If you have some interest in creating an investment portfolio beyond target date funds, then this beginning DIY investing for nurses post is for you. I am not a financial professional, so I’m writing how I approach investing. I recommend you seek professional advice and education before making any changes in your own finances.
Creating a Portfolio
It’s always satisfying to craft your own portfolio beyond target date funds. To be clear, a target date fund works well for most nursing professionals who want to make life as easy as possible.
When crafting an investing portfolio, you usually invest in stocks, bonds, or a money market account. There are other investment options out there such as commodities and real estate. Real estate is a different beast as it is usually not easy to convert quickly to cash and often requires much more effort unless you invest in large REIT funds.
Putting together what you want to invest in is called creating a portfolio. You generally want a portfolio that is diverse or has a piece of multiple non-correlated investment so as to avoid the emotional rollercoaster that comes when one investment type isn’t doing very well. Most retirement or financial independence portfolios invest in a mix of stocks and bonds with a money market fund for the cash piece.
Stocks = Buying Part Ownership of a Business/Company
Stocks are just buying part-ownership in a company. Stocks make or lose money based on the market value of your piece or share of the company. Stocks also make money as companies pay their earnings back to their owners (you the stockholder) and are called dividends. The USA has approximately 3,600+ common stocks available. Internationally there are an additional 6,383+ non-US common stocks.
Picking Winning Stocks
How do you decide which stocks to invest in? It’s simple. You don’t. Instead, you should buy every stock available thus guaranteeing you’ll do as well as the market as a whole.
The market generally increases in value over time. Most people who pick stocks for a living do worse than the market as a whole. It really is a full-time job investing in individual companies. There’s a lot of junk to wade through to figure out the reasonable value of an individual company. Even if the fundamental value of a company is sound, usually all the other competitive full-time investors are already on it. There are few advantages to gain in investing in individual stocks unless you can predict the future.
If that sounds fun to you, then by all means learn and go ahead. Many people just invest in companies that they like or that they perceive are doing well. This is speculating and will almost guarantee you financial loss. Most professionals don’t do better than the market as a whole and those that do usually barely do better. Even day traders and swing traders don’t do better than the market as a whole. The market is already very efficient, and it’s hard to beat. You can’t pick winning stocks every time. Thanks to Jack Bogle there’s a more effective way to invest in stocks.
Buying Index Funds
The only way to buy every stock without having billions of dollars is to buy index funds. Index funds are the brainchild of Jack Bogle and a comparatively new way to invest in the investing world. Index funds track and try to mimic a specific index or guide such as the S&P 500, which are the top 500 companies in the US.
This means an S&P 500 index fund will have approximately 500 stocks in it. You as the investor just need to buy a piece of the fund and you instantly own a piece of those 500 stocks. Brilliant idea, Mr Bogle! Index funds are different from active mutual funds or target date funds. Index funds are a type of mutual fund or ETF. Not all mutual funds or ETFs are index funds so be careful.
A couple of things to look out for when shopping for index mutual funds or index ETFs:
- Ensure they are really total market index funds.
- Look at the fees for buying the fund. NEVER pay a fee for buying a mutual fund. These are called front-loaded funds, and they are probably a sure sign you’re investing in an active mutual fund not an index fund. David Ramsey is great at budgeting advice but fails miserably at investment advice in recommending front-loaded funds. Do not follow his investment advice. You MIGHT pay a trade fee for buying an ETF. Vanguard and most investment companies do not charge you a fee for buying their ETFs or their mutual funds.
- Look at the fees for owning the fund. Buy index funds that have a low expense ratio or cost of owing the fund. NEVER buy a fund with an expense ratio greater than 1%. Index funds are cheap to run and are therefore cheap to own. A computer program runs an index fund in contrast to an active fund which pays the salary of an expensive full-time fund investor.
Vanguard and Fidelity both have index funds with expense ratios less than 0.04%. I personally like Vanguard as they are a company that is owned by it’s fundholders meaning they are not trying to make money off you like Fidelity or the multitude of other financial companies. Other companies still offer great, cheap index funds, so don’t rule them out but be careful.
Often the retirement plans at work are through a specific company, so you have to pick from a limited range of options. Thankfully it seems most of these employer-sponsored plans offer index funds. Unfortunately the expense ratio is usually still higher than you could get elsewhere. If a total market index fund is not available, then invest in an S&P 500 index fund. The S&P 500 is an index of the 500 largest companies in the USA. The S&P 500 covers 85% of the total US stock market, so it’s still a solid index fund to invest in.
Bonds = Loaning Money to Business/Company
Stocks should obviously play an important part of your portfolio. The other major part of a good general portfolio is bonds. Nobody talks about bonds in casual conversation except maybe financial nerds. Why? Because compared to stocks, bonds are boring. Nobody gets wealthy investing only in bonds except the brokers who sell them.
A bond is loaning your money to a company or government for a set period of time. In return, they will pay you a set amount of interest every year. After the agreed upon period of time, they return your money back to you. Thankfully there are bond index funds you can and should invest in rather than individual bonds.
The bond funds that seem best in my opinion for most DIY investors are either a total bond index fund or an intermediate term treasury index fund. There’s a lot more that goes into bonds. Basically they are a safer place to invest your money with a lower return than the stock market.
The Zig and the Zag
Why even bother with bonds? Some people don’t bother with them. J.L. Collins in his book The Simple Path to Wealth makes a compelling argument for investing 100% in a stock market index fund. I like bonds for one main reason: they tend to zig when the stock market zags.
Bonds usually do well when the stock market is crashing. In my opinion the value of having bonds is mainly emotional. Bonds help ease the emotional rollercoaster when my substantial investment in the stock market shrinks by 40-50%.
Basic Premise of Investing
A basic premise of investing is to sell high and buy low. That premise generally goes against our gut instincts. It is human nature to have a strong urge to sell your investments when they are not doing well. That urge is amplified when your investments are shrinking.
While in the long run stocks perform much better than bonds, when stocks are doing poorly it is nice to have the emotional booster from your bonds. We always want to buy stocks when they are hot and sell them when they are doing poorly. This is why we develop a predetermined investment plan with an asset allocation.
The ratio of stocks to bonds or any other type of investment is called asset allocation. Having an asset allocation allows you to sell when something is high and buy when either stocks or bonds are low. Setting an asset allocation ahead of time, you have already decided what you’re going to do no matter what happens in the market.
If you have already decided in advance that you are going to have a certain ratio of stocks to bonds such as 80% stocks to 20% bonds then you prepare yourself in advance for the emotional roller coaster when the stock market crashes. You get emotional stability having a plan.
How does asset allocation work in practice? For every $100 that you want to invest, you buy $80 of the total stock market index fund and $20 of the total bond market index fund. Once a year you compare your ratio of stocks to bonds and either sell some of the higher performing funds or invest more into the lower performing funds until the ratio is back to where you want it to be. Target date funds do this for you automatically.
The Perfect Asset Allocation
A problem I have been wrestling through is my own asset allocation. There is no perfect asset allocation. Asset allocation is determined more by psychological and emotional comfort more than anything else for long term investors who don’t need that money for 10+ years.
Determining the risk you’re willing to take should drive your asset allocation. Stocks are more risky than bonds meaning you might lose a lot of money in the short-term if the stock market crashes. Stocks also offer a lot more reward for taking that risk meaning you could and over the long run will likely make significantly more than less risky assets like cash or bonds or gold.
If you are retired or near retired, then you will obviously want more bonds in your asset allocation to preserve your nest egg. The most rational asset allocation is 100% stocks as historically stocks have always outperformed bonds far and away over a 10-20 year period. But that doesn’t mean it’ll always happen in the future.
My Investing Plan
Having a predetermined plan will help me be a better investor in the future and not make emotionally driven choices. I feel also like it would be very difficult to continue investing in a 100% stock portfolio plan when I know that most investment advice recommends holding bonds. Having a bond to stock ratio allocation will give something to distract me when the market is not doing well as I will be theoretically selling off bonds to rebalance my portfolio.
This is exactly what I should be doing, selling high and buying low. Having a ratio of bonds to stocks even if it’s small will help facilitate this basic premise of investing. I keep track of our asset allocation with a free Personal Capital account.
I have decided to keep a very simple basic 2 asset type investing portfolio of US total stock market index funds and intermediate US treasury index funds. I don’t invest in the international index funds because most US companies already invest heavily in international markets and the international index fund seems to correlate with downward movement and somewhat lag the US stock market in upward movement. I also am somewhat biased towards the ingenuity of Silicon Valley in driving future value as well.
Our asset allocation is between 10-20% bonds depending on the market and 80-90% stocks. With a falling market, we’re increasing our stocks to 90%. When the market is rising, we will theoretically move more towards 80% stocks. So far it’s worked out well as of May 2020.