Copying and pasting from an email I sent to a friend last month regarding how I'd invest in a 401K account if I were in his shoes (42 years old, minimal debt and monthly cash outflows)
As far as good investment books go I can’t think of any
really good ones to recommend for what I think you are trying to accomplish.
Your account is with Fidelity, correct? They should have a host of exchange
traded fund (ETF) options available and, also, some target life funds. ETFs are
exploding in popularity and cover just about every asset class and strategy you
could ever want to pursue (e.g. intl exposure, fixed income, equities, adding
leverage, real estate, alternative investments, etc.).
Beating the market on a sustained basis is pretty difficult. A few big names (e.g. Buffett) have been able to do it over the decades but there is no proof that the average Joe can achieve the same level of success with his or her hard-earned shekels.
Here is my approach to investing 401K assets at a high level which I think is pretty time efficient:
1. As a long-term investor a majority of assets should be invested in equities
1. First, be sure to allocate significant capital to equities since you have 20+ years until you will need to retire and do not foresee any major purchases in the next 3-5 years.
“It’s not about market timing
it’s about time in the market.” This is one of my favorite investment related quotes. The long-term investor should seek to have heavy equity exposure for as long a
period as possible due to the power of dividend reinvestment and compound
investing (i.e. exponential growth of interest on interest / capital gains)
over time. Here’s a tweet I sent out attesting to the power of stock investing over time (#s courtesy of Credit Suisse):
- Per
CS: Real value of equities up 313x vs 7.6x for bonds and 2.7x for T-bills over
last 114 years
#investing#stocks http://ow.ly/tLtnV
Stocks will give you the best inflation protection over time and help you grow your nest egg
2. Second, diversify internationally
The "home" bias is prevalent for retail investors who tend to only invest in markets and stocks in which they are most familiar. For your average U.S. investor this means investing only in domestick markets.
Emerging markets offer the potential for greater growth over time and have been really hammered recently. Geographies like Europe and EM may offer better value so be sure there is some allocation to international in your portfolio.
3. Minimize your allocation to "investments" that will earn you a negative real return
3. Leave
only the bare minimum emergency funds in cash. Leaving money in cash earns you
absolutely nothing on a nominal basis and a negative return after accounting for increases in the cost of gas, rent, etc..
Leveraged loan funds can be an attractive alternative for investors who might require access to capital for a large expense in the near-term (1-3 years) or have difficulty stomaching the gyrations in stocks and riskier bond asset classes (e.g. high yield, EM debt) that offer the opportunity for positive real returns.
The underlying loans in leveraged loan funds are floating rate securities and reset frequently (generally quarterly) and, thus, are less exposed than fixed coupon bonds to the inevitable rise in short-term interest rates (Fed Funds) which the Fed is projecting to occur in 2015 or 2016. An example is Black Rock’s senior loan ETF (http://www.etftrends.com/2013/08/bank-loan-etfs-for-yield-and-rising-rate-hedge/) which yields 4.2% currently (expense ratio is 0.65%). It won’t be a big mover in terms of capital appreciation potential but can give you some positive yield on an allocation that would otherwise earn you a negative real return in instruments such as checking, savings, or money market accounts.
4. How to efficiently accomplish such a strategy:
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Use target date life funds. I’m putting a significant chunk of my 401K allocation in a 2055 fund (the date that I should theoretically
retire . . . ha!). The fund reallocates between asset classes and securities over time based on the time horizon from
current date to the time at which you will need to draw the funds. If your time horizon is
short (less than 5 years) the fund will be primarily allocated to fixed income
investments due to their relatively lower volatility as compared to equities and, hence, lower
probability of a major draw-down in value. For those with a longer time horizon, target life fund investments are heavily weighted toward equities, while providing acess to alternative investments like real
estate and real assets (e.g. timber), as well as exposure to international investments.
The funds essentially allocate assets on your behalf without the investor having to be too
involved and, importantly, achieves this at a very low cost. For example, I believe my 2055 fund has an annual expense ratio less than 0.15%.
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On Expense Ratios . . .
On the expense ratio topic – this is absolutely
critical. The average investor can’t necessarily beat the market by stock or ETF picking, but he or she can minimize expenses by investing in investment vehicles (ETFs & target life funds) with low annual expense
ratios. The main reason to not invest in closed-end mutual funds, are the
load fees that can come at purchase or sale of the funds and eat away at gains. To find a fund's expense ratio visit its Profile page on Yahoo. For
example: http://finance.yahoo.com/q/pr?s=BKLN+Profile
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For cheap ETFs Vanguard, Schwab,
PowerShares, iShares and Fidelity offer some nice options. Might be forgetting one or two of the majors
but those are the majors I would look into.
Passive vs. Active Investing . . .
There is really limited evidence of anyone being able to beat
the market over the long term. Of course there is the Warren Buffett example but he is in a unique situation of
being able to draw up extremely favorable terms not available to the average investor as he did with the Goldman and Bank of America
preferred investments. At best, active managers cover their incremental
expenses by adding additional alpha, but there isn’t a good deal of proof to this. Thus, passively managed ETFs are a cheap and sound alternative to actively managed vehicles for the long-term investor.
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On Sector Investing . . .
Avoid investing into specific sectors unless you
have extremely good conviction with a sound basis. I was long gold last year
(probably way too early) based on the potential of inflation down the road from
the Fed printing money. The precious metal was simply destroyed last year (although it has come back a bit in 2014) as there is
virtually no inflation in wage growth (yay America) and the financial markets had a one-track mind last year with a steady upward slog and minimal meandering. Gold
tends to do well in the riskiest / worst markets.
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Alright, diatribe done for now.
