3019: [Part 1] Stocks - Part XXIII: Selecting Your Asset Allocation by JL Collins on Building and Preserving Wealth

[00:00:00] Stay sharp, save time, and let your money work harder with The Average Joe, a free daily newsletter that breaks down stock market news and personal finance tips into quick, easy-to-digest insights. Each issue helps you invest smarter and manage your money better, all in five minutes or less. It's clear, actionable, and won't cost you a dime. Join 250,000 readers, 20% of which have hit seven figures,

[00:00:28] who are already building a brighter financial future. Subscribe now. Sign up at readthejoe.com slash subscribe dash swap. That's readthejoe.com slash subscribe dash swap. Level up your money game. Subscribe to The Average Joe now.

[00:00:51] This is Optimal Finance Daily. Stocks, Part 23, Selecting Your Asset Allocation, Part 1 by JL Collins of JLCollinsNH.com. Life is balance and choice. Add more of this, lose a little of that. When it comes to investing, that balance and choice is informed by your temperament and goals.

[00:01:14] If I had to do it over, this blog would likely be named The Simple Path to Wealth, after one of my very early posts and currently the working title of my upcoming book. Financial geeks like me are the aberration. Sane people don't want to be bothered. My daughter helped me understand this at just about the same time I was finally understanding that the most effective investing is also the simplest. Complex and expensive investments are not only unnecessary, they underperform.

[00:01:44] Relentlessly fiddling with your investments almost always leads to worse results. Making a few sound choices and letting them run is the essence of success and the soul of The Simple Path to Wealth. If you've read this far in the stock series, you already know this. You also know that with simplicity as our guide, we look at our investing lives in two broad stages using just two funds. The wealth acquisition stage and the wealth preservation stage.

[00:02:13] Or perhaps a blend of the two. And VTSAX, which is Vanguard Total Stock Market Index Fund, and VBTLX, Vanguard's Total Bond Market Index Fund. The wealth acquisition stage is when you're working and have earned income to save and invest. For this stage, I favor 100% stocks, and VTSAX is the fund I prefer. If financial independence is your goal, your savings rate in these years should be high.

[00:02:42] As you invest that money each month, it serves to smooth out the market's wild ride. You enter the wealth preservation stage once you step away from your job and regular paychecks and begin living on income from your investments. At this point, I recommend adding bonds to the portfolio. Like the fresh cash you are investing while working, bonds help smooth the ride. Of course, in the real world, the divisions might not always be so clear. You might find yourself making some money in retirement.

[00:03:11] Or over the years, you might move from one stage to the other and back again more than once. You might leave a high-paying job to work for less at something you love. For instance, in my own career, it was never about retirement. And there were many times when I stepped away from working for months or even years. But using this framework of two stages and two funds, you have all the tools you need to find your own balance. In determining that balance, you'll also want to consider two additional factors.

[00:03:41] How much effort you're willing to apply and your risk tolerance. Effort. For the wealth acquisition stage, an allocation of 100% stocks using VTSAX is the soul of simplicity. Further, most studies have shown that this allocation provides the best return over time. But not all. Some studies suggest that adding a small percentage of bonds, say 10 to 20%, actually outperforms 100% stocks.

[00:04:08] You can see this effect by playing with a calculator called Vanguard Retirement Nest Egg Calculator. You'll also see that adding two greater percentage of bonds begins to hurt results. Now remember that these studies are not carved in stone. And like all calculators, this one relies on making certain assumptions about the future. The difference in projected results between 100% stocks and an 80-20 mix is tiny.

[00:04:34] How those results actually unfold over the decades is likely to be equally close. And the ultimate winner is basically unpredictable. For this reason, and favoring simplicity, I recommend 100% stocks using VTSAX. That said, if you're willing to do a bit more work, you could slightly smooth out the wild ride and possibly outperform over time by adding 10 to 25% bonds.

[00:05:00] If you do, about once a year, you'll want to rebalance your funds to maintain your chosen allocation. You might also want to rebalance any time the market makes a major move, like 20% or more up or down. This means you will sell shares in whichever asset class has performed better and buy shares in the one that has lagged. Ideally, you'll do this in a tax-advantaged account like an IRA or 401k, so you don't have to pay tax on any capital gains.

[00:05:28] Having to pay capital gains taxes would be a major drawback and another reason to focus on holding just VTSAX. This rebalancing is simple and can be done online with Vanguard. It should only take a couple of hours a year. But like changing the oil in your car, it is critical that you actually do it. If you like this idea but are unsure you'll remember to rebalance or simply don't want to be bothered,

[00:05:54] here are two fine options, betterment and target retirement funds. Both allow you to choose your allocation and then they'll automatically rebalance for you. They cost a bit more than the simple index funds you'd use doing it yourself. You're paying for the extra service, but they are still low cost. Risk. Basically, bonds smooth the ride and stocks power the returns. The more you hold in stocks, the better your results

[00:06:22] and the more gut-wrenching the volatility you'll be required to endure. The more bonds, the smoother the ride and the lighter the results. If you're going to hold stocks, you need to be mentally tough enough not to panic when they plunge. And make no mistake, over the decades, you own them, plunge they will. Usually at the most unexpected times. There is a major crash coming and you've got to toughen up, Cupcake, because nobody can predict when, despite all those claiming they can.

[00:06:52] Let's be clear. Everybody makes money when, as it has now since 2009, the market is on the rise. But what determines whether it will make you wealthy or leave you broken and bloody at the side of the road is your ability to stay the course and ride out the storms. If you have any doubt as to your ability in this regard, you will be better off avoiding stocks, regardless of what the calculators say. Factors to consider in assessing your risk tolerance. You'll hear that in tomorrow's episode.

[00:07:25] You just listened to part one of the post titled Stocks, part 23, Selecting Your Asset Allocation, by JL Collins of jlcollinsnh.com. You sign up for something, forget about it after the trial period ends, then you're charged month after month after month. The subscriptions are there, but you're not using them. In fact, I just learned that 85% of people have at least one paid subscription going unused each month.

[00:07:51] Thanks to Rocket Money, you can see all of your subscriptions in one place and cancel the ones you're not using anymore, saving more money. Rocket Money is a personal finance app that helps find and cancel your unwanted subscriptions, monitors your spending, and helps lower your bills so you can grow your savings. The app automatically scans your bills to find savings opportunities and will even negotiate with service providers on your behalf. No more waiting on hold. And their new goals feature makes saving automatic,

[00:08:21] perfect for building an emergency fund or saving for a house. Cancel your unwanted subscriptions and reach your financial goals faster with Rocket Money. Go to rocketmoney.com slash OFD today. That's rocketmoney.com slash OFD. Rocketmoney.com slash OFD. I found the reading today so refreshing as JL's book, The Simple Path to Wealth is the book that finally got me comfortable with investing.

[00:08:48] If you haven't read it, I highly, highly recommend. JL makes such a compelling case for keeping things simple. And for someone like me who has always found investing so intimidating, this approach works so well. And keep in mind that while Vanguard offers the index funds mentioned in this article, there are probably comparable funds wherever you have your investments. So for example, my 401k and HSA offered through my employer are with Fidelity.

[00:09:17] And I was able to invest my HSA in FXROX, which is their zero total market index fund. Zero, meaning zero expense ratio. How can you beat that for a low fee index fund? Well, that should do it for today. Have a great rest of your weekend and I'll catch you tomorrow where we'll finish up this post and where your optimal life awaits.