There are two ways to make money. You, yourself, can go to work, probably by selling your labor to an employer in exchange for a paycheck. Or you might start a small business, or make money by writing on a blog.
That’s the first way.
The second way you can make money is by putting your money to work. This is the art of investing. Instead of selling your labor in a never ending grind to make money, you can, like some sort of perpetual motion machine, use your money to make still more money. And then you can use your gains to make even more.
That’s investing, and it’s a pretty great deal. Of course, everyone knows it’s a great deal, or at least anyone with some basic financial literacy knows it’s a great deal.
Except, according to one Gallup poll, only 54% of Americans own stock. So what’s going on? Why aren’t more people doing it? Why not harness the ability of money to produce more money?
One reason: Americans don’t know how to get started. They’re overwhelmed by choice. After all, there are trillions of possible investment combinations out there. What Americans really need is the best investment plan for beginners.
So I decided to write such a thing.
The Importance of Savings
When it comes to building your net worth, the single most important thing you can do is to get into the habit of saving a percentage of your income. It’s not about how much money you make. It’s about how much money you keep after you take into account expenses.
This is trivial to demonstrate. Consider two people: Bob is a software engineer making 100,000 dollars a year, while Peter is an adjunct professor earning 30,000 dollars each year.
That depends on how much each one saves. If Bob doesn’t save any money and racks up credit card debt, he’s going to have a negative net worth. On the other hand, if Peter saves aggressively, stashing away a third of his income, he’ll soon leave Bob way behind.
Compare Warren Buffet and Charlie Munger, for example. Warren Buffet, as of this writing, is worth about 60 billion dollars. Charlie Munger, on the other hand, is worth around a billion.
What’s the difference? According to Munger, one of the main differences between him and Buffet is that Buffet saves more of his income. He’s a frugal guy. He drives an old car and lives in a modest house in Omaha.
Buffet’s primary advice to young people, by the way, is to, “stay away from credit cards.”
So you’re convinced about this whole savings thing. What’s the best way to get into the habit of it?
Automate Your Savings
The best way to get into the savings habit is to take a page straight from The Odyssey. In one chapter, Ulysses and his crew must sail through the land of the Sirens. The Sirens are beautiful females who lure in sailors with their enchanting music, only to have the sailors wreck themselves on the rocks.
How does Ulysses manage to make it past the Sirens alive? He has his crew tie him to the mast and the fill their ears with wax. That way, Ulysses can’t convince the crew to change course nor do it himself, and the crew cannot hear the enchanting song of the Sirens.
This is the same tact that you need to take with savings. You need to, right now, tie yourself to the mast, so that future-you is not tempted by the Sirens into spending all of your disposable income. Except, in this case, the Sirens are not beautiful women with enchanting songs, but advertisers.
How do you tie yourself to the metaphorical mask when it comes to savings?
Simple. You set up a system that automatically takes some percentage of your earned income each month and sets it aside. That way, you don’t have to exert any willpower. You don’t need to create any habit. It’s all automated for you.
To implement this, you should be able to set up automated cash transfers via your bank and checking account. Alternatively, your employer may allow you to direct deposit your paychecks into several different accounts, so you may be able to take advantage of that.
How much should you save?
Now, at this point, you may be wondering: just how much of your money do you need to be saving? The answer to this is easy: as much as you can.
But that’s not a terribly satisfying answer. It’s easier to plan a budget if you figure out an exact percentage of your money that you want to set aside. I recommend trying to start with 20%. If you set aside 20% of your earned income for your entire working career, you’ll retire very well off, assuming that you’re smart with your investments. But I’ll get to that in a minute.
On the other hand, it’s possible that you’re simply unable to currently set aside that much of your income right now. That’s okay. In such a case, start with setting aside 10%. Then, as your earnings increase, don’t expand your lifestyle. Just increase the amount you save.
The rationale behind this is straightforward: once you’ve gotten used to living a certain way, downgrading sucks. The solution: next time you can afford upgrading your living standards, don’t. Just save more. And voila! No pain.
The Best Investment Plan For Your Savings
Okay, so now you know that you need to save and that the easiest way to get into the savings habit is to automate it. Now you need to know: what should you do with all of this money that you’re saving? What’s the best investment plan for your savings?
Like I mentioned earlier, when it comes to investing, your options are staggering. You could put money into individual stocks, bonds, real estate, collectibles, gold, oil, fine art, your own business, etc.
Depending on your personality profile, amount of free time, interest in markets and business, it’s impossible for me to say definitively which is the right option for you. Imagine if Warren Buffet had read some blog post telling him that he shouldn’t bother picking individual stocks because it’s impossible.
But, with that disclaimer out of the way, I didn’t title this post the best investment plan for beginners for nothing. I do have an opinion on how most people ought to be investing their money, especially if they’re busy and not inclined towards doing their own research.
Betterment or Vanguard’s Target Date Funds
I firmly believe that you can’t go wrong with either of them. When it comes to the tradeoff between return, simplicity, and peace of mind, they’re simply best in class.
Here’s how they work.
Vanguard’s Target Date Retirement Funds
When it comes to your investments, one of the most important things that you can do is decide on an asset allocation that fits your risk tolerance. Here’s what I mean by that. Say that you’re in your mid 20s and looking to invest your money.
Should you put it all in bonds or in stocks? What’s the difference? Well, over the long run, stocks ought to outperform bonds. Both our theoretical models and historical evidence suggest that this is the case.
But stocks are also more risky. During a market crash, like the 2008 housing crisis, a 100% stock portfolio could lose as much as half of its value.
Bonds don’t suffer from this problem. In general, bonds, especially treasury bills, are one of the safest investments out there. But they also have lower returns because of this.
Since this is the case, it’s generally recommended that young people hold more of their money in stocks, because they have plenty of future earning potential that will allow them to recover from a market crash. On the other hand, those nearing retirement or already on a fixed income can’t afford such a thing, so they should shift towards a more conservative, bond-heavy portfolio.
Asset allocation, then, is the art of deciding on how much of each time of security you want to hold in your portfolio. Should you have 90% stocks and 10% bonds? Or a 50/50 split?
There’s no simply analytical formula, and deciding can be stressful. Plus, the more you slice and dice your portfolio among different assets, the more complex it is to manage everything.
Put your money into one of Vanguard’s target date retirement funds.
These are low cost funds that automagically handle everything for you. Vanguard determines asset allocation based on when you want to retire and, as your target date gets closer, they slowly shift your assets toward less risky securities.
Basically, Vanguard does everything that I would recommend for you. You can simply dump money into this fund and, when it comes time to retire, voila! It has all be handled.
Imagine having a personal financial advisor – except smarter, cheaper, and less prone to making mistakes.
That’s Betterment. Betterment is sorta a robot financial advisor.
Here’s how it works: You invest money with Betterment, and then Betterment’s software handles the rest of your portfolio for you. Since it’s all automated on their end, Betterment is able to charge less than a typical financial advisor would. After all, there’s no labor involved.
These savings are then passed along to you. Basically, you invest money with Betterment and, then, like Vanguard, the rest is all handled for you, even included complicated strategies like tax loss harvesting.
Frankly, Betterment is arguably the best approach when it comes to a hands-off portfolio. If you want a dead-simple, impossible-to-screw-up investing approach, the best plan is to open a Betterment account and let them handle the rest.
Also highly recommended. Check it out.
Putting It All Together
Alright, alright, alright. We’ve covered a lot of ground in pursuit of the best investment plan. You learned about the importance of investing and how the number one means of building wealth is regular savings. And that the best way to build a savings habit is to automate it all, so that you don’t have to fight yourself. Just like Ulysses and the Sirens.
Then, I spoke about two different best investment plans. Both of these are simple, hands-off methods of building your portfolio. They are:
- Vanguard’s target date retirement funds
Each of these take care of all your assets so that you don’t have to. You can set them and forget them, and the fees that they charge are very reasonable.