A reader asks:
My wife and I are 42 with a 13-year-old son. We moved to Phoenix, AZ as immigrants 7 years ago with just a couple thousand dollars to our name. Since then have slowly progressed in our careers. At this point, here’s what we have accomplished financially:
- Annual combined income: $350k
- Cash in checking accounts: $230k
- Mortgage: $530k (28 years left)
- Investments through 401k, 529 plans: $100k
- Stock Market: $75k
- Savings rate/month: $8k/month
We both plan to work for the next 13 years and then think about retirement. I need your suggestion on what options I have to better utilize the cash in checking accounts. Should I invest them into ETFs or blue chips in a lump sum? Or should I plan to invest in real estate for some passive income?
First, this is an amazing accomplishment and what makes this country great. I love this story.
You’ve gone from a couple thousand dollars to your name to saving nearly $100k a year which is a savings rate of almost 30% savings rate based on your income.
Creating a six-figure income combined with a high savings rate is the hardest part for most people. That’s how you reach financial freedom.
But you obviously have way too much cash on hand.
Your portfolio right now looks something like this:
- 19% in stocks (I’m assuming this is a brokerage account)
- 25% in retirement/529 plans
- 56% in cash
That is an ungodly amount of cash especially if it’s not being earmarked for a future purchase like a house (which doesn’t seem to be the case here).
I would love to be able to tell you how to invest this money — be it index funds or blue chip stocks or real estate but I can’t.
You can’t just wing it by putting your money into something and hoping for the best. You need an overarching investment philosophy to follow.
Seattle Seahawks coach Pete Carroll does a lot of speaking gigs in the off-season. Carroll is a high energy enthusiastic guy who has a Super Bowl and national championship under his belt so I can see why other coaches and business leaders would be interested in what he has to say.
In his talks he begins with a simple ask of the audience: “Raise your hand if you have a philosophy for your team or organization.”
Of course, everyone in the room always raises their hand.
What kind of leader would you be if you didn’t have a general philosophy?
Carroll then follows it up with this: “Can you describe your philosophy in 25 words or less?”
At this point, basically everyone’s hand goes down.
He’s been known to use this as an interview question for potential assistant coaching hires as well.
You don’t necessarily have to keep it to 25 words or less but having a philosophy is equally important when investing.
Let’s try it with my general investing philosophy:
- I believe less is more, costs & taxes matter, predictions are unreliable and performance is mean-reverting.
- I believe risk & reward are attached at the hip and a long time horizon is your friend.
- I believe investing must be tied to goals to work effectively.
- And I believe behavior will determine your success or failure as an investor.
That’s not everything but close enough.
Your philosophy is a simple set of principles that will guide your actions when making investment decisions.
There’s this old saying that you shouldn’t make one hundred decisions when one will do.
The idea behind defining your investment philosophy is that you can make a handful of the big decisions upfront to save yourself some emotional bandwidth along the way so you don’t have a micro-manage your portfolio on a regular basis.
Without an overarching philosophy to bring it all together, you’ll just be chasing one investment fad to the next.
The way I see it there are 4 kinds of investors:
(1) Those who have no strategy at all and eventually give up or lose most of their money.
(2) Those who chase investment fads with no coherent plan beyond the short-run.
(3) Those who create an investment plan or asset allocation or strategy but fail to follow it when markets go haywire.
(4) And finally, those who have a comprehensive investment plan and have the ability to stick with it during manias, panics and everything in-between
This isn’t the answer you want but before you can put your cash to work you have to figure out what kind of investor you are.
Here’s where I would start if I was sitting on a bunch of cash and didn’t know what kind of investor I am or what my philosophy is:
- Start with a targetdate fund that closely matches your future retirement date. Are targetdate funds perfect? No, but they are one of the simplest ways to gain broadly diversified exposure to the financial markets and they automatically rebalance to a pre-established asset allocation. Plus, there is a glide path where these funds invest more conservatively the closer you get to retirement.
- Automate any future savings into 401ks, IRAs, brokerage accounts and 529 plans. Once you have an asset allocation selected through a targetdate fund start funneling any future savings into that fund automatically going forward. You don’t want to have to make this decision over and over again. Make it once up front and move on with your life.
- Dollar cost average the rest of your cash on a periodic basis. Lump sum investing is a higher probability bet when it comes to the markets but I like telling people with a huge pile of cash to average into the market for regret minimization purposes. The period itself doesn’t matter (weekly, monthly, quarterly, etc.). The only thing that matters is you come up with a plan ahead of time and stick to it.
This is not a perfect strategy by any means but perfect is the enemy of good in these situations.
Philosophy is a prerequisite for strategy. And the emotional discipline to follow a strategy based on a predefined philosophy is what brings it all together.
We talked about this question on the latest Ask the Compound:
Nick Maggiulli joined me on this week’s show to discuss questions about paying off medical bills, when to tap your home equity, the optimal time to take retirement distributions and how dividends keep up when interest rates rise.
Podcast version here: