The Simple Path to Wealth
When do you become financially independent? When you can live on 4% of your investments per year.
- After you have sufficient amount of money, reinvest enough to outpace inflation and keep your spending below the level your investments can replenish.
Warren Buffett strategy is to invest in good companies that earn real money. So the fluctuations in the stock price are mostly inconsequential, as in the long run the value should rise. Even if the value of stock decreases, you are still owning the same percentage of the company.
Market crashes are normal. And you have to remember that market always recovers, if it doesn’t then no investment will be safe (including yours).
Market always goes up. The crashes are part of the process to correct the market. Why is this true?
- Stock market is made up of publicly traded companies. When you buy stock you own a piece of that business.
Actively managed mutual funds often don’t work. Vanguard did a study and found 82% failed to outperform the unmanaged index (like S&P 500). So don’t go for managed mutual funds, as the companies charge high fees to the clients as well for this.
- Bonds are loaning money to a company or government agency.
- It the money loses value, the loan still stands and you make money in deflation.
- If inflation increases prices, then your still stands and you receive the same amount, and thus loose money.
- Some bonds provide benefits that the interest is free from federal or state taxes.
- Using VBTLX (Vanguard’s Total Bond Index Fund) mitigates the risk in owning individual bonds as it holds 7.843 bonds.
- If you loan $1000 at 10% for the next 10 years to a company. Then you will receive $100 every year, and at the end of 10 years you will receive the original investment back. But there is a risk the company defaults on the payment and you do not get paid back.
- Bonds are evaluated from AAA down to D. The lowest rating is the highest risk of defaulting on the loan. VBTLX only bonds higher than Baa.
- Municipal bonds are issued by government at the state and local levels to fund public projects like schools, airports. They are exempt from federal taxes, and generally exempt from state taxes in which they are issued. This makes them appealing to the rich people living in high income tax state. Vanguard also has these.
- DJIA (Dow Jones Industrial Average). Comprised of 30 large American companies. Started in 1896 with 12 stocks from leading Americans industries. (not good now)
- CRSP U.S. Total Market Index. Index of virtually every publicly traded company in the U.S.
- S&P 500. In John Bogle, the founder of The Vanguard Group, launched the world’s first index fund S&P 500, comprising of the top 500 companies in the U.S.
- Vanguard Total Stock Market Index Fund. Created in 1992, uses CRSP U.S. Total Market Index, meaning it uses the portfolio/companies specified in CRSP index. (more than 3700 companies in the index fund, virtually the entire US stock market)
- There are multiple varieties of these (each holding the same set of companies from CRSP index)
- VTSAX (owned by the author).
- and more
Buy these three
- Stocks: VTSAX. Provide the best return over time and serve as inflation hedge.
- Bonds: VBTLX. Provide income, tend to smooth out the rough ride of stocks and server as deflation hedge.
- Cash. To cover routine expenses and emergencies. And also the best best during times of deflation. You have two options for this
- Use a fund like VMMXX (Vanguard Prime Money Market Fund), or a fund that is offering the best interest rate.
- In bank savings account, if the interest is better than the above fund.
To get the maximum returns just invest all your money in VTSAX. You don’t have to manage anything in this case.
- People consider this strategy too aggressive. But when beginning you are fine with putting everything in VTSAX. You will have to ride through the up’s and down’s through, but this should beat about 82% of the managed index funds.
- It has high short-term risk, but high long-term results.
After you have become financially independent and want to take less risk, consider this portfolio
- 75% stocks - VTSAX
- 20% bonds - VBTLX
- 5% cash - in local bank
- Wealth accumulation stage - when you are working and have earned income to save and invest. For this stage favor 100% stocks and use VTSAX for that.
- Wealth preservation stage - when you step away from job and begin living on income from your investments. At this stage, start adding bonds.
If you have to rebalance money between stock and bonds, don’t do it at the start/end of year, as this is the prime time.
- Added risk. You trade in the currency of their home country, and this currency can fluctuate against U.S. dollar and thus add additional risk. Also, a country might have weaker reporting standards and weak regulatory structure.
- The fees to invest in international funds is high as compared to VTSAX.
- 500 largest stocks in the U.S. make up about 80% of VTSAX. The largest of these 500 are all international businesses, man of which generate 50% or more of their sales and profits overseas.
Target Retirement Funds
- TRF are funds that hold several other funds. Vanguard has a series of 12 TRFs from 2020 to 2060 depending on when you are retiring.
- TRF will automatically handle all the rebalancing as your chosen retirement gets closer and you don’t have to do anything, except put money into these accounts.
- The expense ratio of these are from .14% to .16%, as compared to 0.05% of VTSAX.
- Investing in VTSAX is better than this. The benefit that TRF provide, can be done by rebalancing yourself, which takes a couple of hours every year.
ETF like VTI
- It does not have a minimum payment like $10,000 for VTSAX and has the same expense ratio as VTSAX.
- When buying or selling ETFs, commissions and/or spreads are frequently involved, and these costs can offset the savings in the expense ratio unless you have access to free trading.
If your 401k does not offer VTSAX then you use these instead (depending on your need)
- VITPX: 0.02%
- VITNX: 0.04%
- VITSX: 0.04%
If your 401k does not offer Vanguard, look for
- A low-cost index fund
- If holding for many years, then total stock market index fund is preferred, or an S&P 500 index fund is just fine.
- Total bond index fund if the above options are not available.
- TRFs are offered frequently in 401k plans. These can be a good choice but look at expense ratio before making the decision.
What makes Vanguard special
- When you buy mutual funds, you are technically owning a piece of Vanguard, as Vanguard does not have any other shareholders.
- So all the money they make would be put back into the people who invested. And as a result Vanguard has the lowest expense ratio i.e. the money required to operate the fund.
- You do not invest in Vanguard, but instead invest in Vanguard mutual fund, and through those in the individual stocks and bonds those funds hold. Even if Vanguard were to leave, your underlying investments would remain unaffected (as they are separate from the company).