Thank you. Thank you. I’m here all week.
Of all the parts of our financial lives—savings rates, long-term disability insurance, career planning, powers of attorney, thinking through what actually matters to you, and so on—investing is the one that most easily captures our imagination and stresses us out. And for that, a big sarcastic thank you to financial news coverage and dedicated Slack channels at work.
Because it’s quite possible investing is simply Not That Important for your finances and that it’s a waste of your precious time and mental energy to work on it.
But how do you know? How do you know what part of your financial life you should be focused on? How central is investing to your particular financial situation?
How Do You Figure It Out?
Especially because I’m talking about investing here, I feel the CYA need to say explicitly that I am not providing an algorithm that will give you a specific answer to this question. I want to give you some questions to think about, so you can arrive at the right answer for you. In fact, there are two big ones that I think dominate this conversation.
How Early Are You in Your Career?
If you’re 25 years old and plan to work for many more years, earning and ideally saving an income along the way, there are maaaany things more important for you than investing.
Protecting your ability to earn (and then save) that income comes first to mind. And for that, you want long-term disability insurance.
Ideally, in fact, you want a private policy to supplement your employer-provided group policy. I love employer-provided policies because they make it dead easy for you to have insurance coverage. And most people won’t seek it out on their own.
On the other hand, there are inadequacies to employer-provided coverage: if you leave that job, <poof!> that policy usually goes away. The income-replacement rate is too low. They won’t give you benefits in as many situations as a private policy might. Etc.
But what if you’re nearing the end of your career? Your ability to earn money (and add to your investment portfolio by saving it) is drawing to a close, so yes, investing becomes Much More Important.
And as you progress from early career to end of career, investing gets increasingly important. Note I’m focused on your career stage, not your age. If you’re planning on retiring early—or late!—then it’s the career stage that matters, not the calendar.
How Much Money Do You Have Invested?
The bigger your investment portfolio, the more attentive you want to be to it. And this is for two reasons:
- The smaller your portfolio, the more important your savings rate is.
- Mistakes are simply more costly in a larger portfolio, so you need to focus more on investing when you have more money.
Smaller Portfolio = How Much You Save Has A Bigger Impact
Consider this example: you have a $10k portfolio and are able to save $1k/mo ($12k/year). You are saving more in one year than your portfolio is worth. By saving alone, you can grow your portfolio by 120%.
With that big of an impact, I care much less at this point about how that $10k is invested than I do about your savings rate. There just ain’t No Reasonable Investment out there that’ll return 120% per year.
Now consider this other example: you have a $1M portfolio and you’re saving $1k/mo ($12k/year). You are growing your portfolio by only 1.2% per year by saving. Investing can get you a much higher rate of return (over the long run).
Lesson here? If the amount of money you save is or could be large compared to your existing investment portfolio, I’d focus much more on that than on how you invest your money.
Larger Portfolio = Mistakes Cost More Money
Again with the arithmetic.
Let’s continue with the two portfolio examples above.
If you have a $10k portfolio, and you make a 1%, 5%, or 50% mistake, you’re going to lose $100, $500, or $5k.
By contrast, if you have a $1M portfolio, you’d lose $10k, $50k, or $500k. Much bigger ouch.
A bigger portfolio simply means you can lose (or make!) more dollars than you can with a smaller portfolio.
What kind of “mistakes” am I talking about? Well, two come to mind (but there’s really an endless list of investing mistakes we can make):
401(k) fees. Let’s start with the assumption that high fees are bad for investing. High fees are that mistake you’re trying to avoid.
Look at the investment fees in your 401(k). Let’s say the investments cost 1%/year, instead of closer to 0.1%/year. (Usually these higher fees happens with smaller tech companies. The likes of Amazon, Facebook, Google, and recently Airbnb, have gotten the memo about keeping investments inexpensive.)
If you’ve got $10k in your 401k, that’s an extra $100/year you’re paying that ideally you shouldn’t be. Yes, that sucks, but many of my clients could save an extra $200/mo without really feeling it. How about you?
That extra 1%, if your 401(k) held $1M, is $10k/year. That starts to be more painful.
So, if your 401(k) fees are high, you can worry less about them the smaller your 401(k) balance (or if you anticipate leaving the company and taking your money out of the 401(k) soon).
I often recommend to my clients to use the more-expensive target-date fund in their 401(k) than the cheaper-but-more-complicated collection of individual funds…because I know the dollar amount they’ll pay in fees is low and that saving that isn’t worth the additional complexity and stress of having a more-complicated 401(k).
Investing as if you can beat the market. Some of us go through a phase where we think we can outsmart the market. Pick individual companies to invest in, or get in and out of the market because we think we know when a drop is coming, instead of buying and holding the entire market. Empirically and mathematically, this is a loser’s game.
But if you play this game while you’re in your 20s, say, and you’ve got $10k that you’re trading the hell out of…and you lose half of it, well then you’ve just lost $5k. Again, not fun, but it’s a lot better than playing that same game with a $1M portfolio and losing $500k.
So, if you want to play this game, if you want to scratch that itch, play it with a smaller portfolio. Either because your portfolio is small, or because you carve out a small piece of a bigger portfolio.
You’ve Determined Investing Is Very Important. What Do You Do About It?
Again with the “depends” answer.
I certainly can’t give you any specific advice here. But keep in mind that just because investing is important to you, or you have a large portfolio, or you’re actually living on some of the money from your portfolio…none of this means your investing has to be complicated.
instead of justifying that your investing should be simple, I encourage you to challenge anyone to prove why it needs to be complicated.
Why do you need, for example, anything more than some total market index funds?
The “3-fund portfolio” is a thing. I didn’t make this up. Lots of coverage out there. Hell, there’s an entire book dedicated to it. (Which is ironic…I mean, how many words do you need to talk about 3 funds? I assume much of it is debunking investment hoo ha that most of the investing industry pushes.)
The 3-fund portfolio owns most of the known investing universe simply and at very low cost:
- Total US Stock Market
- Total International Stock Market
- Total US Bond Market
This should be the baseline. Any variation from it needs to have a damn fine reason.
Don’t Forget the Other Important Things
Whether or not investing is an important, influential part of your finances, you need to protect yourself and the money you do have. And you can do that in two major categories:
Insurance. Just as long-term disability insurance protects your ability to earn income, you need liability insurance, home or renter’s insurance, health insurance, life insurance, and auto insurance to protect the money you have now and in the future.
Estate Planning. Being sure to set your beneficiary designations correctly on your retirement accounts and life insurance policies, and having the right documents (wills, trusts, powers of attorney, etc.)…both of these are essential to protecting both yourself, your money, and your loved ones.
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Disclaimer: This article is provided for general information and illustration purposes only. Nothing contained in the material constitutes tax advice, a recommendation for purchase or sale of any security, or investment advisory services. I encourage you to consult a financial planner, accountant, and/or legal counsel for advice specific to your situation. Reproduction of this material is prohibited without written permission from Meg Bartelt, and all rights are reserved. Read the full Disclaimer.