In yesterday's e-mail, I wrote about how my three daughters – Alison, Emily, and Katharine – are on their way to securing their financial futures by following in my parents' footsteps.
They hold steady jobs and control their expenses such that they live beneath their means – meaning they're net savers every year.
This brings us to the last piece of the puzzle: how to invest their savings...
I've been in the stock-picking business for more than a quarter century – first as a hedge-fund manager for 18 years and now at Stansberry Research. But I don't think you need to find the next monster stock to achieve your long-term financial goals.
Rather, you need to invest your savings wisely – and the good news is that it's not hard. As I wrote in the book I dedicated to my daughters five years ago, The Art of Playing Defense:
First, max out your retirement plan(s) like an IRA or 401(k) – especially if your employer will match at least some portion of it (this is free money – take it!). Tax-deferred savings are much more valuable than taxable ones because you won't have to pay taxes on your realized gains each year. The difference over time is enormous. Also, because there's a penalty for taking the money out before you're 65 years old, you're less likely to do something stupid with it.
Ideally, set up automatic withholding from your paycheck into your IRA (or another retirement fund) – this makes it easier to save because you never see the money.
Then, set up a plan such that the moment the money hits your account, it's automatically invested in an S&P 500 Index fund. (If you want to set aside some money to invest on your own, that's fine – but index most of it.)
Finally – this is key – don't look at it! Just let it build, year after year, decade after decade. Whatever you do, don't panic during times of market turmoil and sell – just about everybody who does this has terrible timing, selling at exactly the wrong time (for example, in March 2009 or 2020).
My sister is a good example of this, as I continued in my book:
Consider the extreme case of my sister, who had a retirement account at her old employer, then switched jobs – and forgot about it! Years later, she remembered it – and discovered hundreds of thousands of dollars (!) because she'd done everything right up front: her employer automatically withdrew the maximum retirement contribution from her paycheck and then invested all of it in an S&P 500 Index fund.
Another example is when my parents retired and I took charge of their financial affairs:
[They] were much too conservative in how they'd invested [their nest egg]. Though they were still in their mid-fifties and would likely work another 15 years and live into their nineties, their savings were mostly in cash and bonds – an allocation more appropriate for eighty-year-olds.
So I put a third of their savings into my hedge fund and another third into an index fund, such that two-thirds of their savings were in stocks.
It was the right call. Two decades later, they're in their late-seventies, and their net worth is multiples of what it once was. They're comfortably retired – though you wouldn't know it from how frugal they still are...
(Given the performance of the stock market, my parents' financial situation has only gotten stronger in the five years since I wrote this. In my June 9 e-mail, I shared my analysis of their current assets and the two tweaks I recommended.)
When my daughters graduated from college and started working, they did exactly what I recommended. They set up retirement accounts with their employers, withheld as much as they could possibly afford, and automatically invested it in the S&P 500 Index.
They were saving so much that it was sometimes painful. I remember one time Emily called me, totally distraught, because one of her semimonthly paychecks was only $200.
"How am I supposed to pay my rent, much less eat?" she worried.
I explained, "This was a one-time large deduction at the beginning of the year, so don't worry – your paycheck will go back to normal the rest of the year. I know you're stressed, but it's incredibly valuable to get your savings into a 401(k) because then it will compound tax-free for decades until your retirement."
Today, a few years later, Emily has a nice nest egg building up in her retirement account and a lot of money sitting in cash. I couldn't believe how much it was... But it's the result of her living frugally while enjoying a rising income thanks to a new job and promotion.
This is the wealth-building dream: to be a net saver every year and save a greater amount each year by having your income rise faster than your expenses. The latter isn't always possible, especially with inflation, but it's a good goal to work toward.
Emily asked me how she should invest her growing savings, so I built a simple financial spreadsheet showing all of her assets – the same as I did for my parents.
Please keep in mind that the following is not a one-size-fits-all allocation recommendation. It's specific to my daughter's individual situation. Your personal situation is your own and likely very different from hers.
I'm sharing her story because it highlights some key questions and practices I think everyone should follow to manage their finances...
Emily had a bank account and three brokerage accounts, which I suggested she consolidate into two – one she's required to have with her employer's 401(k), and the other at Fidelity.
Her financial picture couldn't have been simpler. She had 60% invested in the S&P 500 and 40% in cash. (Thankfully, almost all of her cash is in a brokerage account earning 3.5% rather than 0% in her checking account. As I've written many times, making sure your cash is earning a market interest rate is the biggest no-brainer, free-money step everyone should take.)
Her 60/40 allocation might make sense for a 70-year-old, but it's much too conservative for a 27-year-old. So I told her she should use half the cash to make it 80/20. (I'd like to eventually see her at 90/10, but with the market close to an all-time high and cash earning a decent return right now, I think she should keep some dry power to take advantage of a possible market sell-off.)
To increase her equity allocation to 80%, I recommended diversifying away from the huge allocation she has to the S&P 500.
I'm worried that it has become too concentrated in its top 10 holdings, which account for roughly 40% of its value – up from 18% at the end of 2015. And tech stocks are at an all-time-high percentage of the index, as this chart by Charlie Bilello shows:
So my first recommendation was for Emily to sell the S&P 500 fund in her 401(k), which was roughly 25% of her assets. At the same time, I recommended she not sell any of the index that she owned in her taxable account. That's because it had nearly tripled in value, so selling would trigger big capital-gains taxes.
This move took her 60% equity exposure down to 35%, leaving 45% to reallocate (keeping the last 20% in cash).
With this 45%, I would have recommended 25% in an equal-weighted S&P 500 fund like the Invesco S&P 500 Equal Weight Fund (RSP) and 20% in an international index fund like the Vanguard Total International Stock Index Fund (VXUS). However, those weren't options in her 401(k).
Instead, I suggested allocating 15% to a European index fund, 10% to a small-cap U.S. fund, and 10% to a mid-cap U.S. fund – the closest I could find to VXUS and RSP.
With the last 10% to allocate, I recommended Berkshire Hathaway (BRK-B). In general, I don't recommend individual stocks to friends and family because I don't need the stink eye if one goes down. But I made an exception for Berkshire...
Because it's so big and diversified, I've long viewed it as a close proxy for the S&P 500. And it has indeed traded in line with the index for the past two decades.
However, as I've shown in many e-mails – most recently on September 18 – when it trades below a 10% discount to my calculation of its intrinsic value, it's highly likely to outperform the S&P 500 by a few percentage points over the next few years. So I think Berkshire is a good addition to Emily's portfolio (and it's currently trading at an 11% discount).
In summary, Emily has shifted from a simple 60/40 allocation to 35% in the S&P 500, 15% in an international index, 20% in small- and mid-cap U.S. index funds, 10% in Berkshire, and 20% in cash. I don't think this will make a huge difference for her, but there's a good chance it'll be better than the 60/40 mix over time.
Best regards,
Whitney
P.S. I welcome your feedback – send me an e-mail by clicking here.
P.P.S. Greetings from Ukraine! It's my seventh trip here in the past three and a half years. In my February 11 e-mail, I described why I first got involved and some of the things I've done to support the country.
On Sunday night, in Munich, I met up with 63 other volunteers who have driven 52 ambulances across Germany, Czechia, and Poland to Ukraine – an effort organized by a wonderful charity called Ukraine Focus. (Longtime readers may recall that I did a similar drive in May with my family and friends.) We'll soon deliver the ambulances to the Ukrainian military.
After reading about my May ambulance drive, five of my readers signed up for this trip and are on my team (along with a wonderful Canadian guy). Here's a picture of us:
