Here is my recommended way to invest your savings. I've used a frequently asked questions (FAQ) format to make it easier to comprehend, and for clarity I've given my guidance a silly name: Fatherly Advice on Investing Safely (FAIS). The intent here is use this like a roadmap to help you navigate the confusing maze of investment highways and byways.
1. What money should I invest using the FAIS guidance, and why? Starting early is a huge advantage when it comes to building wealth because it gives you time to maximize the power of compounded rate of return. With compounding, you can save a little now and reap big rewards later. My aim is to touch on the financial steps you should take today to provide for a better tomorrow, in order to be able to:
- afford future big ticket items (FBTI) such as a new house, cars, kids' college, vacations, medical emergencies, etc.
- have a secure retirement by creating a sizeable nest egg, and in so doing, be less dependent on Social Security and other government programs.
For retirement savings, I think tax-sheltered Roth IRAs are too good a deal to pass up. For FBTI savings, an account at a brokerage firm (like Vanguard) offers many ways to grow your money beyond what's available at a bank, but remember that such gains are taxable income, unlike in an IRA or 401K. Cash that's necessary to meet near-term expenses (3-months' worth or a bit more) ought to be left in a bank checking or savings account, thus available for immediate access. [updated 3/19/19].
2. What is the FAIS approach to investing? Five alternate approaches are presented. They vary in the number of Vanguard funds that you would own at the same time: from a four fund strategy (FAIS-4) that is the most diversified to address the risk of loss; to strategies with three or two funds (FAIS-3 or -2); to a single fund strategy (FAIS-1 or -0), the easiest but not the preferred way to invest. The FAIS strategies require minimal maintenance -- if two or more funds are held, you need only to rebalance your portfolio once a year (see FAQ_4). [updated 3/19/19].
a) FAIS-4: The FAIS-4 asset mix is the result of combining Harry Browne's classic strategy with more recent research in portfolio design. Basically the allocations to stocks and bonds have been increased from Browne, with an emphasis placed on intermediate term US treasury bonds. In addition, his allocation to gold has been decreased, and there is no allocation to short term government debt instruments. These changes reduce downside risk without lowering the upside growth. Your investment therefore would be in three basic asset classes according to this allocation:
30% Stocks, 60% Bonds, 10% Gold.
The specific funds to purchase in your Vanguard account(s) are three mutual funds (MF) plus one electronically traded fund (ETF), all of which are free to buy or sell. FAIS-4 requires annual rebalancing.
- 30% VTSAX Total US Stock Market MF
- 20% VUSTX Treasury Bonds Long Term MF
- 40% VFITX Treasury Bonds Intermediate Term MF
- 10% IAU Physical Gold ETF
b) FAIS-3: This approach eliminates the allocation to gold, otherwise it is similar to FAIS-4. The change somewhat simplifies managing your portfolio. The basic asset class allocation is:
30% Stocks, 70% Bonds.
The specific funds to purchase are three mutual funds, all of which are free to buy or sell in a Vanguard account. FAIS-3 requires annual rebalancing.
- 30% VTSAX Total US Stock Market MF
- 20% VUSTX Treasury Bonds Long Term MF
- 50% VFITX Treasury Bonds Intermediate Term MF
c) FAIS-2: The FAIS-2 method puts 1/3rd of the portfolio in US stocks and 2/3rds in intermediate US treasury bonds. Even with only two funds, it comes close to the historical performance of the FAIS-3 and FAIS-4 mixes. FAIS-2 requires annual rebalancing.
d) FAIS-1: No more complicated than to buy and hold the Wellesley Income Fund VWINX. It contains about 1/3rd stocks and 2/3rds bonds and is actively managed for Vanguard by Wellington Management, and has been since 1970. The fund's risk-adjusted rate of return is among the best of the 9,000 mutual funds in the marketplace.
e) FAIS-0: No more complicated than to buy and hold the Federal Money Market VMFXX, an essentially risk-free investment that is among the best money market funds anywhere. Be aware that its rate of return is usually about the same as the rate of inflation. By selecting this alternative, over the long haul your savings in real dollar terms will basically tread water.
3. How do I decide what FAIS strategy to follow? I've given you choices that offer good returns with greatly reduced risk, all for the low-low price of spending an hour each year managing your Vanguard account(s). I'll leave it up to you, but my personal recommendation is FAIS-3. Note that I do not recommend FAIS-1 or FAIS-0 unless you feel too intimidated to manage your accounts, or if life is in the way and you are too distracted. In that case I suggest FAIS-1 for your Roth IRA and FAIS-0 for your taxable FBTI account.
4. How often do I adjust my investment mix? Every year your account(s) must be rebalanced to the portfolio percentages specified in FAQ_2 for the FAIS strategy you select (unnecessary for FAIS-1, FAIS-0). My research finds that the later half of April is the optimal time to do so, but what's most important is to pick a date and consistently stick to a regular 12-month cycle. I'd avoid the Christmas-New Year's time period because the markets can get distorted from so many investment managers conducting a similar task, keeping in mind they are rebalancing billions and billions of dollars. [updated 12/18/18].
5. What is the Browne strategy? Known as the Permanent Portfolio, it is a novel approach by Harry Browne that he refined throughout the 1970s and 1980s. Using the investment funds available in a Vanguard account, applying Browne's idea is fairly simple: (1) purchase VTSAX, VUSTX, IAU, and VMFXX, putting 25% of your money in each fund; (2) rebalance annually back to the 25% allocations. I've previously summarized the Browne strategy [link] if you desire to read more.
6. How do I add money to my Vanguard accounts? Each year you should try hard to stash away 15% of your gross income for retirement (paycheck deductions for a 401K count to that objective), up to the IRA limit imposed by the IRS. This is in addition to your FBTI savings. Before buying stuff, pay yourself first!
The best way is to set up automatic monthly transfers to a Vanguard taxable account and a Roth IRA account from your bank checking account. From your Vanguard webpage 'My Accounts', go to 'Account maintenance' > 'Automatic investments' > 'Edit', then specify the same percentages found in FAQ_2 for the FAIS approach you've chosen. This step can be taken only if you already have money in the funds listed for your selected FAIS approach. To set up automatic investments into a fund you don't yet own, use Buy Vanguard funds to purchase the fund first.
Note: for 2019 the federal government has increased the IRA contribution limit to $6,000 per year, which corresponds to a $500 monthly deposit. [updated 11/2/18].
7. How do I withdraw money and do I rebalance then or wait? You may only withdraw from your taxable (non-retirement) account -- you should never touch your retirement savings during your working years. If the amount you withdraw in any one year is more than 10% of your account balance, it's necessary to reallocate the remainder according to the FAQ_2 percentages (unnecessary for FAIS-1, FAIS-0).
To move money from Vanguard to your bank checking account, go to 'My Accounts', click on the 'Holdings' tab, then the 'Transfer money' pull-down menu, then select 'Send me money'.
It takes up to 4 business days for the transfer to be completed and available in your checking account -- so plan accordingly.
8. What if I don't have enough in my Vanguard account to meet mutual fund minimums? Most funds in the FAIS portfolios require an initial investment of $3,000. If you've decided on the single-fund approaches, FAIS-1 or FAIS-0, then $3,000 is all you need in an account. For the multiple-fund approaches, you will need to use substitute ETFs until your account reaches a certain level ($15,000 for FAIS-3 or FAIS-4; $9,000 for FAIS-2):
These ETFs are bought or sold commission-free in a Vanguard account [updated 9/25/18].
9. How do the FAIS strategies compare to investment portfolios I've read about in various books, magazines, and blogs? Below is a summary comparing the best of the Lazy Portfolios or Couch Potato Portfolios, terms often applied to asset mixes that require minimal monitoring or adjustment. Performance metrics are shown for the 40-year period 1978 through 2017. It assumes rebalancing is done annually, and does not include costs for any commissions, fees, or taxes. Straight investing in the "US Stock Market", without any bonds, gold, or other assets included in the portfolio, is also presented for comparison. Scroll down for definitions of the column headers.
|Minimum Fat Tails||Swedroe||9.30||-9.50||-22.8||0.65||0.92||0.415|
|"US Stock Market"||--||11.62||-37.0||-50.9||0.51||0.73||0.286|
I'd like to point out that the FAIS-3 and FAIS-4 strategies have demonstrated better reward-to-risk ratios than virtually any other Lazy Portfolio promoted by "experts", including proven money managers as well as those hosting TV and radio infomercials. And you'd be hard pressed to find portfolios that beat the other FAIS strategies.
10. Will I lose money? Historically all the FAIS strategies have shown a positive return over any timeframe of three years or longer. But losses over a daily, weekly, or monthly basis (and sometimes for a full year) are bound to happen. Only an account held in a money market fund (like FAIS-0) will grow in a straight line, albeit at a low rate. The up-and-down cycles of prices for stocks, bonds and other investment assets are a fact of life.
The hardest thing for an investor is being able to endure large drawdowns (i.e., the peak-to-valley drop in account value which will inevitably occur) and the extended time it takes to get back to the peak value. Because the psychological toll of prolonged states of fear and stress can lead to poor decision making, it's essential to have an understanding of both the risk and the reward characteristics of investment strategies. By doing so, you are attempting to improve the odds that in actuality you'll stick with the plan.
Warren Buffett, the famous billionaire investor, advises the heirs to his fortune to invest 90% of the inheritance in the 500 largest US stocks (VFIAX) and the remaining 10% in short-term government obligations (VMFXX). His advice, although a smart and simple way to continue growing generational wealth, is very likely to put the investor on a wild roller coaster ride. In 1987, as an example, you would have seen a 20% drop to your account value in just two weeks! More typically, large drawdowns last for many months, and the drop's size can be gigantic: -14% in 1990; -15% in 1998; -40% in 2001; -46% in 2008; and so on...
The table above compares the performance of Buffett's recommendation with my FAIS-3 over the 31-year period 1987-2017. The 90/10 Portfolio results in a higher return, however, when you consider portfolio volatility and downside risk, FAIS-3 has far better performance. This is due to the combined effect of asset diversification along with annual rebalancing [updated 4/2/19].
The graph below shows the growth of $10,000 invested January 1987 in either Buffett's idea or in FAIS-3. Notice the very smooth curve that is achieved by carefully selecting and blending assets, in contrast to the highly volatile nature of a portfolio with 90% concentrated in the stock market. Also on display is the magic of compounding: the 8% annual return of FAIS-3 grows to about $110,000 after 31 years, while the greater return of 10% reaches $180,000, but the long ride is much bumpier.
So if you have an iron will and steel nerves, go ahead and take Uncle Warren's advice. A better fit may be my FAIS strategies if you are like me and can't stomach watching half, or even a quarter, of your savings evaporate during the down cycles of the stock market.
The acronyms, abbreviations, and terms are defined here. Do a google search if you want more of an explanation.
FAIS Fatherly Advice on Investing Safely
Asset Something that you invest money in with the hope that it will build future wealth. Asset types can vary widely; often referred to as asset classes.
Portfolio Grouping of the money that you have invested, commonly represented as a pie. The slices of the pie are how much you have invested in certain asset classes.
Asset Allocation Percentage of your portfolio held in a specific asset classes, such as stocks, bonds, gold, cash, real estate, etc.
FBTI Future Big Ticket Items; savings for that next car, new house, kids' college, etc.
MF Mutual Fund; a managed investment pool; trades once a day at market close
ETF Electronically Traded Fund; a managed investment pool; trades continually during market hours just like a stock
B&H Buy and Hold; no rebalancing of portfolio
Rebalance Periodic readjustment of portfolio to the target asset allocation
CAGR Compounded Annual Growth Rate, in percent
WrstYr Worst Year's return, in percent
mDD Maximum Drawdown based on monthly returns, in percent
Sharpe Reward-to-risk ratio created by William Sharpe
Sortino Reward-to-risk ratio created by Frank Sortino
JLratio Weighted metric of various reward-to-risk ratios