This article is an excerpt from the Shortform book guide to "The Simple Path to Wealth" by JL Collins. Shortform has the world's best summaries and analyses of books you should be reading.
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Do you want to get into investing but aren’t sure where to start? Do you need professional financial help to get started?
Investing doesn’t have to be complex. People selling investments profit by making them complicated—they convince you that you need professional help to get started with investing. Yet the actively managed funds they sell are costly and underperform index funds. According to financial blogger J.L. Collins, getting started with investing only requires answering three questions and applying three wealth-building tools (stocks, bonds, and cash).
We’ll consider Collins’s three questions for beginner investors and the wealth-building tools below.
Three Questions for Beginner Investors
Getting started with investing requires that you answer these three closely related questions:
1) What investment stage are you in? Are you in the wealth accumulation (income-producing) stage, the wealth preservation (post-working) stage, or a combination of the two (for instance, you’re between jobs)?
2) What level of risk are you comfortable with?
3) What’s your investment horizon? In other words, for how many years do you plan to accumulate wealth? If you’re just starting your working life, your investment timeframe will be much longer than if you’re close to retirement.
These questions are interrelated in that your risk tolerance will correspond with your investment horizon—you’ll take more risk early and less later as you near retirement. Also, your level of risk and investment horizon will drive your investment strategy. Your job and future plans factor into all three questions. For example, if you’re planning to retire early, you’ll have a shorter investment timeframe, and you’ll want to reduce your risk and preserve your wealth.
When answering these questions, keep the following in mind:
- All investing carries at least some risk. You can’t eliminate risk but you can choose the type of risk—for example, choosing less-volatile bonds if you’re uncomfortable with risk as you near retirement.
- Your investment stage isn’t necessarily tied to your age. It can shift back and forth during your life, impacting your earnings: Sabbaticals, early retirement, taking a lower-paid position to follow a dream, or re-entering the workforce after retirement all affect whether you’re in the wealth accumulation or preservation stage.
- Having F-You Money is essential. Life and jobs are uncertain, but you’ll have more room to make choices if you have F-You Money. If you don’t have this financial cushion now, start building it—it’s never too late.
- You should be a long-term investor, even if you’re older. Don’t follow the typical investment advice and shift too great a percentage of your money from stocks to bonds (often considered to be a safer investment) to protect your nest egg as you near retirement. At age 60, if you’re in good health, you might have another 30 years to build wealth, which is a long-term horizon. Maybe you’ll want to keep building wealth in retirement to leave money for a younger spouse, grandchildren, or a charity.
Three Wealth-Building Tools
The next step after answering the three questions is building your investment portfolio. To do it, you need only three simple tools: a stocks index fund, a bonds index fund, and a money market or bank account.
1) Stocks: Collins’s preferred option is investing in VTSAX, Vanguard’s Total Stock Market Index Fund. (He writes that he’s not being paid to promote Vanguard.) Stocks give you the best returns over a long timeframe and because they grow in value, they serve as a hedge against inflation. VTSAX is your wealth-building tool.
2) Bonds: At the point where you’re nearing the wealth preservation stage, you’ll want to shift some money into less risky bonds. Bonds pay interest and counter the ups and downs of your stocks fund. They also serve as a hedge against deflation (declining prices) because in these periods, bonds increase in value. Collins’s choice is VBTLX, Vanguard Total Bond Market Index Fund. (The next chapter explores bonds.)
3) Cash: You need accessible cash for expenses and emergencies. It’s also another deflation hedge. When prices drop, your cash buys more. But when prices rise, cash buys less. Don’t keep more cash than you need because when interest rates are low, cash has little earning potential.
You could put your cash into a money market fund like VMMXX Vanguard Prime Money Market Fund. But while interest rates are low, you’re probably better off putting it in a bank account. Money markets used to offer better interest rates than banks, but currently, bank rates are higher. You can always switch if money market interest rates start rising again.
These three tools—a wealth-builder and inflation hedge, a deflation hedge, and cash for needs and emergencies—comprise a simple, diversified, low-cost portfolio. Next, we’ll further discuss index funds and bonds, then investment strategies and how to determine your asset allocations.
Why You Should Choose Index Funds
Collins recommends index fund investing over choosing professionally managed funds because index funds get better results and have lower fees. The chances of anyone regularly selecting stocks that outperform the market in the short term are minuscule—you can get better results by buying into an index that contains a lot of stocks (VTSAX covers over 3,700 companies) that grow steadily over time. Yet index funds remain somewhat controversial in the investment industry. Professionals have denigrated index fund investing ever since Bogle introduced the index fund in 1976.
The primary reason for the backlash is that because index fund investing is so simple and low cost, it threatens financial industry profits. As previously mentioned, money managers, mutual fund companies, and financial advisors make big money by charging investors fees, which they justify by making investment too complicated for you to pursue on your own and by claiming they can outperform the market.
Many financial advisors argue that index funds may be fine for average people who don’t want to work at investing, but that with a small effort and professional advice, you can get better returns (outperform the market). However, Vanguard founder Jack Bogle, who died in 2019, contended that in 61 years in investing, he never met anyone who could do this.
In fact, research indicates that only around 1% of fund managers outperform the market consistently, although they’re occasionally lucky. In reality, most professional money managers underperform indexes. Over 15 to 30 years, the index will do better than 82-99% of managed funds.
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Here's what you'll find in our full The Simple Path to Wealth summary:
- A simple road map to achieving financial independence and a secure retirement
- How to put your money to work for you as your “servant”
- Why you don't need a financial advisor to help you invest