The 10-second version: Keep your investment horizon and risk tolerance in mind when you are investing. When you are building up your portfolio initially, look to invest in funds that mirror indexes like the S&P 500 (i.e. SPY) and avoid trying to pick stocks. There is value in diversification, however, depending on what stage of investing you are in, it could make sense to start by building up your equity exposure through the S&P 500 for now and build out a more holistic portfolio later.
Okay, let’s dive in.
The ever present question – how do you invest your money?
I’m going to answer this question in two parts.
First, why I pay attention to my investments closely and don’t blindly trust mutual fund managers to manage it for me.
I got interested in managing money after a particularly unfortunate experience:
I had a 529b savings account with some money for college put in one of those mutual funds where the allocation would change as you age. I ended up fortunate enough to get a scholarship for college and didn’t need the money. The period of time where I knew I wouldn’t need this money for my education was February 2014 (when I accepted my offer) – May 2018 (when I graduated).
Turns out that since I was supposed to be using the money for college during this period, the pre-made allocation was almost 100% in cash/money market funds and barely appreciated.
For some context (w/ dividend reinvesting) the total return of the S&P 500 was ~62% over this 4 year period.
Now, I’m not saying that every period of time is going to have returns like that…in fact it may very well be that there is a huge crash somewhere during that time, but given that I didn’t have any foreseeable need for those savings for a while, I should have had a much longer timeframe in mind when investing.
2 things I took away from the experience:
- I want to know what my money is invested in at all times
- Your individual situation and investment horizon are EVERYTHING when it comes to investing
Second, how I invest now
My investment strategy now is fairly simple. For my retirement accounts (I play around a little more with some other accounts), I know I’m not going to touch them for the next ~40 years so I have completely invested them in the S&P 500 (SPY). My friends are probably sick of hearing me say “put it in the S&P 500” by now.
Finance nerd tangent – For reference and entirely unnecessary for all but the finance nerds like me out there – the S&P 500 is an index, it is not a
stock itself. When you invest in it, you have to invest in a fund that mirrors the index value by taking all of the investments made into the fund an
replicating the allocation of the index (SPX and SPY are two such funds).
The S&P 500 index value is a weighted average of the market values (i.e. price of a stock * number of outstanding stocks) of the largest 505 public companies (ironically the S&P 500 tracks, not 500, but 505 stocks)).
Back to the ‘how I invest’ part:
A lot of people are going to fire back with the following issues with my portfolio:
- That’s over-allocated to equity (stocks), meaning when growth expectations slow or inflation expectations rise your portfolio will get hammered
- That’s over-allocated to the US, so if anything happens that fundamentally changes US economic growth in the long run you’ll will be in trouble (think about Japan for the last couple decades)
Here’s what I would say:
- Why just an equity index, not bonds or individual stocks –
- While this is risky in the short term, i.e. in any individual year my portfolio may be up or down significantly, in the long run, it will average out to some expected return for which stocks on average will return more than bonds. Since I have a long timeframe and would prefer higher returns, I would rather invest in just stocks.
- An individual stock (for example, Facebook) is subject to a lot of company-specific risk. Who knows if the government decides to crack down on Facebook for privacy issues and the company goes under. A basket of stocks, like the S&P 500, will perform according to broader macroeconomic factors and the expected returns are correlated more to the level of risk you are taking
- It is fairly easy to find indexes that mirror the S&P 500 and there are essentially no management costs/tracking issues in this index so I am not losing any money to overhead and I know exactly how the funds are being allocated.
- *Caveat – with the proper access to leverage there are ways to create a well-diversified portfolio without giving up returns – but that will come in a later post.
- Why a US-only portfolio –
- You would be right to question this, and in the long term I plan on diversifying geographically (I am specifically looking into Indian equity markets)
- A lot of the companies that I am invested in are globalized, so my exposure is international anyways
- For now, I am based in the US, want to maintain low management costs, and minimize volatility due to currency value changes.
Finance nerd tangent – Financial markets conceptually are vehicles to transfer money from those who have it and aren’t using it to those that don’t have it
but can use it. By lending your money out you are compensated based on how likely it is that you will get the value of your money back (i.e. the risk).
When money flows into a corporation, there is a pecking order in who gets paid and how rigid the payments requirements are. This is what determines the level of risk with stocks and bonds and as a result, determines the compensation you can expect from lending your money out through these instruments. This is fundamental to financial markets. If I wasn’t compensated more for taking on more risk, then I wouldn’t have an incentive to take the risk in the first place and the system would break down. You can usually trace the correlation between the risk (or expected volatility) of an asset and the expected return (i.e. on average the asset will return X% in a year):
The point of diversifying between stocks, bonds, etc. is to minimize the volatility in your portfolio while ideally maintaining your returns. You don’t want a recession to hammer the value of your stock if you need that money soon. That being said, I know that my investment horizon is ~40 years and to be honest, I don’t have the capital invested to prompt me to look into that kind of diversification…yet. Post to come on how you would do this in an optimal way if you wanted to.
In any individual year it’s anyone’s guess how each asset will do, but over a long period of time returns tend to correlate to their level of risk. Given that, I am okay with the volatility associated with US equity returns and have a preference for paying minimal transaction and management fees so funds that mirror the S&P 500 are the optimal and most accessible funds for me.
Great read Ansh! I’m curious as to which long-term funds you would suggest looking into in the Indian markets, given short-term the Indian markets tend to be extremely volatile and those like INDL give big returns but also tend to be extremely risky?
Hey! Good to hear from you. Great point! I am specifically looking at a broad equity index fund (MSCI India USD). I agree Indian markets have a ton of volatility, but you are fairly well compensated for it. Over the last 10 years (both hedged and unhedged) you have had a sharpe ratio of ~.53, which is not bad for an asset class (In the long run most asset classes run ~.3). My choice to look into a broad basket of Indian equity stems from more fundamental factors too – I think they are well placed to perform despite US/China trade tension as a lot of their growth comes from internal demand, they are moving towards more non-dollar denominated deals which will give their central bank more room to control the market, and demographically I think they are in the right place to sustain long-term growth. Also, with US immigration policies hardening it seems like a lot more talent is being retained which I believe will continue to sustain growth in medium term. All that being said, it is still an area I need to do a lot more research in before making move. Let me know if that helps/you have any ideas there!
Ansh , excellent and to the point; this is exactly how I started out. I liked that my company offered a S&P option in our 401k that did not fee me to death and the index concept was easy for me to understand- no rocket science required. Even now that I face retirement I still like the S&P 500 for some of my portfolio; I won’t need a lot of my money for 15 to 20 years, I still need that piece working. I going to dance with “what bring me”☺