Twelve Reasons I Sleep Well at Night While Investing
- February 19, 2018
- by Michael
When I was in my early 20’s I was adverse to the idea of putting money into retirement accounts. I knew on a basic level that my money was “safe” at my credit union and it was “at risk” in the stock market. Paper assets like stocks, mutual funds and bonds seemed fake and far away. I had dabbled in stocks and got burned which didn’t help. Money wise I was caught up in what kind of car I drove but someday wanted to buy a house.
Fast forward a few years and it started to make sense to put some money into “the market” through my work’s retirement plan. The goal being to max out the matching contribution (and give myself a net pay increase in the process).
Still my gut reaction was - this sucks because I don’t have access to the money for years, I don’t understand where it goes, and what if it drops in value???
It is easy to distrust Wall Street, am I right? There are countless scandals, ponzi schemes, and sales people promising fake returns.
It took me many years to absorb the investing knowledge I have, to know how to tell a good investment from a bad one, and to build up faith in the following ideas. I’m not a financial advisor. I’m merely sharing the ideas that worked for me. Right now my strategy is to play it safe and get rich slowly (so I can retire comfortably, hopefully early).
I want you to study up on it yourself and come to your own conclusions.
How I Sleep Well At Night While Investing:
1) I Diversify Through Funds
They say diversification is the only free lunch on Wall Street.
The idea with diversification is to spread out your risk across many many assets. If you own a single stock and it goes bust, you go bust. Diversification insulates you if a single company goes bankrupt or one bond defaults. Yes you take a hit, but it is such a small portion of your overall portfolio it doesn’t hurt much. The flip side is, you get exposure to the good things too.
Diversification applies to all kinds of assets (stocks, bonds), to entire industries and sectors (technology, consumer goods, etc), and across international borders.
Given that diversification is so handy there are countless mutual funds and exchange traded funds (ETFs) that offer it. What they do is hire a manager and a team of finance people to acquire and manage all the holdings. They also have a team of sales people who promote the fund. The individual investor is allowed to buy a slice of everything in the fund in the form of a share. In return for giving the investor access to such variety, they charge a fee, called an expense ratio which is paid by the investors. Since the contents of the fund are made public, the overall value of the fund is driven by the market, making it in theory fairly priced and safe to invest in.
Some funds are very specific, others are very broad, and you can get extremely detailed in your approach.
I keep it simple and focus on the following four asset categories:
- US Stocks (a blend of large, medium and small companies)
- US Bonds (US treasuries, corporate bonds, and municipal bonds in my taxable accounts only)
- International Stocks (non US based publicly traded companies)
- International Bonds (non US bonds)
To make life easy there are funds that target multiple asset categories in a given allocation ratio (conservative, moderate, growth, aggressive). Allocation funds, and “funds of funds” also offer the advantage of automatic rebalancing (more on that in a little bit).
Note that Hedge Funds are different in they may not disclose everything they own, making them out of bounds for my purposes.
2) I Opt For Index Funds
I use index funds when I have the option to. Not all retirement plans have them. Index funds don’t try to beat the market. Thinking you can beat the market is folly anyway (read Fooled by Randomness if you want your mind opened).
Index funds instead try to match the market or whatever index they track. If you’ve seen the S&P 500 or the Dow Jones, you’ve seen an index. The idea with index funds is the overall expenses are lower (since someone isn’t working hard to out pick the other guy), and there is less risk (since nobody can screw it up).
Going with index funds means I accept I’m not going to beat the market. That is just fine with me.
3) I Watch My Overall Allocation
I track my overall asset allocation (for example 60% stocks, 40% bonds) and target levels my wife and I are comfortable with. In general the more bonds the less risk. But too much bonds early on means having a shortfall risk (not enough growth in the long run).
In the case of my wife and I, as we get older the percentage of bonds will increase a little. That reduces risk and locks in the overall portfolio.
You can play with allocations in the Retirement Nest Egg Calculator and how they have worked out historically.
4) I Rebalance and Prefer Automatic Rebalancing
Another thing they like to say in the stock market is “buy low and sell high”.
Rebalancing is a built in mechanism to do just that. Let’s say you opt for a 50% stock 50% bond portfolio. Then let’s say stocks go up by 10% and bonds stay flat. Now you have 55/105 = 52.4% stocks and 50/105 = 47.6% bonds in your portfolio. To rebalance, you’d sell stocks then buy bonds to rebalance your portfolio back to 50% stocks, 50% bonds. In theory you bought low and sold high...
Not only do I rebalance my portfolio a few times a year to match my allocation, many of the funds I own are also doing internal or automatic rebalancing. The automatic rebalancing is really nice because I don’t have to think about it.
5) I Keep Expenses Low
I keep my expenses low by selecting funds that do what I want but also have low expense ratios. This gives me maximum compound returns over the next 20-30 years. For more on this subject see Keeping Your Investment Costs Low: The Golden Rule of Investing. Avoiding transaction fees, load fees, account fees, and fees in general is a good practice, and the good brokerages make it free to invest in a wide array of options. If you are paying maintenance fees, or more than a 0.25% expense ratio, look around and see what else is available.
6) I Dollar Cost Average Into My Positions
Remember I said I was afraid that I’d put my money into the market and it would lose value? Well that is a natural fear that any reasonable person should have. Consider though, if you are young, that most of your money will be earned in the future. Had my young self realized that, it wouldn’t have seemed like such a big deal.
I automate my contributions so I’m dollar cost averaging into the market every pay period. Some weeks I buy at the top, other weeks I’m getting a deal. After awhile I stopped paying attention to that because my contributions are based on a plan, not based on getting the “best deal”. It is impossible to time the markets anyway.
7) I Use Several Financial Institutions
I spread out my money across multiple financial institutions.
Sure Bank XYZ would LOVE IT if I rolled ALL my money to them, let them sell me loans, investments and insurance. But I’m not doing that, for good reason.
If one of my investment account gets screwed up, since it is one of many, it will be above the proverbial water line of my ship. I can handle dealing with multiple statements and having to login to several different web portals from time to time. I just don’t want all my eggs in one basket, in one database, beholden to a single corporation with crappy customer service (don’t they all?).
8) To Me Cash Is Not An Investment
History has shown that cash is a terrible investment. Check out this link for proof based on 90 years of historical data. The interest you get on cash is ‘risk free’, so it isn’t gaining any real purchasing power. This idea helped me get comfortable with moving money into the market.
9) Inflation is Coming
Given that inflation is baked into the system, market will have to go up, just like prices in general. Stocks typically do okay during inflationary periods. So does real estate and I've got my primary residence to cover that.
10) Capitalism Is Here To Stay
Given my diversified investment strategy, what I’m actually investing in is the global economy, well mostly the US economy. So as long as capitalism is alive and strong, my assets will do really well. If capitalism gets taken down, I’ll have a lot more to worry about than what my net worth is.
There are just too many people invested in capitalism, many of them way richer than me, not to have faith in it.
11) I Choose Not to Own Rentals (for now)
A lot of homeowners don’t realize it, but their net worth is heavily concentrated in their local real estate market due to their home equity.
Some people think buying a rental down the street would be a good investment. Even if it was going to return 8% (which would be great for a rental), would it make sense to have all your money tied up in one zip code that could get knocked out by a hurricane, an earthquake, or an economic downturn? That is the opposite of diversification!
For me personally, having owned rentals and sold them, I can say it is a LOT of work and they did cause me to lose sleep at times. There is hidden risk in rentals, just like individual stocks, so I plan to avoid them for now. If you want to bet on real estate, but not own a rental, you still can through a type of fund called a REIT. With a REIT the toilet never clogs. See our post Understanding the Realities of Investing In Real Estate for more ideas.
12) I Do Not Worry About Another Recession or Great Depression
Yes the globe may fall into a depression, and if it does, I’ll get to watch my hard earned retirement funds dwindle, possibly to a whisper of dust… At least I’ll be in the same boat with all the other index investors. My hope is to maintain enough of an emergency fund so I never have to touch my retirement contributions until I actually retire.
Based on what I learned from the the 2008 recession, for index investors the best thing to do was hold on and rebalance like normal. During that time there was a 30-50% drawdown depending on allocation, so be prepared to face that again. Rebalancing paid off nicely in the resulting rebound.
Many people kept their jobs during the recession. Those who were able to continue contributing to their retirement plans got a great deal during that time.
I’ve come to accept that paper assets like stock and bonds are okay, provided I have proper diversification and my overall asset allocation stays where I want it. I think it is fortunate to live in a time where I can own a small slice of every major publicly traded company while keeping a portion of my money in bonds to moderate against volatility. Maybe my generation is due to face a depression or a decade of zero progress, but I can’t control that and I don’t see any better options.
One thing that helped was realizing that money is just a tool. I’ve done what I can within reason. Stressing about it or falling into the trap of second guessing my decisions because hindsight is 20/20 isn’t worth my time.