take them back in the same job and at the same pay when they return.  In the US we obviously have no government mandated system, but many women (and some men) take time off when they have children.  Some, those who wish to continue to work, then put their children into daycare at 6 months or at a year or two.  If they have very understanding employers, they may be able to come back into their old job.

Others stay home until the children are in kindergarten or older, which normally means finding an entirely new job, possibly in a different line-of-work.  Because they are not able to work full hours even once the kids are in school, they often take part-time jobs in whatever is available with the needed hours and flexibility.  Even when the children are in high school and full-time work is possible, many find that they don’t want to work full-time anymore since their priorities have changed or they don’t want to go through the effort needed to regain skills and get on-the-path again if they even can.

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As the author points out, the reason for the wage gap is that parents who stay home as full-time parents, even for a couple of years, miss out on experience, raises, and promotions.  This is not a temporary issue since future raises and promotions typically build upon where you are now.  If you miss out on 20% now, you’ll always be 20% behind, even if you work full-time after that.  And because most of the time it is the woman who stays home, men in their thirties, forties, and later will tend to make more than women in the same industries. It has nothing to do with sexism by the employer.  It is due to a break in a career.  There could be some sexism involved, in that an employer who fears that a woman of child-bearing age might go on maternity leave, might not select her for a critical position.  Women who never have children might, therefore, be passed over for the best opportunities.

She advocates that it is an investment to pay for daycare since then women (and men) who are the initial primary caregiver for the children will not miss out on as much time at work.  (She does not advocate that Canadians forego the year of paternal leave, although doing so would make sense if your career were your primary concern since taking a year off per child does not help your career progression either.  I’m guessing that there is a feeling of entitlement to that paid leave, so while daycare is an investment, foregoing paid leave is not.)  While I agree that taking less time off would help, it would not solve the issue.

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The problem is that while you can lessen the initial effects of having a child on your career by limiting your time off, the person who remains the primary caregiver for the children will continue to see their time split between kids and work.  If a child has a cold or another illness, the caregiver must take time off work.  If the kid’s school gets done at 3:00, the caregiver must leave work on a schedule to pick up or meet the children.  The people who make the most in the workforce are those who have their employer as their primary responsibility.  They are able to work over as needed, come in weekends sometimes, and perhaps travel on short notice.  Unless you have someone who can take the children when plans change, often on short notice, this cannot be a person who is primary caregiver.

While Ms. Casey advocates for 32-hour work weeks and the ability to work from home so that stressed mothers can take care of that pile of laundry, the truth is that those who make the big incomes are often putting in 100-hour weeks and are always at the office.  (They are also not doing laundry when they are supposed to be on-the-clock.)  Their employer knows that they are dependable and able to drop other things to be there when the business needs them.  Someone who is the back-up when childcare falls through cannot meet that kind of responsibility.

One idea would be to have both parents split the responsibilities.  The issue here is again, to really advance in salary and position, you need to be able to put work first.  If both parents are putting in just enough hours at work and taking time off sporadically due to the normal childcare issues, neither parent will get into one of these high-paid roles.  They will both top out in salary and stature.

The only solution I can see, if your goal is to equalize pay, is for more women to choose to be the primary bread-winner and more men to choose to become full-time parents while the kids are young and then part-time or self-employed workers when the kids are older.  This will mean that women who are planning to focus on career will need to choose men who have traits of great parents (patience, charisma, responsibility, energy, organization) rather than the type-A traits of a CEO.  They will need to also shy away from professionals with gobs of college and look for guys who would be willing to give up whatever they do to focus on parenting.  Women will soon discover what men have known for ages:  To be successful in a career, you need someone behind you that will relieve you of other responsibilities so that you can focus on career.

For the guys, I think the real issue is that men currently gain most of their identity and their pride from their work.  This will be difficult to overcome, but eventually, I think that they will find that being a fulltime parent is far more important than things that most people do at work in a given day.  They may also find that the benefits when the kids get older – having more time off during the day and the home to themselves – also can be nice.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

The Basics of Investing: What is a Stock?


Before we get into mutual funds and other topics, let’s start with the very basics and talk about what a stock is and why you should be interested in buying shares of stock.  Shares of stocks are just what the name implies – they are a portion of ownership in a company.  If you own 1 share of GE, you are a partial owner of GE, meaning that you get a share of the profits they make, you get a partial say in how the company is run and what they do, and if they are ever bought by another company, you would get a share of the money when GE was sold.

The term, “shares of stock,” is used to indicate the amount of ownership, where the term, “stock,” is often used by itself when referring to the shares of stock for a particular company.  For example, you might talk about the “stock” of Apple going up in price, meaning the shares of stock for the whole company are selling for more money.  You might also talk about your “stocks,” referring to the shares of the different companies in which you have ownership.  You would say that you have “100 shares of Apple” if someone asked you about your ownership in Apple.  You would say that Apple was one of the “stocks” that you owned.

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Why would you want to own shares of stock?  Well, one of the easiest ways to become wealthy is to run a business.  This is because, when you own a business, your potential income is not limited by the salary that someone else is willing to pay you.  If you add customers, add locations, and add employees, you can increase the amount the business makes.  If the business makes more money, you as the owner, make more money.  You can either take a larger amount of the income that the business is making home with you or you can sell part or all of the business to someone else for more money since the business is making a larger profit.

For example, if a pizza restaurant you own is making a profit of $100,000 per year, you could take up to $100,000 home with you, investing the amount you don’t want to take home back into the business.  If you double sales and now make a profit of $200,000 per year, you could take up to $200,000 home.  If someone wanted to buy the business after you had increased the sales, they would also be willing to pay you more than they would have before the increase since they could make $200,000 per year instead of only $100,000 if they owned the business.

Many people don’t want to go through the hassle of owning a business.  It means you need to deal with suppliers, find customers, deal with employees, worry about you building and equipment, and worry about all of the business and tax paperwork.  Perhaps you want to work at a bank or in a middle-management job at a company where someone else worries about all of these things and you just get a paycheck.  Yet you still want to be able to increase your income.  Eventually, you want to get to the point where you don’t need to work anymore, instead just having money come to you like it would if you owned a business and had other people running it so that you could lie on the beach and collect the profits.

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Owning shares of stock allows you to do this.  You buy a partial interest in the company by purchasing shares of stocks.  You can thereby be a partial owner, getting a share of the profits, but not need to run the company.  Instead, the corporation hires managers who take care of the day-to-day details of running the company for you.  All you need to do is find companies that have good teams of managers and invest your money there.  (Theoretically you could also buy a company with bad managers and vote out those bad managers, but that is almost impossible with the way things are set up.  It is better to just sell your shares and go somewhere else where they managers are good if you don’t like the management team.)

You can buy a very small percentage of the company by only purchasing a few of the shares that have been issued, or you can buy a big portion of the company by buying lots of shares.  The number of shares you own divided by the total number of shares out there shows what percentage of the company you own.  Most of the time you’ll only own a very small portion of a company, but you’ll still be able to receive a return from the business, assuming it is profitable and able to grow, eventually sending you a portion of the profits the company makes a few times per year in a payment called a dividend.

So there you have it:  What a stock is and why you want to become a stock investor.  It gives you the ability to generate income like a business owner does without actually needing to open and run a business.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

How to Tell if Your 401k Plan Really Stinks


There is nothing wrong with the 401k, but there are a lot of really bad 401k plans out there.  If you’ve never invested, you may not be able to tell the difference.  But it is worth learning how to spot a bad 401k plan because it might be something to consider when looking at a prospective job.  You can also change your behavior if you have a bad plan to improve your investing options.  We’ll talk about this at the end of this article.  But first, here are some things to look for in your 401k.

1.  A lack of index funds.

In the world of investing, there are managed funds and index funds.  Managed funds have a whole team of managers who go out and find “investment opportunities” and “seek to manage risk while providing a reasonable return.”  The trouble is, the vast majority of mutual fund managers don’t do as well as the markets, and all of that research and pontificating comes with a hefty price tag.

An index fund doesn’t try to beat the markets.  It just buys stocks as dictated by some index, which is a hypothetical portfolio of stocks designed to track the behavior of some part of the market.  For example, in the early 20th century, Charles Dow wanted to have a way to see how the large industrial companies in the US were doing.  He chose a group of large industrial companies that covered the different industrial business areas at the time and pretended that he invested an equal amount in each company.  He then began to track what the value of that portfolio was compared to its value when it was formed and the Dow Jones Industrial Average was born.  About 90 years later, a company started an index fund that simply bought the stocks in the Dow Jones Industrial Average, and thus the “DIAmonds” index fund was born.  Unlike a managed fund, the index fund just buys what’s in the index and doesn’t need to pay a team of analysts and managers, thus the costs are a lot lower.

An index fund will typically have fees of 0.25% of assets or less.  This means it will cost you $25 per year if you have $10,000 invested.  A managed fund can have fees of 1% or more, meaning you’ll be paying $100 per year for each $10,000 invested.  While this difference may not seem like much, it means you’ll be making about 0.75% more each year in the index fund, which will add up to hundreds of thousands of dollars over your working lifetime.  A plan that lacks index funds stinks.

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2.  A lack of diversity of funds.

As a minimum, a good plan should have:

  1.  A total stock market index fund
  2. A total bond market index fund.

A better plan would also have:

3.  An international stock index fund.

4.  An REIT fund.  (An REIT is a mutual fund of investment real-estate properties, such as apartment buildings or malls, even cell towers and storage centers.)

The best plans would also have:

5.  Target-date retirement funds.

6.  Small and large-cap funds.  (Capitalization, or “Cap,” refers to the size of a company.  Small-caps are small companies, large-caps are large companies.  Mid-caps are – you guessed it – medium companies.)

7.   Growth and value funds.  (Growth funds invest in companies that are growing, while value funds invest in companies that are undervalued.   This is either buying what is doing well or buying what is considered cheap.  Both strategies work with one outperforming the other at different times.  Most index funds give you both, but some specialize in one or the other.)

Having choices allows you to tune your retirement investing.  The target-date retirement funds also allow you to put your retirement investing on autopilot if you wish.  If your 401k choices only include high-cost funds that don’t really tell you in what sector of the market they invest, your plan stinks.

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3.  Your plan switches in and out of funds.

This really isn’t so much the plan itself, but the people setting up the plan.  Sometimes the board who creates and manages the plan will change the funds available because some funds have not done well.  Assuming the funds don’t have high fees or something, the reason they may not have done well is that the sector of the markets in which they invest may not have done well.  For example, maybe you have a value index fund during a time when growth stocks are doing well, so the value fund returns 3% while the growth funds return 20%.  The board may see this and get rid of the value fund, substituting another growth fund in its place.

This is exactly the wrong thing to do.  Because growth stocks have done well, it means that they may have already gone up in price to the point that they are expensive.  Conversely, value stocks may now be especially cheap.  Think of going to the store and finding that strawberries have doubled in price, while grapes are selling for 80% of what they normally sell for.  While you don’t know what strawberries and grapes are going to sell for next week, you can bet that over time strawberries will not go up in price as much as grapes will.  The same is true for stocks.  While the timing is difficult, you will not do as well buying stocks when they are expensive after a big run-up as you will if you buy them after a drop when they are cheap.  If you find that your funds get dropped when they don’t do as well as other funds, other than due to the fact that the fees are high, your 401k plan may stink.

What to do if you have a stinky plan.

There is not that much you can do if you have a bad plan, but there are a few things.  These are:

  1.  Invest outside of your plan in an IRA.

You can open up an Individual Retirement Account (IRA) with any mutual fund company or brokerage firm.  This will allow you to get the same tax-deferral that you get with a 401k plan.  Inside an IRA, you can invest in almost anything.  If you open an IRA with a mutual fund company, you will often be able to invest in their mutual funds without paying a fee when you buy or sell the funds.  Tax laws may limit the amount you can put into an IRA if you have a retirement plan at work, but you may be able to put some into an IRA.  You will also probably be able to put the full amount (currently $5500 per year) in an IRA for a non-working spouse even if you have a 401k plan at work.

2.  Invest in a taxable account.

While not as good as an IRA, there is nothing from stopping you from investing for retirement in a taxable brokerage or mutual fund account.  If you invest in index funds and hold them for long periods of time, you’ll still pay very little in taxes each year.  While you may pay some taxes on capital gain distributions from the fund, as well as on dividend and interest payments, most of the time you’ll only see a big tax bill if you sell funds at a big profit. If you buy and hold, most of your money will be left to compound just like it would in an IRA or 401k.  In fact, your tax bills at the end may be lower than you’ll see with a 401k since capital gains rates, which you’ll pay on profits from a taxable account, are usually substantially lower than standard income tax rates in the top brackets, which is what you’ll pay for large 401k distributions.  You won’t see a tax break when you put the money into a taxable account, however, like you will when you put the money into an IRA or 401k.

You can also buy some individual stocks in a taxable account and not see a big tax bill (until you sell).  You just need to hold them for long periods of time, like ten to twenty years, rather than buying and selling stocks for a quick profit.  The good news is, you’ll do far better buying stocks for long periods than you’ll do trading.  This is like a win-win.  You can also reduce your taxes when you do sell by selling losing positions to offset gains in winning positions

3.  Be sure you still get the company match.

If you do decide to us an IRA or invest in a taxable account, you’ll still want to put enough money into the 401k plan to get whatever matching funds the company provides.  This is like getting a 100% or 50% return on your money right from the start.  If you do this, but your 401k plan stinks, you can always roll whatever is in your 401k plan to an IRA when you leave the company.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

Why the Debt-Free Dave Ramsey Snowball Works


I wrote a contributor post for Camp FIRE Finance this week.  I hope that you will take a look at the post and also the other great articles on that site.  This is a website with articles for people who are attempting to become Financially Independent and Retire Early.  Some individuals who achieve FIRE have large incomes and just live a modest life.  Others have normal incomes but then decide to live very frugally so that they can put money away to retire early.  This second group would be the tiny house types, cutting things down to the bare necessities so that their cost of living was very low.

My post was on cash flow.  Specifically how the way to gain financial independence is to create a large free cash flow, defined as the money that you have left over after paying for everything and putting money away for things like retirement and healthcare.  In both of the cases described above, the high-earning couple who live modestly and then put a lot of money away and the couple who cut their expenses to the bone so that they can save up, really what these individuals are doing is creating free cash flow.  If the high-earning couple makes $500,000 per year but lives on $400,000, it is no different than the couple earning $120,000 per year who lives on $20,000.  Both have a free cash flow of $100,000 per year.  This means that they will both be in the same condition financially in ten years.  They will both have $1 M, assuming they both put their money in their mattresses rather than investing.

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A comment on my post really made me think.  He said that what I was describing was what Dave Ramsey calls the “Debt Snowball,” but done in reverse.  That is almost correct.  What I am really doing is telling you what to do after you’ve paid off your debt and done the debt-free scream on the show.

The Dave Ramsey show tells people how to pay off their debts using his “baby steps.” He advises people to first 1) build up a baby emergency fund, then 2) get current on all of your bills, then build up a full emergency fund (3 to 6 month’s worth of expenses) 3) start attacking the smallest debt while paying the minimums on the other debts, 4) once the first debt is paid off, use the money you’re saving on payments plus the money you were using to pay the smallest debt to attack the next highest debt, 5) continue to pay off debts, adding the money you’re saving to your payments each time, 6) pay off your largest debt, becoming debt-free, then call up the show and scream about it.

The trouble is that he then kind of leaves you hanging.  He will talk a little about putting money away into mutual funds, particularly for retirement.  He will also tell you to continue to budget to avoid going into debt in the future.   But he really doesn’t keep you focused,  continuing to use your snowball of free cash to build wealth now that you have gotten this far.

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And that is really what the debt snowball is – building up a snowball of free cash.  At the start, because you have so many obligated expenses each month – things that you are forced to pay like the mortgage, car payments, student loan payments, and credit card payments – you have very little free cash flow. Pretty much every dollar that you have is already spoken for before the month even begins.  But you gather up the little bit that you have, forming a little bit of free cash like the kind of snowball you can hold in your hands and use it to attack the first debt.

When you kill off the first debt, you now have a little more free cash flow.  The money that was going towards payments on your smallest obligated expense is now free since that obligation is gone.  Maybe it was $50 you were sending in each month to pay on a credit card for a department store.  You add this to the $300 per month you had in free cash, and now you have $350 in free cash each month.  The snowball gets a little bit bigger.

Maybe you now attack a $3000 debt you have on another credit card that you were paying $75 per month on.  You attack this debt with your $350 per month in free cash flow and pay it off in 10 months.  Now you have $425 in free cash flow to attack the next debt.  You continue on this path, increasing your free cash flow each time that you pay off a debt.

Once you have paid off your last debt, you now have a huge free cash flow snowball.  Maybe you have $2500 per month that you were spending on student loans, car payments, and credit cards.  Maybe you even pay off your mortgage and now have $4000 in free cash flow each month.  You can use this free cash flow to start building up assets, which now pay you interest each month instead of charging you interest.  (We’ll talk about how you do this in the next post.)  That is how you go from being debt free to financially independent.  If you can do this while you’re still young, perhaps you’ll reach FIRE as well.

Have a burning investing question you’d like answered?  Please send to vtsioriginal@yahoo.com or leave in a comment.

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

It’s Time for the Public Sector to Follow the Private in Retirement Plans


Let’s say that you went to a bed and breakfast, checked in, and went up to your room.  The room was a mess with bed-clothes strewn on the floor, breakfast dishes piled up on the table, and a big black ring around the whirlpool tub and soap suds near the drain at the bottom.  You are then told that you owe a $100 cleaning fee to get the room back in shape so that you can enjoy it.  At least, you might get to enjoy it, but then again they may need to raise the rates after you pay the cleaning fee, or maybe they’ll just shut the place down entirely.

You protest, saying that you were not the ones who used the room last and that the ones who did should pay the fee.  The host replies that the last people have gone, that someone needs to pay to have the room cleaned, and that the someone is you.  You try to back out of your reservation, but you’re told that you must pay the fee or they are calling the cops.

How would you feel?  Would you feel that you had a responsibility to pay the fee?  Would you begrudgingly do so, hoping that the next person would pick up the tab for you?  If you paid the fee, would you then feel entitled to having the fee paid for you by the next guest?  A guest who, just like you, hasn’t stayed in the room yet and had nothing to do with any bargain you make with the inn keeper.

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The same thing happens with things like public pension plans and Social Security.  People long ago made agreements with politicians long since gone to receive something far in the future in exchange for their services or tax money.  In the case of public workers, voters and residents forty years ago received services for which they paid some taxes, but salaries were low in exchange for promises of generous retirement pensions, free healthcare for life, and other benefits.  Those benefits were not paid for by the residents who hired the politicians who made those deals.  They only paid for the salaries of the workers and in exchange they received various city, state, and federal services. Now that the workers are retiring or have been retired, the next generation is expected to pay for those retirement benefits.  This next generation is paying for the retirement of workers from which they received no benefit based on agreements they did not make.  Kind of like needing to pay for a room to be cleaned that you did not use.

Social Security is the same way.  Back in the 1930’s, people voted for President Roosevelt and a Congress who created Social Security, originally charging about 2% of pay in exchange for just enough retirement income to avoid starvation and to keep the lights on.  Voters at the time agreed to pay these taxes and pay out benefits to people who were starting their retirement at that point even though those people had paid next to nothing into the system, in exchange for the promise that they would receive a payment in the future.  As it looked like more people were going to retire than the system could sustain, the tax rates were raised in anticipation of needing more money, eventually reaching more than 12% of pay even though benefits remained flat.  This would have helped, but all of the extra money was spent as soon as it was collected, leading to the current situation where benefits will need to be cut in the near future unless taxes are raised further.  Again, people who had no part in the agreement are expected to pay up.

What if they say, “No?”  What if they decide to cancel Social Security, or cancel public pensions?  If they are forced to pay for these items because they are in the minority, what if they just decide to work minimal amounts, or quit work and raise a garden, producing just enough to feed themselves?  What if they move away to other countries or simply stop working and go on the public dole themselves?  What then?  Are you going to try to force them to work?  Isn’t that called, “slavery?”

Sorry, but those in the next generation are no more morally obligated to pay these bills than you would be if you would be obligated to pay for the cleaning of a room if you showed up to a bed and breakfast with a dirty room.  They did not make this agreement.  They did not continue to vote the politicians in who made these arrangements.  They did not look the other way while all of the extra money raised for Social Security was blown on battleships and public rail lines.  It is neither their agreement nor their responsibility.

“But someone needs to pay the bill,” you say.  There is no good answer for this.  Somebody will feel some pain because of bad agreements made years ago.  Perhaps the pain should be spread around a bit, but perhaps those who made the deals should take a greater share of the pain.

Going forward there is a better way.  Public employees and public retirement plans should follow the lead of private employers.  Rather than a future promise, retirement should be paid for as-you-go.  If a politician promises a lavish retirement in the future, the city, state, or Federal government should pay for their share of it right away by putting money away into an account owned by the employee.  Future governments are free to stop putting money into the account, just as the employee is free to leave and find another job if the retirement benefits being funded are not to his/her liking.  When the employee retires, his/her retirement is paid for and there is no need to rely on future taxpayers.

Likewise, money for Social Security should be paid into private accounts.  These could be invested automatically in broad stock and bond market index funds to eliminate the risk of poor personal management.  When individuals are ready to retire, they would have their own account and not need to rely on future workers contributing in order to continue to receive a check.  Isn’t that a better way?

Follow on Twitter to get news about new articles.  @SmallIvy_SI

Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.