This was the year I dialed in my investment strategy.
The motivation was an increasing awareness that I was accumulating a fair amount of money. At the end of Year 5, I had almost eighty thousand dollars available to save and invest in one way or another. Every month that went by, that number increased.
Look – when you’re just starting out, it doesn’t really matter what you’re doing. Your savings rate is by far the most important variable in the Retire Early equation. It’s much, much more important than your asset allocation or how much your funds are or aren’t growing.
A quick example: You have 10K invested and it makes or loses 10% a year. So this amount swings a thousand up or down. It doesn’t matter much either way, because the numbers are too low to have any real effect on your FIRE date. Further, on the saving side of things, if you’re making 100K and you increase your investing percentage from 20% to 60%, you’re talking about a forty thousand dollars a year difference. That’s why your savings rate is a big, big deal when you start out.
Once you get around the 100K mark in invested assets, strategy and performance starts to matter a bit more. It’s still much less important than your savings rate, but at the same time, the dollar amounts are no longer inconsequential.
So that’s about what I have in the middle of Year 6: 100K. It’s one of those magical financial milestones for people on this FIRE journey, where you sit back and say “Holy shit, this thing is working! Awesome!” It’s suddenly important to make better decisions around how, exactly, you should be investing.
I decided to take a deep breath, schedule some time for myself, and hit the books again.
Back in Year 3 I’d hit the San Francisco library in an attempt to get up to speed on what to do with my money. I read Four Pillars of Investing, Mutual Funds for Dummies (surprisingly NOT bad — they are Vanguard advocates), and The Single Best Investment: Creating Wealth with Dividend growth.
But the lessons were foggy in my head. I remember my big takeaway at the time was that I wanted to be probably 90% in stocks and 10% in bonds, and that was it.
By this time, things were a little different. A few years had passed. Amazon’s reviews were getting more numerous and reliable, allowing people like me to zero in on some books over others. I decided to read Common Sense on Mutual Funds, by John Bogle.
In case you’re not aware, Bogle is the founder of Vanguard. He advocates investing exclusively in index funds. I’m completely, 100% sold after reading this book. In fact I was so thoroughly convinced that I basically stopped reading books on other investment strategies.
The asset allocation part of things took me a bit longer to work out. Long story short, I ended up going with a slightly modified “coffeehouse” portfolio, which worked out to 30% Total Bond, 20% US Small Cap, 10% REIT, 10% Total International, 30% US Value funds.
For the funds held in my company 401(k), fund selection was a little trickier because I couldn’t simply select the Vanguard funds, so I did the next best thing: I tried to pick the most similar fund from the list of available options.
I held this allocation until 2009 when I made the change to my current allocation. But all things considered, it’s not a bad way to go and I don’t have any regrets about it.
For fun, I walked around the office and asked team members if they’d be willing to talk to me about their investment strategies.
Not numbers, of course. That’d be crass.
But generals. What did you think worked? What didn’t?
Keep in mind I worked for FinancialCompany. I was expecting some really high-powered, unusual responses that would be head and shoulders over the stuff I’d just read in the books listed above. Instead, I got very standard crappy advice. I break down the investing types into a few distinct categories.
Investor Type 1: Individual Stock Picker
Description: This type of investor likes to park on E-Trade and buy and sell ETFs in his/her favorite companies based on a combination of research and gut feelings.
Rationale: I’m never going to retire unless I hit it big on a specific company. So I’ve got to find that company. Grab the bull by its horns. And pray.
Investor Type 2: Allocation Changer (AKA Market Timer)
Description: People who fell into this category basically bought into the mutual fund idea to reduce risk, but couldn’t settle on exactly what mutual funds to own, and in which percentages. As a result, they constantly shifted money around from Fund A to Fund B and back again, making their portfolios look completely disorganized, like they were chosen at random by hyperactive six year old who’s just downed a coke and followed that sugar-fest up with some cotton candy and skittles before clicking boxes on daddy’s computer. Good job, sweetie!
Rationale: I just know when the markets are or aren’t overvalued and I’ll get in and get out when my spider sense is tingling because if I stay in then I’m guaranteed to periodically lose a lot of money. So like if inflation is rising I’ll take money out of bonds and put it into maybe sector funds. I like energy right now. Yeah. I’ll put 20% in energy. Then if things change again, maybe I’ll go with emerging markets or Biotech. That’s the ticket.
Investor Type 3: Actively Managed Fund Lover
Description: These folks like mutual funds but prefer active management over passively managed index funds.
Rationale: Some people are just smarter than us and can beat the market over time. All I need to do is identify those people and buy into those funds. Then I’ll beat your average Joe Investor. This advantage will easily be worth the higher expense ratios. Know the Man, Know the Fund.
I didn’t meet anyone at FinancialCompany who was a straight index investor. They all thought they could beat the system in some way or another.
I think they were wrong.
All of those conversations made me more certain than ever that the best approach was to let go of the illusion of control and accept average returns. My coworkers thought that there was some secret sauce to investing — if they could only pick the right manager, find the right tidbit of information on a stock pick, move money into gold at the right time — they’d beat the system. Instead they received below market returns.
I asked one guy in particular who fell into category 3 if his funds were beating the market average over the last 5 years. “Of course!” he said. I asked him to log into the system to just double check, and provided him with the S&P return over the same timeframe. His funds came out slightly ahead at .5% more.
See?? he said, totally bragging.
Then I reminded him about fees. His funds averaged 1.5% or so. He spent the next 10 minutes trying (and failing) to explain why his strategy was still more effective than indexing even though we’d just looked at data to the contrary.
One thing about investors which is true across the board: We’re very, very good at lying to ourselves — and others — about our own performance.
It feels far superior to pretend we’re doing better than we actually are.