July Stats

Just a quick update this month.  The main reno is complete, but there’s still so much to do.

Student Loans 3.75% $23,280.44 $180.74 $0.00
Mortgage 3.50% $307,917.09 $2,259.03 $0.00
Total $331,197.53 $2,439.77 $0.00

How to invest

So, you’ve slashed your spending and suddenly have all of this money to invest, but you need to know how to invest it to get the best return for your hard-earned moola.  Let’s go over your options:

Financial Adviser

At this point, most people would open an account at a full-service brokerage and give their money to a broker / money manager / financial adviser / investment counselor to manage.  In exchange for the privilege of trying to beat the market for you, this adviser will charge you a percentage of your investment with them – typically something like 1%, but DW’s adviser charged 0.75% for her account, so let’s stick with that in our discussion.

When determining if investing with an adviser is a good idea, the most important thing to explore is whether that adviser will be able to get you returns at least 0.75% (or whatever their fee is) above the market returns you would make if you just bought an index fund that tracked the market.  There’s loads of literature you can read on why financial advisers are a pretty terrible bet, but here’s what you need to know:  over time, a vanishingly-small number of advisers beat the market, and the odds of you picking the right one that will “go the distance” is basically nil.  While some may beat the market in one year or another, they won’t continue to beat the market.

If you invest in the market as a whole (index investing), you can expect 7% returns; if you’re losing 0.75% returns to adviser fees, you’re losing over 10% of your returns by investing with an adviser, and that’s before we even factor in their sub-par performance!

Stock Picking / Timing the Market

Okay, let’s kick all advisers to the curb and go it alone.  We can pick our own stocks!  We’re all smart, beautiful, and dedicated; why can’t every one of us be in the top 10% of investors?

Except that the advisers have access to loads of research that we don’t have, and they still can’t get it right.  In fact, if there’s one thing that a good adviser can do, it’s prevent us from making some terrible decisions.  The basic premise of making money in the market is to buy low, sell high.  However, as humans, we’re pretty terrible at this:  when the sky is falling, we panic and sell.  A good and smart adviser can hopefully prevent you from doing this.  In fact, the best thing to do when the market is crashing is to buy!

Most of the money lost in the 2008 financial crisis was due to people selling when they should have been buying.  It was a golden opportunity to get into the market cheap, and most people blew it, because we as humans are terrible at making decisions when everything is going to hell around us.

Now, I’m not saying that timing the market was the right thing to do there, either.  People who continued with their investment plans and kept reinvesting dividends recovered from the crash and were looking pretty rosy within a couple years.  If you had some way to invest more money during that time, you made more money, since the market was discounted.  This is different than trying to figure out when a particular stock will go up or down, but, if you were trying to find the bottom of the market, you still would have been out of luck.

In fact, it would be great if there were some way to automatically factor in the rise and fall of the market while still investing via a plan that can keep you from losing your head precisely when you need to keep it.

Dollar-Cost Averaging

So, since we can’t trust advisers, and we can’t trust ourselves, what are we to do?  Well, the most important thing is to make a plan and then to stick to it.  You don’t want to be watching the daily market fluctuations and ripping your hair out (or selling your kids to get money to buy stocks).  Just find a low-cost index fund and put money into it regularly.

The easiest way to do this is dollar-cost averaging.  If you have a 401k, you’re familiar with this style of investing:  every paycheck, some money goes into your investments automatically, and you probably don’t even look at how you’re doing except once a quarter, when you get a report and go, “Oh, yeah, I have investments.  Neat.”  If you’re investing on your own, in an IRA or a taxable account or another vehicle, you may want to pick a day every month and put money in then.

The key thing is that you stick to the plan – don’t let market fluctuations change your behavior.  Consistency is the key to success.

This method is called dollar-cost averaging because it averages out the cost of the funds you’re buying over time – thus shielding you from variations in share price.  If your fund is expensive on the day you’re buying, you’ll buy fewer shares; inversely, if your fund is inexpensive on the day you’re buying, you’ll buy more shares.

Anywhere you go, this sort of automatic investment strategy should be available, which is really great.  It’s an easy “set it and forget it” way to invest, which is exactly what you want to take the emotion out of your investment decisions.

Value Averaging

However, if you’re looking to maximize gains, you really want to buy as much as you can when prices are low and as little as possible (or maybe even sell) when prices are high.  But, without a future-seeing crystal ball, how can we possibly know when prices are low or high?  And, if we’re trying to make a consistent plan and stick to it, not allowing emotion to get in the way, we really need to veer away from trying to time the market.

That’s where value averaging comes in.  This is a slightly more involved investment strategy, because putting this on auto pilot could potentially get you in trouble.

Where dollar-cost averaging targets a specific investment every time period (let’s say month), disregarding the current performance of the asset, value averaging does the converse:  it targets a specific invested value, regardless of how much needs to be bought or sold to get there.  If your investments have gone up over the past month, you invest less money, because you’re closer to your goal.  If your investments have gone down over the past month, you invest more money, because you’re further from your goal.

This method of investing adds an additional element to your investing decisions:  now, not only does your money buy more shares when prices are low, you’re also investing more money to capture that opportunity.  When prices are high, your money buys fewer shares, but you’re also putting less money in.  In fact, if gains have pushed you over your target investment, you sell some shares to realize those gains.  (Note:  if you’re doing this in a taxable account, realize that this will create a taxable event.  You may want to have a tax-deferred account as well, if you’re going to be selling.)

Basically, value averaging is how you can make a plan to capture “buy low, sell high” without having to make decisions, and thus potentially deviate from your plan, every month.  Since the amount of money you’ll be moving into investments every month varies, it is a more involved strategy, and can still get pretty stressful at times of large swings in value.  However, the great thing about value averaging is that it will tell you exactly when you should be buying (because everyone is selling) and selling (because everyone is buying).

As Warren Buffet says, “Be fearful when others are greedy, and be greedy when others are fearful.”


(Now that we’re starting to delve into investments, I’ve put up a legal disclaimer here to cover my ass.  I hope you’ll stick with me anyway.)