In
the last few weeks, I was involved in quite a few discussions relating to
investing. Sharing my investment strategy might give others a starting point to
explore. Tax code is complex; every situation is different so tax strategies are
outside the scope of this blog.
The
key for investing is to protect and increase the real value of the principal. This
means that the return should be more than inflation, otherwise the buying power
for the principal is reduced. This is the same as losing money. Many beginning
investors seem to be comfortable with inflation risk. By investing in secure
investments such as CDs, although the principal invested is protected, the real
value is often reduced.
WARNING:
I am not a financial consultant. Do your own research before investing. Everyone’s
situation is different, so what works for me, might not work for you.
Basic Investment types
I will touch on the ones
that are related to my portfolio. You can read more at link.
Bonds (Debt) – Are debt
based securities. Buying a bond means that you are essentially lending money to
the institution, which will give you interest. Some debt securities like
municipal bonds get preferential tax treatment but have lower returns. Be sure
to check out if it is better for your situation.
Stocks (Equity) – If you
buy a company stock (share), it means that you own part of the company. You get
to share the profits and participate in company’s growth.
Mutual Funds – The company
that offers a mutual fund, pools money from a group of investors, and manages
the investment on behalf of the investors. The company will charge a fee for
this service. The advantage of mutual fund is a) a professional manages your
money, b) you get better diversification. This is called expense ratio. Expense
ratio is expressed as a percent of your principal amount. Say if the expense
ratio is 1%, and you invest $100 in the fund. You will pay a fee of $1 per year
regardless of the fund makes profit or loses. The expense ratio is deducted at
the backend, so you don’t see this transaction explicitly in your statement. You
are still paying this fee!
Stay away from mutual
funds that have transaction fees or loads. More info at link.
A load can be a front end load or a backend load. Front end load means you pay
a sales fee when you buy the fund. This can be as high as 8.5%. The backend
load means, you pay the sales fee when you sell the fund. There are thousands
of no-load funds available, so stay away from load funds. BEWARE: Financial
advisors may want to sell local funds to you.
ETF – This is a basket
of stocks but is traded like a regular stock in the stock exchange. ETFs are
typically managed passively and will follow an index. An index is an average of
the stocks selected based on certain criteria. (e.g.) Vangaurd S&P 500 ETF
(VOO),
tracks the large cap in US. The expense ratio for VOO is 0.05%, which is
nothing.
Taxable vs Tax deferred accounts
Regular investment
accounts are taxable. At a high level a) you need to pay the tax on dividend
distribution yearly even if you reinvest. b) Capital gain need to be paid when
you sell the security.
On the other hand, in a tax
deferred account, investment grows tax free. Generally there are two kinds of
accounts, a) the account that lets you invest pre-taxed dollars (this lowers
your current taxable income), you will pay taxes when you withdraw (for both
principal and growth). 401k and Traditional IRA fall in this category. b) The
second type of account is the one where you put in after tax dollars. ROTH IRA
falls in this category. This account is advantageous because you don’t have to
pay taxes during withdrawal (both on earnings and principal).
Be sure to read about
the restrictions and understand the differences before you invest.
My style
Lazy long-term
investing. By that I mean I don’t actively manage my portfolio and don’t even
look at my portfolio for months together. I make some adjustments maybe once a
year. I picked the end of December to rebalance my portfolio as it coincides
with holidays.
I don’t believe in
timing the market; my philosophy is no one can consistently beat the market. Of
course there are some god fathers in investing like Warrant Buffet, who was
able to beat the market consistently, but for all practical purposes, I assume
that no one can consistently beat the market. Beating the market means making
more than the market average.
Keep the investment cost
low. Any fee paid is the money taken away from investing. In the long-term
compounding this lost investment expense will have a significant negative
impact.
I am willing to take the
downward ride as the market goes down. As someone who is investing in a broad
market index and who has a long-term perspective of investing, I am willing to
follow the market. This means the investment can drop to 50% or more….
Don’t be greedy or
emotional. It is very tempting to gamble in the stock market or panic when
market goes down. Define the strategy upfront and stay the course.
Concrete Tips (based on my style)
- Start investing early in life. Let us take an example of investing $100 a month with a target to retire at the age of 70. For this calculation assume an annual return of 8%. If you start to invest at age 50, you will end up having a grand total of $54,914. On the other hand if you start at 20, you will end up with $688,924! As you can see the growth is not linear. This is the power of compounding. You can try this at link.
- If you are eligible for a 401k plan, put the maximum amount possible. At the minimum you should contribute to the extent that company contributes. Otherwise you will lose the company contribution.
- Invest in IRA to the yearly limit. Chose ROTH IRA if you qualify, otherwise go with Traditional IRA. Find info about ROTH and Traditional IRA at link and link.
- Irrespective of the income bracket, at the present moment you are allowed to transfer funds from Traditional IRA to ROTH IRA. Do some research, you might be able to take advantage of this. If you have lot of growth in your traditional IRA this might not be a good option. Some info at link.
- Plan well so that you don’t have to dip into your retirement accounts.
- Invest for your kids’ education early. My favorite is 529 account.
- Use credit cards only if you have the discipline to pay off your monthly bills. If you can pay off the credit card bill then pick a rewards card. My favorite card is fidelity rewards card which can get you 2% back and has no annual fee. The nice thing is, cashback is directly deposited into fidelity account. You can even use this amex card in Costco, meaning you get 2% back on your Costco expenses. Check out this link.
- It is beneficial to have high dividend yield funds in nontaxable accounts like IRA/401k. This is because you need to pay taxes on yearly dividend distribution. In IRA/401k you don’t need to worry about this. Bond funds typically have high dividend distribution.
- Don’t invest in the company stock you work for. This has nothing to do with how good your company is performing. (i.e.) don’t put all eggs in the same basket.
- If your company offers stock purchase plan (offered at a discount), max out that you can buy. Best to sell it right after you get it (for the same reason (i.e) don’t put all eggs in the same basket).
- If your company does offer stock options, you might consider keeping it longer and not sell right after it is eligible for vesting. This is because of the leverage, potentially to make more money. This depends on future prospect of the company. In general I don’t believe in timing the market, in this case I think it is worth the risk. Again this is my opinion, given my situation.
- To reduce risk, diversify your investment.
- Invest only in no-load, no transaction fee mutual funds. No-load means that there is no commission either when you buy or sell the fund.
- Pick funds with a low expense ratio. Typically vanguard index ETF/funds are lowest in this respect.
- Something like a brokerage link account might give you flexibility to choose your 401k investments. Some info at link. Talk to your company/brokerage.
- DO NOT invest in a security that you don’t understand. The financial market is filled with complex instruments.
My asset allocation goal
Based on risk tolerance
and diversification goals, pick an allocation. The link
talks about asset allocation, diversification, and rebalancing. At a very high
level, I strive to achieve the following allocation.
Security
|
Percent
|
|
Stock US
|
50%
|
|
Stock International
|
20%
|
|
Bond US
|
10%
|
|
Bond International
|
20%
|
|
Every December, I will
do minor adjustments to get back to this allocation. At the moment I am
debating if I should further increase my international exposure. NOTE:
International investment has both market risk and also currency fluctuation
risk.
My portfolio
My combined investment portfolio is shown below. I was
able to get Franklin Templeton funds via employee purchase, otherwise it would
have incurred a load.
Security
|
Percent
|
11%
|
|
10%
|
|
12%
|
|
5%
|
|
Pimco Total Return
|
6%
|
5%
|
|
9%
|
|
5%
|
|
15%
|
|
22%
|
Explore & Enjoy!
/Siva
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