How to invest for retirement when you're just starting out


This post is for my friends and family just getting into the workforce and considering investing for retirement or to meet their financial goals. This is stuff I wish I knew when I first started out, and I’ve come to these conclusions based on lessons accrued through trial and error and hours upon hours of consuming market related books and media. If this stuff fascinates you like it does me, feel free to reach out and I'll give you plenty of books or places to find good content.

3 Tools of Portfolio Management

This comes from David Swensen, manager of the highly successful Yale endowment fund. His book, Pioneering Portfolio Management, serves as the bible for asset allocation. Here are his three tools:

1) Asset Allocation – The goal of the portfolio is provide equity-like returns of 7-10%, compounded annually, with minimal risk. In order to achieve these goals, your portfolio should have an equity bias. However, putting all of your money in an S&P 500 index fund leaves you very vulnerable to steep drops in your portfolio’s value. Diversification, or owning several uncorrelated assets, provides a cushion against implosions in one asset class. Have a very long term orientation and always think in terms of risk. 

2) Market Timing – Serious investors do not even bother trying to time the market. However, it’s always good to have a general understanding of where we are in the economic cycle. In the throes of a recession, start buying. When the market is reaching new highs every week, be very conservative. As Warren Buffett says, “be fearful when others are greedy and greedy when others are fearful.” 

3) Security Selection – low cost ETFs or index funds is the best way to get started. Do not start investing in individual stocks until you understand how to value them. Here are a few mistakes I’ve seen from beginning investors:

“Electric cars are the future, so I’m investing in TESLA.” Sure, but there are better ways to play the “EV revolution.” TESLA has a negative operating margin (meaning they lose money on the cars they build) and $10 billion (with a B) in debt that I do not see them being able to pay back.

“Amazon is taking over, so I’m investing in them.” Not at these prices. Amazon is a great company, but buying at a price to earnings ratio of 156 will not play out well. Always remember the old adage of “buy low, sell high.”

The Portfolio

In this section, I’ll tell you exactly how much of your money to put where. The first step is to open a brokerage account. You can do this through Vanguard, USAA, eTrade, etc.

20% large cap U.S. stocks (Ticker: SPY) – owning a basket of large, successful American business should be the foundation of your portfolio. For the past 90 years, the total return for the S&P has averaged 9.8%. You might be asking, “so why I don’t I just put all my money in there?” Well, it’s more complicated than that. The last 90 years, the U.S. won two world wars, created the Bretton Woods system, became a global superpower, and the baby boom generation entered the workforce and consumed like there was no tomorrow. Now we have more debt, systemic deflation, and poorer demographics (all those baby boomers are retiring and want their pensions). In the very short term, SPY should rise. In the medium term, there should be a correction. In the long term, it will go up, but I wouldn’t expect 10% a year for the next 50 years. That’s just no realistic.

10% small cap U.S. stocks (Ticker: IWM) – this is a basket of smaller American businesses. While highly correlated to SPY, they have historically outperformed large-cap stocks in periods of economic turbulence.[1]

20% emerging markets (Ticker: EEM) – I’m very bullish on the long-term prospects of emerging markets. For the most part, they have less debt, regular monetary policy, and good demographics. Emerging economies grow faster than developed ones and there are many exciting sectors in the developing world. They are currently not performing well, so consider buying at these levels.

5% gold (Ticker: GLD) – Gold has been used as a store of value for 5,000 years. Gold also serves as an insurance policy for your portfolio. In times of political/economic turmoil or inflation, it tends to perform well. Putting money on gold is considered “going long on fear,” and there will always be fear. Thucydides once said that man has three primary drivers: fear, honor, and self-interest.

5% bitcoin/basket of crypto-currencies (Ticker: none. You have to do this by opening a coinbase or related account) – This is where I lose some investors. Anyway, if you’re young and can take the risk, I think the future is bright for Bitcoin and we’re at or near the bottom. Investing in Bitcoin is kind of like an early stage venture capital investment at this point: high risk, high reward, and not correlated to regular financial markets.

10% commodities (Ticker: DBC) – Commodities rise on fall according to long supercycles of supply and demand. Understanding this allows you to buy on weakness and sell on strength. Not many investors understand this sector, but it can be a powerful diversifying tool. 27% of the Yale endowment fund is in real assets and commodities such as real estate, oil/gas, and timber. 

20% bonds or cash (Tickers vary. Open an account at treasurydirect.gov) – At the current time, I would recommend bonds themselves as opposed to bond funds asthe prices of bonds are finally falling after a 30 year bull market while the yields are rising. 6 month treasury bills provide a guaranteed return of 2%. This is very low, but it allows you to preserve your capital and use it on other assets later. For a complete list of bond funds, go here: https://www.thebalance.com/bond-etfs-the-complete-updated-list-416949

Other considerations: real estate. Buying rental properties is also a good way to go for passive income.

Rebalance

Once a year or once a quarter, go to your mortgage account and rebalance. You’ll find that in a year, some asset classes have performed well while some have performed poorly. Let’s say equities rose and commodities fell, leaving your portfolio with 26% SPY and 7% DBC. Sell 6% of SPY to get back to 20 and buy more DBC to get back at 10. Or, don’t sell and simply buy the underperformers to get to the above percentages. This forces you to buy low and sell high. Buying low and selling high is hard to do when first starting out. Just remain disciplined and stick to this strategy. Happy investing!

[1] https://www.cmegroup.com/education/featured-reports/equities-comparing-russell-2000-vs-sandp-500.html

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