4 quick things that will help you build wealth sustainably with investing:
- Goals
This is a key factor in building wealth and investing. I know it may seem ‘boring,’ but you need to define a plan for your money. Doing so will help you understand exactly how much you need to invest and for what purpose.
For example, you can have goals like:
– Retire at the age of 60 with $2M portfolio
– Have an annual income from investments of at least $50,000
– Leave a meaningful inheritance for my children
– Live off my investments tax-free
Then, you can start thinking about how to turn these goals into action. I really like this hypothetical return chart from Vanguard:
It shows that for short-term goals, the most meaningful progress comes from savings.
However, for long-term goals, the majority of gains will come from investment returns. Achieving these goals will also depend on a few key factors:
- Balance
Once you’ve defined your goals, it’s important to determine the mix of investments that will help you get there (also called asset allocation).
By diversifying investments across stocks and bonds, and across different sectors, you can reduce the overall portfolio risk and guard against large losses.
If you are young, you can take on more risk to achieve your goals, and you can deleverage as you get closer to reaching your goal.
The chart below shows the top 5%, bottom 5%, and average annual returns for various global stock/global bond allocations from 1901–2022:
Using these averages and your portfolio goals, you can determine the necessary savings and investing amounts.
If you are getting close to your goal, it makes sense to lower equity exposure to reduce the overall volatility of the portfolio.
I also like Vanguard’s Investor Questionnaire, which asks questions about your risk tolerance, like “What would you do if your portfolio dropped 25%?” This can help you determine the appropriate allocation as well.
- Cost
I feel very strongly about this one. I don’t own a single fund with an expense ratio higher than 0.1%. Costs make a huge difference, especially over the long term.
Let me show you with one simple visual:
The difference between 0.1% and 1.3% is $167,537 on a $100,000 initial investment.
Yet I personally know people who pay these fees to invest in actively managed funds that provide minimal growth.
I understand that with a 401(k), you might not have many options, but many companies often offer Vanguard or Fidelity funds, which typically have the lowest fees. Make sure to review your options.
If you quit your job, you can roll your 401(k) balance into a rollover IRA to buy cheaper investments (e.g., VTI with a 0.03% expense ratio). However, high earners should be careful, as this could impact your Backdoor Roth strategy.
- Discipline
You must have discipline with investing.
You’ve established your goals, asset allocation, and minimized costs. The last step is to stick to the plan and be consistent.
If you overreact to the market, you will lose.
For example, if you moved to 100% cash at the bottom of the COVID downturn, you would have received a -2% return, compared to a 21% return if you had stayed consistent with your plan:
If you panic, it means you don’t have an appropriate asset allocation, aren’t properly diversified, or don’t fully understand what you’re investing in.
Analyze it. Adjust it.
Hope you enjoyed this one!
See you next Saturday.
MC, CPA