Sunday, January 25, 2015

Using the Investment Map

This essay is intended to be a quick tutorial on how to use the Investment Map.  This is a distillation of what you might hear from a decent "Fee Only" financial adviser during the first half of your earnings career. This is information that is available in a thousand other places but I have never seen it explained using the Investment Map.

See the bucket?  That is where you start out saving.
Many fine plans fail because they cannot be seen through to the end.  So the first part of the plan is to figure out how much money is reasonable to have in your emergency fund.  For the ERJ family it is about $2000.  That is the cost of an emergency car repair (transmission).  Those funds should be placed in a very safe place that the owner can write checks against.  Most savers will put it in a non-tax-defered account because easy access is critical.

If one makes $10 an hour and saves 10% of their gross it will take more than a year to save $2000.  If it is any comfort, it is much easier to get rich slowly than to get rich quickly

Keep saving.  When you are very, very comfortable, move your "extra" money to a higher risk, potentially higher return investment vehicle.  Remember,  higher risk is guaranteed while the potentially higher return is a matter of faith.  I show the bucket of money being moved to a large stock, mixed fund like a S&P Equity Index fund.  Strongly consider placing this in a tax sheltered IRA or 401-k for reasons too numerous to elaborate on.

So every time your emergency fund gets "plump", you will spill the extra money to the right while taking care to always keep at least $2000 (or whatever amount you decide) in your emergency fund.

Guess what:  At some point your bucket in the middle of the map will be pretty big.  At that point you will want to exploit "the efficient frontier".

Points that are farther to the left have less bounciness while points that are higher have greater returns.  Portfolios that are 10%-90%, 20%-80% and 30%-70% International-US stocks have historically show LESS bounciness and MORE return than 100% US stocks.  Picture (and a pretty good article) from HERE.

Studies have shown that overseas markets do not move in lock-step with domestic markets.  That can exploited by having some percentage (most studies suggest 10%-to-30%) of your portfolio in overseas markets and by rebalancing your portfolio every year or so.

This model was suggested for the first twenty working years.  The last twenty working years involves locking in those gains by gradually increasing the percentage of money you have squirreled away on the left side of the map.  So you start out on the left, then the center-of-gravity shifts to the middle or slightly to the right of the middle.  At mid-career you start gently shifting the center-of-gravity to the left of center.

The problem with this kind of map is that the map is ALWAYS outdated.  Sadly, it is not possible to buy "past performance".  In the dry language of legal disclaimers, "Past performance is no guarantee of future results."

The benefit of this map is you can become lost with confidence.

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