Where’d you get that mo — stop, don’t tell me.
I don’t want to know.
Maybe you stole it.
And if my television knowledge is anything to go by (it isn’t), then, if I know how you got it, that makes me an accessory-after-the-fact.
The two of us are way too pretty for prison. I don’t want to know.
But, okay, so you’ve come into this money. Somehow. Now you have a problem — just as the poet Notorious B.I.G. foretold.
“Mo’ money, mo’ problems.”
Your problem is choice.
In the United States alone, there are more than 15,000 publicly traded companies — you have 15,000 possible choices once you’ve narrowed the universe of possible investments down to individual, publicly traded stocks in the United States.
I can go on.
What if you want to be diversified across two public companies in the United States, instead of just one? 112,492,500 choices.
Three companies? 562,387,505,000.
And so on.
Overwhelming choice. That’s the problem with figuring out the best way to invest 50k.
I’m going to walk you through a sampling of your options — I won’t lie to you. I won’t tell you how simple it’s all going to be.
Because your choice isn’t. You can choose to enact a simple investing plan and, from there on, it can be simple.
But the choice itself isn’t.
As Charlie Munger put it, “It’s not supposed to be easy. Anyone who finds it easy is stupid.”
That being said, if you do find the choice overwhelming, for God’s sake, man, just choose the simplest option and be done with it.
Shutting down and doing nothing is rarely a successful strategy in real life, and never with money.
Let’s get to it, then.
What makes something an investment
This is the art of investing.
How does this magic occur?
Through the purchase of a productive asset, like a company or a rental property. A company throws off cash in the form of business profits, while a rental property’s value is derived from, you know, rent.
So, concretely, let’s say you take your 50k and you buy the house next door. I don’t know of many 50k homes but, for the sake of this example, let’s assume they exist.
If you can rent this house for 5k a year, it will take you ten years to earn back the money you spent, and you will still own the underlying asset.
Investment produce cash flow
All investments worth owning produce consistent cash flow.
Let’s consider McDonald’s stock.
If you buy 100 shares of McDonald’s, congratulations, you’re now part owner of the company.
Each quarter, McDonald’s produces some amount of surplus cash, after operating expenses are taken into account. This is the company’s profit, which it makes from selling hamburgers and what-have-you.
As part owner, you’re entitled to a cut of that profit. This is paid out each quarter in the form of a dividend.
So, like rental properties, stocks are an asset that throws off cash flow — in this case, profit-sharing via dividend payments.
Stocks and rental properties are two of the three asset classes you should consider investing in. The third and final asset class?
When a company or a government needs to raise money, they sell bonds. Basically, you’re buying that company’s debt, and they agree to pay you some percent interest on your money.
Like, you have 50k to invest, right? So imagine that I send you an email and I’m like, “Hey, gentle reader, I here you have some excess cash — Can I borrow it all for like, I don’t know, thirty years?”
And unless you’re exceptionally generous or we’re very close friends, you’re going to say, uh, no way.
So I’m going to have to come back to you with another offer, something like, “Okay, can I borrow 50k now and over the next thirty years I’ll pay you back 150k?”
At this point, that offer starts looking more tempting.
At some high-enough number, you ought to be willing to lend me that 50k.
This is how bonds operate.
You buy some amount of debt from a company or a government — lending them money — and they slowly pay it back, plus some interest. In this case, the cash flow we’re looking for is these interest payments.
Investments That Fail The Cash Flow Test
Some asset classes don’t produce cash flow and, as such, are not suitable investments, although many people will try to tell you otherwise.
Most collectible items fall under this umbrella.
Things that are not investments:
- Beanie babies, for example. Not an investment.
- Fine art. Also not an investment.
- Commodities. If you buy ten tons of wood or gold or chocolate, in 5 years, you’ll still have ten tons of the stuff.
Buy these because you enjoy them, not because you expect that they’ll be worth anything more in the future. Maybe they will, maybe they won’t, but you’re here to invest.
Not to gamble.
Things that are investments:
- Businesses (via stocks).
- Real estate.
Okay, so how should you allocate your money across and into these asset classes? Wait, wait, I’ll get to that in a minute.
More risk equals more return
In investing money, the amount of interest you want should depend on whether you want to eat well or sleep well.
Dangerous jobs pay well.
They pay well because they must.
If you want workers who will risk their lives, you have to offer a commensurate incentive: good pay.
Of course, as an employer, you’re not going to pay workers extra for taking on excess, unnecessary risk.
If you hire me to sell propane and propane gas accessories and, during my breaks, I like to jump from the roof, you’re not going to give me a raise — and , if you do, it will be in spite of my roof-jumping habit, not because of it.
Likewise, higher risk assets are theorized to offer a higher rate of return.
Say, for instance, you need to raise money for your business, Acme Co. — except, your business has a shoddy financial record, at best.
You’ve had no less than 4 recalls for faulty products in the last quarter alone, and your revenue is highly dependent on the orders of your largest customer, Wile E. Coyote.
So you issue some bonds to the public, at 5% interest, which you feel is a very fair return for the debt of the esteemed Acme Co., well-known and maybe even beloved by children everywhere.
But investors disagree, and none of them buy your debt.
Thus, you’re forced to raise your prices to adequately compensate for the perceived riskiness of your debt — Investors suspect you might go out of business, so they want substantial returns for the risk that they’re assuming.
Thus, logically, one should expect that a riskier asset will offer a higher return.
There’s only one problem.
When we look at historical data, this relationship has not held up.
If you buy risky stocks — like those trading for below 5 dollars — you’ll end up doing worse than if you had invested in mature, giant companies, like McDonald’s.
Stocks outperform bonds over the long-term
With that said, there is one way that this risk-return relationship has a legitimate claim on reality — I wouldn’t be telling you about it if it didn’t — and that’s across asset classes.
What do I mean by this?
Consider two investors: Bob and Alice.
Let’s say that Alice invests 100% of her money in shares of different businesses. It’s all in the stock market.
Bob, in contrast, is a bond guy. Never met a bond he didn’t like. His money: all in bonds.
Over the long-term, Alice’s portfolio should substantially outperform Bob’s, because stocks are riskier than bonds. Bond-holders have certain protections in the case that a company goes bankrupt — they get paid first.
Real-estate has a similar risk profile to stocks, while bonds are not so risky.
We thus have two high(er)-risk asset classes:
And one lower risk one:
I can almost tell you how to invest your money now, except one thing…
Bottom Up Versus Top Down Investors
There are two types of investors: top-down investors and bottom-up investors.
Top-down investors decide how much risk they’re willing to take on, and then split up their portfolio based on that.
They might decide that they don’t have the stomach for wild rides with their money, or maybe they’re retired and no longer have the earning potential to recover from a market crash. Thus, this person decides on an asset allocation of 50% bonds, 40% stocks, and 10% real estate.
Top-down investors first decide on an asset allocation.
After that decision has been made, this class of investor typically chooses to satisfy each percentage by investing in a broad index representing that asset type.
Index fund: a financial instrument that tries to represent an asset class, like large stocks, by buying a small slice of the entire universe of that asset.
Concretely, our hypothetical person here might fulfill their 40% stocks by buying the Vanguard Total World Stock ETF.
This is like buying a small slice of all the publicly traded companies in the world.
Such a person could do something similar with real-estate and bonds.
This is sort of the Jack Bogle school of thought.
Bottom Up Investors Seek Undervalued Companies
The other type of investor is the bottom up investor.
Let’s say that you’re an expert in microprocessor technology.
As such, you might start following the performance of different companies in that space.
- ARM Holdings
After learning to read balance sheets, such an investor might decide that the stock market has undervalued Intel stock.
Right now the company’s market cap is about 175 billion, but you’re convinced that it’s worth more than that.
In the opportunity is compelling enough, you might put a substantial amount of your money in shares of that company.
Essentially, this type of investor is betting that:
- A company is undervalued and
- Wall Street will eventually recognize the company’s true worth, at which point your shares will be worth substantially more.
This is the investment philosophy espoused by people like Warren Buffet and Charlie Munger.
Which is right for you?
As to which is right for you, it’s difficult to say.
The top-down approach is much simpler and requires less work.
If you’re not interested in taking an active role in researching different companies for a few hours (or more!) each week, I’d suggest this route.
On the other hand, if you like to read hefty tomes of non-fiction and have an interest in business — if you’re a researcher at heart, or just in it for the learning experience — a bottom up approach is probably more your style.
I should also note here that although it may appear that bottom up investors would earn a greater return than passive, top down investors, this is very far from guaranteed.
It has proven so difficult for so many to “beat the market” (that is, beat a passive index) that many academics have argued that current prices adequately reflect all current information.
This would imply that there is no way to identify opportunities in the market, and that research is a waste of time.
For the rest of this article, I’m going to assume you’re a top-down investor.
Finding attractive opportunities in the market is an art unto itself and, if I did have a magic formula, I wouldn’t give it away for free.
If you’re inclined to be a bottom-up investor and interested in more information, I recommend buying a copy of The Intelligent Investor.
Okay, now I can finally tell you the best way to invest 50k.
The Best Way to Invest 50k
You now have a solid foundation for making investment decisions, and you’re left with the choice of how you want to split up your money among the three asset classes: real estate, stocks, and bonds.
Unfortunately, there’s no analytic way to optimize your asset allocation.
You need to choose the level of risk you’re comfortable with, and then construct a portfolio along those lines.
For instance, a young person who intends to be investing over the long-term — say, 30 years or more, should shift their asset allocation towards riskier assets.
Over the long-term, they’ll make much more money and, should something go wrong, they have a life-time of earning potential to make it back.
Thus, an example portfolio might look like this.
High-risk, high-return portfolio:
- 10% bonds.
- 10% real-estate.
- 80% stocks.
On the other hand, if you’re risk-averse, and just want a safe way to invest this cash, you ought to shift more of your assets towards bonds. The more bonds, the safer your portfolio.
An example conservative portfolio might look this way.
Low risk portfolio:
- 70% bonds.
- 20% stocks.
- 10% real-estate.
If you’d like something in between, you can just shift the level of bonds and stocks. I recommend maintaining real-estate at 10%.
Implementing Your Asset Allocation
Once you’ve determined what kind of asset allocation you’d like, you then need to actually buy up these assets.
The simplest way to implement this is by purchasing index funds that track that asset class.
So, if you want to put 70% of your money into stocks, you’d buy 35k worth of the Vanguard Total Stock Market Index Fund (or similar).
For bonds, you would buy Vanguard Total Bond Market Index Fund, and for real-estate, you’d buy a REIT, which is a small slice of many different properties. I recommend Vanguard’s REIT Index Fund.
To actually buy these, check out this guide.
And there you have it. That’s the best way to invest 50k.
Putting It All Together
Alright! I’ve covered a lot of ground. To recap:
- Investing is the art of setting aside money now so that you’ll have more money later.
- All assets worth holding produce cash flow.
- The three asset classes I recommend investing in are stocks, bonds, and real-estate.
- A stock is a part ownership share. It’s cash flow comes from the company’s profit which, as part owner, you share in via dividend payments.
- Real-estate produces cash flow via rent.
- A bond represents buying a piece of a company’s debt. It’s cash flow is derived from interest payments on that debt.
- In contrast, there are so-called investments that don’t produce cash flow, like commodities such as gold and oil, or collectibles, like art and beanie babies.
After I covered all of this, I touched on the importance of risk:
- There is a relationship between risk and return, such that riskier investments are theorized to have higher long-term returns.
- This relationship has historically existed across asset classes, but not in them, such that riskier investments, like stocks and real-estate, have higher long-term return than safer investments, like bonds.
- Thus, a safer portfolio should contain more bonds, while one with higher expected return should shift more towards stocks.
With that out of the way, we moved onto the types of investors:
- There are two classes of investors: top-down and bottom-up investors.
- Top-down investors first decide how much risk they’re willing to take on, and then construct their portfolio accordingly.
- Bottom-up investors look for buying opportunities, like undervalued companies, and then jump on that opportunity.
- A top-down approach is much simpler than a bottom-up approach, and more fitting for those looking for hands-off investing.
- If you enjoy research and learning about businesses, you might want to consider a bottom-up approach, but that’s outside the scope of this article.
And then I finally got around to what you actually ought to do with your money:
- There’s no analytic way to decide on a portfolio allocation.
- If you’re young and willing to take on risk, you should consider a portfolio with 90% stocks, 10% real-estate, and 10% bonds.
- On the other hand, a conservative portfolio might have 10% stocks, 10% real-estate, and 80% bonds.
- Once you’ve decided on an asset allocation, you can implement it by buying up index funds representing those assets. I’ve recommended different assets above.
- To actually buy these assets, see this guide.