This is our third of four recommended New Year’s resolutions that together form the foundation of the Financial Guide to Life personal finance principles. Investing is a big topic that we will cover more thoroughly in the future, but for now let’s explore how easy it can be if you choose. Investing can be as complex or easy as you choose and for most of us, complex does not mean richer. You may not think you have enough money to “invest”, but if you have savings that aren’t buried under the mattress or in the back-yard, then you are investing it. Your emergency fund is likely invested in a low risk/low rewards savings account while most people (and all young people) should have their retirement savings invested in higher risk and reward investments.
The key to investing is to balance risk versus reward. Low risk investments will pay lower rewards while higher rewards mean greater risks for you savings. Know that if you are promised, or are getting, big rewards for little risk for an extended time period, you are probably being scammed (think Bernie Madoff). So you need to know which savings should be invested in low risk/reward or high risk/reward investments. The easy answer is that money you may need within the next 3-5 years (like an emergency fund) should be invested in low risk/reward places like savings accounts, certificates of deposit, or money market accounts. Long-term savings (like retirement and college savings) should be invested in higher risk/reward investments such as mutual funds, exchange traded funds (ETFs), or stocks because when they go down, you still have a long time frame for them to recover.
From this investing foundation, there are plenty more complicating principles that can guide you to balance risks and rewards such as diversification (don’t put all your eggs in the same basket), asset allocation (dividing your eggs into different baskets), and rebalancing (shifting your eggs between your multiple baskets). But for now, let’s skip over these and many other complicating factors and just explain how you can make your long-term investing (money you won’t need for more than five years) super simple.
You need investments that are based upon applying all these rules rigorously rather than an “expert’s” stock picking ability or the ups and downs of any particular investment of the month. Combine this with really low investing fees and you will want Balanced or Target Date funds. These are two types of mutual funds or ETFs that diversify your savings among a wide variety of both low and high risk stocks, bonds, and other investments so you don’t have to worry about things like stock picking, asset allocation, and rebalancing. Balanced Funds aim for a set balance between higher reward stocks and lower risk bonds, usually the classic 60/40 split. Target Date funds start with higher risk/reward investments and gradually shift to lower risk/reward investments as a specified target date approaches. For example, if you expect to have students entering college in 2020, you could choose a “Target Date 2020 Fund” for your 529 college savings; or if you expect to retire around 2040, you could invest your 401(k) or IRA retirement savings in a “Target Date 2040 Fund”. This is the easiest way to get professional, “set it and forget it” investments appropriate for your investment goals and timeframes that ensure high returns at the beginning and safety at the end.
If your 401(k) retirement account does not have a balanced or target date fund, then create your own by splitting your savings between a couple of stock and bond funds based upon your age. Subtract your age from 110. The answer is the percentage you should invest in stocks and index funds with the rest in safer funds such as bonds and real estate.
If you want to make your investing more complicated, do it with a small portion of your investments such as 5-10%.