The markets are down, inflation is up, and the thought of a recession is looming. It's heavy stuff. And it puts strain on our emotions and brokerage accounts. It takes some mental fortitude even to consider long-term investing in tough times, but historically, they present long-term investors with the opportunity to build substantial wealth. That’s why I want to spend the next two newsletters talking about investing. In this email I’ll share the fundamental considerations you need to build a foundational investment mind and then in my next newsletter, I’ll get a bit more advanced and technical.
😫 Investing can be hard
I'm not going to sugar-coat it. Investing can be hard. Amidst too much information, differing opinions, and endless tools to choose from, the process can feel overwhelming. So, over the next two newsletters, I’ll share my thoughts and pull wisdom from some of the smartest investing minds I know to give you what you need to know to invest for the long-term.
While one thing is sure - there is no perfect formula for investing success. It largely depends on your circumstances, personality, and timeline. The good news is that there are specific things to know and do to increase the likelihood of success. And while none of this should be misconstrued as personalized financial advice, I hope it will help you make decisions and actions that propel you to become a successful investor.
I'd love to hear how you think about investing, so please reach out and share your ideas, thoughts, and hacks that have helped you along the way.
🥱 Good investing should be boring
While growing your wealth through investing is exciting, I have learned that nothing about good investing should feel exciting. In Episode 19, Andy Rachleff explains that investing should be boring, and that you should put your money in long-term index funds and let it go. Why? Well, because it's hard to pick stocks and even harder to pick long-term winners that beat the market. Only ⅓ of professionals outperform the market in a given year. And when you extend the timeframe to 10 years, the number of professionals consistently beating the market is shockingly tiny. This means it makes it even harder for an individual who doesn't spend all their time picking stocks to be successful long term.
Investing is like a diet. It should be boring. And what's more boring than index funds? Low cost. Diversified. Passive. But it’s the favorite strategy among professionals.
🤑 Scratching the itch
Boring sounds logical, but some of us need that bit of excitement. It's hard to overlook the stories of people making quick wealth through angel investments or early crypto bets (though might be worth checking back in with those folks now). While these are engaging and fun, those investments are often much more speculating than investing.
One approach to making these types of bets comes from Ben Carlson in Episode 42. He suggests you only consider alternative investments after you have done everything to get your financial house in order. Protect your downside first. And while boring index funds are the preferred strategy, if taking 5%-10% of our portfolio to scratch our investment itch with investment ideas that excite us, it may simply be the cost to keep the rest of our portfolio on track.
And when I say alternative investments, I mean real estate, commodities (e.g. gold/silver), cryptocurrency, NFTs, art, private companies, wine, and even royalties.
📝 Important investment considerations
The term asset allocation gets thrown around a lot. And while asset allocation is how you shape your portfolio among different asset classes, the trick is to think about asset allocation as it relates to your world, not others.
At its core, asset allocation is the answer to a simple question, "what should I invest in?" And while we've talked about index funds already, the answer really depends mainly on your risk appetite, liquidity needs, volatility tolerance, and time horizon. Let's talk about what those are and why they are essential.
Risk.It is the level of downside exposure you are willing to endure for the potential return you are expecting to receive. While no investment is purely risk-free (even cash is exposed to inflation risk), lower-risk investments will carry lower returns while high-risk investments come with higher-upside (in theory, of course).
Liquidity.It is the ability to access money quickly and easily. Cash sitting in a savings account is liquid, while an investment in a private company probably is not. While you can think of liquidity as short-term needs, you can also think of it as a planning mechanism for future needs. For example, if you know that you need money to use for a downpayment on a home in 3 years, then you may need to plan your asset allocation around future liquidity needs, not just emergencies. Re-listen to Episode 19 to hear Andy Rachleff highlight the importance of liquidity and why it might be undervalued.
Volatility.It is the speed at which prices or the value of investments can go up and down. While volatility is not a cost per se, it is an emotional fee. Nick Maggulli explains in Episode 59 of the podcast that it's an admission fee to investing, except it’s not paid with your dollars, it's paid with your emotions. And volatility is embedded in the fabric of the markets.
Time horizon. It is the time between buying and using the money for non-investment purposes. With a short time horizon, you might be better off not trying to squeeze that extra yield so you’re sure you have the money you need. However, with a long- term horizon, you might be willing to accept more drops along the way, because you don’t need the money for a while.
📉 I'm ready to buy low and 📈 sell high
While asset allocation is what to invest in, you must also consider when. I'll save you the trouble of guessing. You probably won't be able to time the market, so don't try. I know from experience. Trying to hold cash to wait for the perfect entry exposes the risk of losing a lot of upside. Many are worried about investing during 'all-time highs' but that phrase is doing a disservice to investors, because the market should always be at all-time highs because on average the market is always going up. So yes, in theory, the market should always be up and to the right.
So when is the right time to buy? Well according to this Vanguard study it’s as soon as possible. Mathematically, if the market goes up in the long term, then the average daily return is positive, and therefore you should invest all your money right away to not miss out on those returns. And any mathematical argument against that would have to assume you can time the market, which I'm going to assume you can't do.
However, you really need to factor in emotions, because spreading an investment out over time (Dollar Cost Averaging) has psychological advantages you can't ignore. For example, if investing everything all at once and seeing it all drop 5-10% over the following wee week (which has already happened a few times in 2022) would make you miserable and worried, then it might be worth investing that money over time, even if it has the possibility of smaller returns.
However, I would strongly encourage you to make a plan and commit to it, because too often I hear people say things like "now that the market it going up, I'll just wait for it to go down a little more before investing" and I've seen people wait for years and miss out. In the past I've typically done my dollar cost averaging over a shorter period of time like 3-6 months. But given that I should have some extra cash to invest later this year, I might as well share exactly what I plan to do.
First, I'm going to set aside all the money I'll need for taxes and put it in my Wealthfront Cash Account (currently paying 1.4%). For the rest I’ll probably invest it all over a 3 month period, split 1/3 each month into my Wealthfront Investment Account (get $5k managed free at Wealthfront here). However, knowing myself, if the market is down after the first investment, I'll likely start to accelerate the rest...
While I don't think you can time a dip, I'm not afraid to buy it if I find myself in the middle of it.
💰 When do you sell?
All too often, I hear about panic selling when the market declines. Those instances are when emotions get the best of us. It runs counterintuitive to investing, but it's a common theme among many. We’ve talked a lot about buying, so let's discuss the logical instances for selling your investments.
You need to rebalance your portfolio. You may need to trim some positions because a single investment now dominates your portfolio. Or a losing position may amplify your risk and you need to cut it. Or if your time horizon or lifestyle evolves, you might need to shift to a safer asset allocation. It's less about selling entirely and more about repositioning your portfolio to suit your needs.
Your original investment thesis turned out to be wrong.When you bought it, there was some method to your madness. But as time passed, it didn't go up as much as you expected. When you compare your initial thesis to the current situation, it might not make sense to keep going.
There is a better use for the funds.Sometimes a better option comes along. Maybe it's for tax advantage purposes, a lower-cost option, or an investment that meets all of your criteria. When there is a better option, don't feel pressured to stay just because you’ve already made the investment.
When you wouldn’t make the investment today.One of my favorite thought exercises for investors struggling to decide if they should sell, is to pretend they accidentally sold the position (and temporarily ignore any tax consequences) and then ask if they’d use their cash to make the investment again. Often times (especially when the investor is an employee at Google or Facebook with 95% of their net worth tied up in their companies stock) the answer is no, in which case I think you should definitely think about selling.
You’re using the money to spend on your lifestyle. I don't mean buying a fancy car or something out of your means, but instead spending it reasonably on the things that fit your lifestyle. Isn't this the reason we invest in the first place?
Selling is a different mindset, an entirely new set of decision parameters. The problem is that we often can't remember why we bought it in the first place (other than hoping to make more money). In Episode 48 of the podcast, Brian Feroldi says to use an investment journal during the buying process to help during the selling process. Include three items: the type of investment, the price, and why you buy it. So when it comes time to consider selling your assets, you can recall why you invested in the first place and match your current decision process with the previous one.
A final reminder... every sale of an investment that’s gone up triggers a taxable event (if it's not in a retirement account). So don’t forget to set aside money to pay the IRS at the end of the year. I’ll never forget hearing about a colleagues friend who sold an early crypto investment in 2017 and netted over $1 million, only to lose it all on a risky investment in 2018. Unfortunately, when it came time to file and pay his 2017 taxes, he didn’t have the money and ended up having to file for bankruptcy. Whenever you have gains, always set aside money for taxes.
🧑🏻💼 Hiring a financial advisor
Should you hire a financial advisor? While an index fund strategy does not require a financial advisor, that doesn’t mean they should be ruled out forever. In Episode 42, Ben Carlson discusses options for when a financial advisor might make sense.
When you're just not that interested in investments
When you don't have the time to invest at all
When you experience a life event and don't want to mess it up
When your life gets complex enough that it prevents you from taking action
Suppose investment overwhelm prevents you from investing, and a financial advisor enables you to act rather than do nothing. In that case, I'd say it's a better option than doing nothing at all. However, financial advisors are not the only options to help you with your investments. Finding a great tax advisor can get you a lot of the way there at a fraction of the cost.
🔍 Focus on the things that you can control
To wrap up this post, I want to revisit Andy channeling his inner Burt Malkiel in Episode 19. You cannot outperform the market, so you shouldn't try. Instead, it would be best to focus on the things you can control: diversification, minimizing fees, and minimizing taxes. And what most people don't realize is that there are far more advantages to minimizing taxes.
I look forward to sharing the next investment newsletter, where I’ll dive deeper into investing topics like tax hacks, inflation, debt, and more. Stay tuned!
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