How should I invest my savings (part 1)?
Surviving the cost of living in the Bay is like going to war with two weapons in your battle suit. The first is lowering your expenses. The second is investing your savings wisely (and if you don’t have any savings I’m not judging). Let your money do some of the hard work too.
In this post, I’m going to synthesize all of the investment advice I’ve received from the smartest, most level-headed people who work in finance that I’ve been fortunate to meet. In other words, if you happen to have a well balanced friend who works at a hedge fund, investment bank, etc, this is what they would (or at least should) tell you to do.
Goals
Most investments do not beat “market returns.” That means most of the world’s money managers and investment guru’s do not outperform buying all of the biggest stocks that are publicly traded. If you’d like to learn more about why this is the case, read A Random Walk Down Wall Street.
So if you can get market returns, that’s pretty good. You’re beating most of the pro’s.
Market Returns and the S&P 500
Here’s the good news. Getting market returns takes zero critical thinking and a few minutes of your time. This is like the best worst kept secret in personal finance.
Here’s how you do it:
- Invest all of your savings
- In an
- S&P 500 ETF (the 500 largest US stocks)
And you’re done.
Use whatever brokerage you’d like, E-trade, Charles Schwab, or Heaven-forbid even Robinhood. There are several different ETFs (exchange traded funds) that index the S&P 500. I prefer VOO, which is issued by Vanguard. The fees are extremely low and Vanguard is a highly trusted brand. But they’re really all about the same.
Why is this a good strategy? The 500 largest US stocks are something you can count on to perform long-term as much as any asset with reasonable expected returns. It’s essentially a diversified bet on the US’s ability to grow and build new companies.
You may be wondering, “How much should I expect to grow my savings with the S&P 500?” No one can predict the future, so no one knows for sure. With that said, since the beginning of the S&P 500 until now, it has returned 10%. The S&P 500 started heading into the Great Depression, which is an anomalous baseline. If you look at its returns from 1957 until now, the returns are 8%. (1957 was the year it standardized on the top 500 stocks). I use 8% as my go forward assumption.
Robo Advisors
I’m okay with one alternative to the S&P 500 strategy, robo advisors. You’ve probably heard that term before, but you may not know what it actually means.
A robo advisor essentially automates the principles laid out in efficient-market hypothesis, or in other words, what A Random Walk Down Wall Street describes. It automatically allocates your money to different asset classes like US stocks, foreign stocks, bonds, even natural resources according to your risk tolerance. The theory is that your risk-adjusted returns are better by diversifying into all of these assets classes vs only holding a single asset class like US stocks.
Wealthfront and Betterment are the two largest robo advisors. They’re all pretty similar, but I prefer Wealthfront based on the strength of its leadership team, and it has a few nice extra features. I have a small Wealthfront account just for fun, and below is my actual asset allocation.
I’ve selected a relatively high risk tolerance, so I’m stock heavy. The US stock bucket is actually an S&P 500 ETF. All of the others are different ETFs targeting the associated asset class. In addition, Wealthfront automatically employs some tax savings tactics that typically required a bunch of manual work from a financial advisor.
At the end of the day, I’m not sold enough on betting on other asset classes long-term (eg, emerging markets stocks) to choose a robo advisor over just owning the S&P 500, but I think you can make a compelling argument either way.
The Most Important Thing
Okay, now that we’ve covered market returns and where to invest your savings, let’s talk about something much, much more important: your stock options.
If you work in a tech startup, a huge percentage of the expected value of your compensation is stock options. Often, it’s 50% of your compensation or higher. Eg, if you left your startup job and went to a big tech company like Google, what would your annual salary plus RSU compensation be? If you answered double or more than your startup salary, then you need to believe the expected value of your stock options makes up the difference (or be comfortable with lower overall compensation).
Picking a startup that’s more likely to have its stock options pay out will have a much greater impact on your savings than how well you invest because you’re betting half of your compensation on a high risk / high reward asset. If your options pay out, how much money would you expect to receive? Now compare that to the 8% per year you should earn on your savings (if you invest well)? I think I know which one’s higher, and I don’t think it’s very close.
You should invest your time in picking the right startup.
What Not To Do
Last, but not least, let’s cover a couple of common mistakes people make.
Mistake #1: hire a financial planner. Most of them don’t beat market returns, and they charge a fee of 1% (or more) of your assets per year. Why would you pay someone not to beat the market? You might like talking to them on the phone, but those are the most expensive phone calls you’ll ever make.
Mistake #2: leave your savings on the sidelines. At the time of this writing, we’ve been in a 10-year bull market. You may be thinking, “We’re due for a correction, and I should hold my money in my bank account until the market drops, then I’ll invest.”
Wrong! Wrong, wrong, wrong!!! The world’s best macroeconomists aren’t able to time the market and neither are you. Don’t leave your savings on the sidelines waiting for the market to drop.
It is a good idea to leave cash in your bank account (ideally a high yield savings account) for your “safety net,” typically 3–12 months worth of living expenses.
If you hit a big pay day, like if your startup has a liquidity event and your options cash, it’s also a good idea to leave some of your payout on the sidelines… but only for a little while. In this case, you want to slowly invest your payout over time. The reason is that you’re “smoothing out” market volatility while investing that big, one-time payout.
In Conclusion
What did we learn?
- Most professional investors don’t beat the market
- But you can get market returns in just a few minutes of your time!
- Invest in an S&P 500 ETF or a robo advisor
- Don’t hire an investment advisor
- Don’t leave your money on the sidelines
In personal finance, there usually aren’t shortcuts. Investing your savings is no exception. It just happens to be that the easy way is also the right way.
