J.D. Moyer

sci-fi author, beatmaker

Category: Money/Personal Finance Page 4 of 7

Investing a Lump Sum, Part I: The Dangers of Wealthfront

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On January 28

In Advice for Young People, Money/Personal Finance

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Ready to stuff under the mattress.

Wealthfront is a new company that manages your investments according to an allocation plan that you decide. Primarily they invest in low-fee ETFs. Generally I like the idea of what Wealthfront offers, but there are some significant risks.

Generally I think asset allocation is a good investment strategy. Pick sectors that don’t usually correlate (bonds, stocks, possibly real estate, gold, commodities), decide on percentages that make sense given your age and risk tolerance (your age in bonds, as a percentage, is a common rule of thumb), and rebalance every year or so. I provide details on exactly how to do that in my post How to Get Rich Slowly Without a High-Paying Job, including Google Sheet examples and projections.

However …

I’m concerned about the following scenario:

  1. Millennials, many of whom are more financially savvy and conservative than they are given credit for, choose services like Wealthfront to automate an asset allocation investment approach.
  2. After answering the questions in the Wealthfront asset allocation questionnaire, they select an allocation plan that is something like 80% stocks. This is because they are all young and all think they have a high tolerance for risk (most of them will find out later that losing money isn’t as fun as they thought it would be).
  3. They invest their hard-earned savings nut, buying into the stock market when the Shiller PE Ratio is well-above 20 (months ago it was up to 26). The Shiller PE Ratio, which includes historical earnings in its calculation, isn’t meant to be used as a market timing indicator, but historically it has predicted long-term returns quite accurately.

Investing 80% of your life savings in the stock market when the Shiller PE Ratio is this high is not wise. So what’s an alternative approach?

Choose an Automated Plan, but Lean Conservative (and Adjust Later)

I like the Wealthfront service. If I were to create my own investment management company, it would operate pretty much in the same way. Though I’m not an early adopter, I might even use it myself down the road (though probably not — I enjoy managing my own investments). But I wouldn’t rule it out. For the ostrich investor, it’s an ideal service.

My only criticism is from what I can tell, it’s too easy to end up with a very high stock allocation, which, under these market conditions, is damn risky. If your initial nut is $1000 and you are investing $1000 a month, the initial allocation doesn’t matter as much. Over time, you’ll be buying low more often than not (the automated allocation algorithm will do that for you–if the stock market plummets then the algorithm will have to buy more stocks to maintain your allocation percentage).

But if you invest $20K and then add $500 a month, the initial allocation makes a big difference. If you are 80% stocks, and the stock market tanks hard over the next few years (look how much it has gone down just in the last few months) then you’ve just taken a big hit, especially if you consider how much that initial investment can compound over 30+ years.

My simple advice for new Wealthfront investors is this: don’t go over 50% allocation in stocks while the Shiller PE Ratio is over 20, no matter what your allocation questionnaire results say, if you are investing a significant initial amount. Start with a more conservative allocation, then take a look in a few years. If the Shiller PE is closer to 15, or even 18, then up your stock allocation percentage (risk tolerance) as high as you want.

Usually asset allocation percentage adjustments go the other way — reduce your stock market exposure as you get older. But for young investors I would recommend the opposite at this point.

Is this strategy the same as trying to “time the market”? The Wealthfront blog offers a good argument as to why you shouldn’t change your risk tolerance score all willy nilly every time the market moves. You’ll end up selling low.

I’m simply suggesting that you don’t buy high, with all your money. If you want to make money long-term in the stock market you need to get in somehow, but there’s no reason you can’t limp in. It’s just safer that way.

Of course I could be wrong. The biggest stock market rally of all time could be about to begin, defying all historical trends. What do I know? I’ve made every investment mistake in the book.

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The System is the Result

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On January 11

In Metaprogramming, Money/Personal Finance

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Goals are useful. A goal points you in the direction you want to go, gives you a metric by which to measure progress, and ideally provides the motivation to get there.

But goals don’t produce results. A behavioral system (including automated behaviors) produce the actual results. Your system of diet and exercise will produce physical and health results. Your system of saving and investing will produce wealth results. Your system of communicating and being kind and generous to people will produce relationship results.

They may not always be great results. That depends on the quality of your system, your compatibility with the system you’ve chosen, and how effectively you implement it.

I’ve managed to overcome health problems by tweaking my diet and supplements, and those system continue to work well for me. I feel pretty good about my saving and investing system too. My chess system, on the other hand, needs a lot of work. I only know a few openings, I fall into simple traps, and I too often impulsively make the first decent move I see without considering other options. But I’m working on it.

Writing, chess, and racquetball are three skills I’m actively developing. Some of the work is just doing the thing a lot. Learning new techniques and practicing those techniques — actively pushing the boundaries of your skill and paying the learning tax — is a big part of getting better. So where does the system part come in? What does that even mean?

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What Does Financial Freedom Mean to You?

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On November 9

In Creative Work/Career, Money/Personal Finance

Not the skylight in my house.

Not the skylight in my house.

As the water poured into my house from two leaky skylights, I had a thought …

What does financial freedom mean for me, personally?

It’s a phrase Tony Robbins uses in Money, Master the Game. I considered the question on my first read through the book, but I wanted to come back to it. I’ve been thinking about how high net worth can limit time, lifestyle, and relationships. This is especially true for expensive possessions which require management and maintenance (houses, cars, boats), but money itself requires management, and a whole lot of money requires a complex network of people and institutions to manage taxes, investments, trusts, insurance, and other aspects of wealth legality and retention.

Net worth can also influence social relationships. It’s harder to form and maintain relationships with people who are in completely different economic territory, especially at the extremes of poverty and wealth.

Possessions, including money, can be a pain in the ass.

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How To Get Rich Slowly Without a High-Paying Job

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On September 15

In Advice for Young People, Money/Personal Finance

There are many advantages to getting rich slowly.

There are many advantages to getting rich slowly.

Today’s topic is how to get rich slowly, with a little help from Google Sheets.

Why write this post? In college I was just starting to save money from my part-time jobs, but I had no idea what to do with my savings. My parents had some savings and property assets, but no positions in the stock market or bonds, and nothing approaching an investment portfolio. I had no advice from them, nor did I know which questions to ask.

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What’s Your Investor Personality (Shark, Monkey, or Ostrich)?

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On August 14

In Money/Personal Finance

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In terms of your investing personality, are you most like a shark, monkey, or ostrich?

Over the past year I’ve been attempting to get my own financial house in order, and writing about it. In the next few money/investment posts I’ll be referring to sharks, monkeys, and ostriches. Might as well explain what I mean.

Shark

You are a heartless sociopath, or close to it. This makes you potentially the best kind of investor, but also the most dangerous (to both yourself and others). You view money as primarily an abstraction, and are able to make cold rational calculations and decisions without getting emotionally involved. You are prone to both gaining and losing large fortunes quickly. With training, you are able to clearly evaluate risk and make good financial decisions (low risk, high potential gain). However you do like making big bets and nobody wins all the time.

Monkey

You are clever, but not as clever as you think you are. You are good at creating investment systems and strategies but bad at consistently following through on them. Investing is so much fun for you (at least when you are winning) that it’s hard not to meddle and “improve” your system. You are prone to both excessive enthusiasm and wild panic, and thus often find yourself buying high and selling low. You vacillate between “money as a game” and “money is real” and thus underestimate your tolerance for risk and market fluctuations. The investment history of a typical monkey might look something like this.

Ostrich

You would prefer to not think about money, investments, or how you will fund your later years. You feel ambivalent about accumulating money, and conversations about investing stress you out. Can someone else just deal with it? You may sensibly pick a wise fiduciary to manage your investments and do very well. On the other hand you might get snookered by a Bernie Madoff type. Ultimately you have good instincts about investing, and also have the capacity to follow an investment strategy with discipline. The hard part is thinking about it long enough to get started.

The Basics

Investment personality aside, I think the same basic strategy works for most people who aren’t born rich (and yes I realize that term is relative — I’m referring to the poor, working, and middle classes in the U.S.). The basic plan:

  • consolidate all high-interest debt and pay it off as quickly as possible with no less than 20% of your income
  • save at least 10% of your income via automated transfers into savings and/or investment accounts (“pay yourself first“)
  • keep some of your savings in an “emergency cash” fund to cover at least a few months of expenses
  • allocate some % of your savings stream into “dream” accounts (travel, toys, gifts, etc.) and/or to charitable causes
  • invest the remainder of your savings stream in low-fee investment vehicles (like exchange traded funds), diversified with fixed %’s into categories that fluctuate independently (stocks, bonds, commodities, gold, real estate), weighted more heavily towards less volatile categories like government bonds (depending on your age), rebalancing periodically

The last bullet point is incredibly dense and probably makes no sense unless you already understand it. I unpack it here in this post (and I highly recommend the Robbins book mentioned in same post, for both novice and seasoned investors).

How to Deal with Your Weaknesses

As a monkey, I’ve been a happier investor since I realized I don’t have much tolerance for giant fluctuations in my net worth. Since this realization I’ve invested more conservatively, and it better fits my personality.

I’m lucky to have an ostrich as a partner. If we discuss major financial decisions we’re much better off than my typical “leaping without looking very carefully” approach. The hurdle for Kia was getting clear about why she should invest in the first place. Like many people (including myself) she can’t really visualize retiring, and thus had a hard time thinking about “saving for retirement.” The cold fact of the matter is that even if you don’t want to retire, you might be forced to, or people may no longer want to pay money for what you have to offer at age 65. Yet you could easily live for another 30 years. Longevity variability aside, having a portfolio that pays you passive income allows you to do the work you want to do, regardless of if anyone is willing to pay you for that work.

But what should the shark do? The main shark pitfall is losing everything on “all in” bets. So don’t go all in. Follow a diversified portfolio strategy with most of your savings, and limit your high-risk bets to a limited %. This is a good strategy for monkeys too.

Next Up …

I’ll write at least two more posts on this topic in the coming months, including:

How To Create an Automated Trading Prompt System with Google Sheets
I’ll create and share a public Google Sheet that calls current market data from both Google Finance and Yahoo Finance, and discuss some of the simple valuation formulas I’m using. [Link]

How To Invest a Lump Sum
If you have cash but don’t yet have a diversified portfolio, should you buy in all at once at your % allocations, or “limp in” buying cheaper categories first? How do you know if a general category (stocks, bonds, gold, etc.) is cheap?  [Link]

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