Picking The Right Investments

EngFI2022

28 Apr, 2022

Picking The Right Investments

Picking The Right Investments

You have a 401-k an IRA and or a brokerage account but how do you pick from the thousands of investment choices available?  It doesn’t need to be as complicated as it may seem.

There are plenty of choices: cash, money market accounts, government bonds, CD’s, short and intermediate term bonds, large-cap stocks, REIT’s, mid-cap stock, high-yield bonds, small-cap stocks, foreign stock, micro-cap stock, commodities, options, futures, limited partnerships, alternative investments, IPO’s, etc.  Rest easy knowing you can reliably build wealth by focusing on US corporate stock within a single index fund.

Allocation

The first step will be to determine your allocation of investment types based on: 1) your goals, 2) risk tolerance and 3) timeline.  If you need help with your allocation, check out my post on “Investment Risk” https://www.1engineeronfire.com/?p=358.  Once you select an appropriate allocation you can then start looking at your investment choices.

Employer Plan

Many people do the majority of their investing via their employer’s plan.  Within that plan you will have limited options but most plans cover the basics.  A safe bond option, a number of stock options and typically some balanced or target date funds.

If you are a set-it and forget-it investor a balanced fund may be for you.  They are often called a target retirement 2030, 2040, 2050…fund.  They are a mixture of stocks and bonds based on a retirement date corresponding with the name.  These funds will automatically balance the stock bond allocation based on your retirement year.  I find these funds a bit conservative so dig into the details and see if the allocation mix suits your goals.  Typically, these funds have a higher expense ratio (fees) because they are doing the rebalance work for you.

If you want to be more involved in your selection select from the stock options.  There will often be a S&P 500 fund, Russel 2000, NASDAQ, Blue Chip, Large cap, etc. These funds attempt to mimic various stock indexes.  When the names get confusing just go to the research page and do a little digging.  You are looking for pure index funds or Large, Mid, Small or Micro cap funds.  You could easily just pick the S&P 500 fund and get ~500 of the largest US stocks.  Or make a mixture of the other funds say 30% large cap, 25% mid cap, 25% small cap and 20% international.  Your goal is to diversify among the various stock classes.  If your allocation is anything but 100% stock you need to mix in the appropriate amount of bonds.  With this plan you will need to rebalance annually to maintain your proper stock to bond allocation.

Self-directed Accounts

If you have your own IRA (Roth or traditional) or brokerage account (taxable) your choices are virtually endless.  You can invest in individual stocks, mutual funds, bonds, etc.  Today’s index funds from mainstream companies are available to you at the click of a button as well as individual stocks.  The data indicates consistent investing in a simple US stock index fund like Vanguard’s VTSAX or Fidelity’s FSKAX or FZROX will match market returns with the lowest fees.  This is the investing strategy at the heart of the FIRE community.

If you are inclined to pick individual stocks, the data indicates you will underperform the index funds over time.  But if the urge to “play the market” is strong, allocate no more than 10% of your holdings to this venture.  You may catch the next rising star or buy the next Netflix the day before it drops 35%!  The thing you have to ask yourself is “Are you smarter than Warren Buffett?  The data suggests otherwise.

Advisor Accounts

What about advisors?  Investment advisors used to be the only way the average investor could buy stocks.  Now with online brokerage we can buy stocks without an advisor.  A good advisor can provide valuable advice, at a cost.  A bad advisor will make himself and his company rich at the expense of your portfolio.  Typically, an advisor will charge 1% of your invested funds annually.  That 1% gets charged whether you win or lose!  Large firms, like Fidelity or Merrill Lynch, have significant research teams analyzing the markets.  Their advisors have instant access to that research.

I suggest starting simply on your own with a Fidelity or Vanguard account and just buy a broad market index fund.  Once your assets reach over $100,000 you may find an advisor may offer some value.  They can offer other planning services and keep you on the right track in down markets.  I started investing on my own and when my family and professional life became complicated, I realized I wasn’t paying enough attention to my investments.  That is when I moved a portion of my investments to an advisor.  At that point in my life the 1% fee was worth the advice and gave me some confidence that I was on the right track.  Now in retirement, I have a proven plan in place and I may eventually reduce my portfolio share with my advisor.

Keep it Simple

As I look back on my 35 years of investing, I realize it could have been simplified.  I was buying mutual funds chasing last year’s returns essentially ending up with 25 funds that made up the whole market.  I did well because I unknowingly created my own index fund made up of many individual funds.  The problem was, even my low-load funds had high fees compared to the modern index fund. This is why the simple index fund is so right for so many investors.  These low expense (fee) index funds invest in good US companies.  Companies that don’t measure up automatically fall off the index and new growing companies are added.  You as the investor don’t need to perform individual company research attempting to pick the winners.   You can invest that time into the things you enjoy!

Conclusion

  • Buy the index fund or build your own version within your employer’s plan. 
  • Invest in a target date retirement fund if you are a hands-off investor.
  • Use the same strategy within your self-directed accounts knowing you have more choices. 
  • Invest in the best low-cost index funds from proven brokerage firms. 
  • If you must pick individual stocks, do so with no more than 10% of your assets.
  • Use a good advisor based on your situation but understand the cost.
  • Keep investing and enjoy the returns of good US companies!

1EngineerOnFIRE