You work hard for your money – but does your money work hard for you? No one wants to work until they die, right?
If you feel like you never have time to really delve into the tangled web of market investing philosophies, this is the article for you.
I will break investing down into seven modern methods and rate them on a risk scale from low to idiotic. (After reading this post, you'll start sounding like an investing whizz at social gatherings.)
So, why are we discussing investing philosophies specifically? What does this have to do with making your money work for you?
Well, let's look at some of the common terms and questions people search for regarding this topic:
- How to invest 100K
- How does investing work?
- How to invest in the S&P 500
- Best way to invest 5K
- How to invest 50K
- What investment carries the least risk?
- How many stocks should I own?
To answer these questions, you must first decide on an investing method (or philosophy) to reach your end goal. Once you decide that, you then place your money into the best investment vehicles to take the long ride to the promised land (aka retirement, or even possibly early retirement)!
Before I go on, I would be remiss if I didn't mention that if you want to invest in the market, I highly recommend you start by tracking your spending, creating a monthly budget, and maximizing your savings rate. Then choose which investment vehicles will produce the best returns for those savings.
A Couple of Ways You Can Invest Your Savings
If you read my blog (or just this one post on big picture investing) you will have noticed I am particularly bullish on two investing avenues: public markets investing and personally owned real estate.
Public markets investing is commonly known as “investing in the market.” It is a broad term that encompasses many things, including buying stocks, bonds, commodities, etc.
Personally owned real estate refers to owning actual physical properties yourself. This may include residential rentals, commercial rentals, and even positions in syndication deals. (To learn more about real estate, check out this post – Real Estate 101.) In this post, however, I will discuss investing in public markets!
Now, let's discuss the market philosophies on how to make your money work for you.
7 Common Methods (or Philosophies) to Consider When Investing in the Market
The sheer variety of investment products out there can make your head spin.
Thankfully, investing is much easier to understand if you begin by looking at investing methods and then consider specific investment vehicles later.
A method is simply something that guides how you allocate your assets.
With that in mind, let's explore seven basic methods you can base your investment decisions on, so you can make your money work for you.
(Note that the names I have given these methods are my own. The names are partly inspired by the various online communities that have grown behind each method. Just remember, although the internet has given some of these methods a new lease of life, they have all been around for a long time!)
The Motley Fool Method – 20 to 30 Individual Stocks
Risk Score: High
The Motley Fool (TMF) is essentially a stock advisory service. They started out as a newsletter (like the one you would get in the mail) that would give you stock recommendations. Now they have grown into a full-service money management firm.
The foundation of TMF's philosophy is that you can get the best investing returns by investing in 20-30 quality, well-researched individual stocks for the long term, as opposed to investing in the stock market as a whole via an S&P index fund.
Their initial flagship newsletter, Stock Advisor, still exists and is $99/year. For that price, you also get access to lots of great research and stock tracking tools.
My big issue with TMF is that while they say you should buy 20-30 stocks, they actually recommend a few hundred in their newsletter.
So, if you still have to decide which of these to narrow it down to… it somewhat negates the value of the service. Of course, you can pay them a lot more money to get that more specific guidance on your portfolio.
The FI/RE method – 100% Stocks Via an Index ETF
Risk Score: High to High/Medium
For those of you not familiar with FI/RE, it stands for “Financial Independence / Retire Early.” It's a totally cool new(ish) movement of people who want to retire early for some strange reason.
FI/RE people (often) advise investing your savings in the entire US stock market. Yes, all of it.
No, you won't try to buy 3000 individual company stocks. You would invest all your money in a low-cost “Index Fund ETF” (see glossary below if you need to).
There are two index fund ETFs you would probably look at for this.
Option 1 would be the S&P 500 SPY ETF, which collectively buys for you the top 500 publicly traded companies in the US (many of which have significant international business exposure).
Option 2 would be The Vanguard Total Stock Market Index ETF or VTI. This fund collectively invests your money in 100% of the investable US stock market.
The Boglehead Method – A Mix of Stocks and Bonds
Risk Score: Can range from High/Medium to Medium/Low
You may have heard the term “Bogleheads.” These people subscribe to the basic investing philosophy of John Bogle, founder of the well-known financial firm, Vanguard.
Bogle hypothesized that most money managers wouldn't beat the average market returns over time, so you should just invest in the market as a whole through index funds with low fees, instead of individual stocks or managed mutual funds.
Sounds familiar? Yes, you just read about this in the preceding method (investing in the entire market using Index Fund ETFs). Also, the fact one of those two funds I mentioned was a “Vanguard” fund is not a coincidence. Vanguard made investing in low-cost stock market index funds mainstream (if not invented it).
However, Bogle didn't think you should be fully invested in just the stock market, because it’s too risky. So he basically said that you should invest in a mix of the stock market and bonds. He advised you the percentage of bonds you hold should roughly equal your age.
You would add the bonds to your portfolio via a bond fund and adjust the percentage of bonds roughly annually.
If you think this sounds like too much of a hassle, you can look at Vanguard's Target Retirement Funds, where they rebalance this based on your age and target retirement date.
Although I have credited Bogle with this method, in truth, it is probably the most widely used approach among money management firms.
The Dividend Method – Cash Flow and (Hopeful) Appreciation Through Dividend Stocks
Risk Factor: Ranging from High/Medium to Medium
This method is somewhat similar to the Motley Fool method in that your portfolio is made up of individual stocks. The difference is that these stocks would not be “growth stocks.” They would be very mature companies, often called “Blue Chip Stocks” (like Coca-Cola and AT&T).
These mature companies don't take all of their profits and reinvest them back in the company (like growth stocks). Instead, they distribute some of those profits to shareholders every quarter. Some of these dividend yields can range from 4% to 12% (compared to today's savings account interest rate ranging from about 0.25% to 1%).
Dividend investing is somewhat similar to owning real estate. The idea is that you get a steady stream of cash from the dividend, but you also hope to grow your cash investment through stock appreciation.
That said, since these companies are larger, more established businesses, their potential appreciation would, in theory, be far less than that of a growing company. But, the flip side is that these companies would be far less volatile as well, reducing risk.
So here's the rub. These companies can cut their dividend at any time, and their stock price itself can still be quite volatile. So I personally still consider dividend investing to be relatively high risk.
The Permanent Portfolio Method – A Mix of Stocks, Bond, Gold, and Cash
Risk Score: Medium/Low
The “Permanent Portfolio” method is an investing philosophy invented by a fella named Harry Brown, who wrote a book called “Fail-Safe Investing.” In the book, he outlines why he thinks you should invest all of your money in a simple asset allocation of 25% US Stocks, 25% Bonds, 25% Gold, and 25% Cash. If you get off track, you rebalance back to these portions once per year.
It’s an excellent book that I highly recommend to people. It not only prescribes this method but gives you a good overview of investing and economics in general.
Now, this method is probably more correctly coined as a “Capital Preservation Strategy” or an “All Weather Portfolio.” Another similar version of this would be The Golden Butterfly portfolio.
The idea is to have a broader asset allocation of non-correlated assets (more than just stocks and bonds), which, working in tandem, limits your risk significantly while still producing hopeful compound annual returns of 6-8%.
As with the previous approaches, these days, you would buy into this using ETFs. For example, you could split it between three funds like 25% SPY, 25% TLT, 25% GLD, and then keep 25% cash in a bank account. You could go with different funds, though, of course.
(FYI: I adopt this allocation for my retirement portfolio. Being “semi-retired,” capital preservation is much more part of my thought process now.)
The Fixed Income Method – A Very Conservative Strictly Bond Portfolio
Risk Factor: Low
“Fixed income” is another term for bonds. Remember, bonds are loans you make to governments or companies where they have promised to pay you a specific interest rate for the loan. The interest they are paying you is fixed and is also income, hence “fixed income.”
Don't think bonds are totally boring though. Under the right conditions, they have often greatly outperformed stocks. But generally speaking, people who get into bonds want as much capital preservation as possible while getting as steady of a return as possible.
So when we apply life's old adage of “no risk, no reward,” you can quickly surmise that the returns for bonds will generally be lower over time, as the risk is intended to be lower.
If you wonder how they could outperform stocks, it's because bonds can be traded in what's known as a “secondary market.” For example, if I bought a 20-year bond at an 8% p.a. return, but since then, rates have gone down to 6%, I can sell that bond in the secondary market for a premium.
That said, if you “trade bonds,” they can become riskier. And often, bond funds do just that. So even with bonds, you have to decide what your risk tolerance is and invest accordingly.
Other than that, bonds can be about as safe and vanilla as it gets. US Treasury Bonds, for instance, are backed by the full faith and credit of the US government.
The “Day Trading” Method – What Most People Do at First (Without Knowing It)
Risk Factor: Idiotic to Very High
To be honest, I barely consider this a “method.”
So what's a day trader? My definition of a “day trader” is: “Someone who buys, sells and short-sells stocks throughout the day in the hope that the stocks continue climbing or falling in value for the seconds or minutes they hold the shares, allowing them to lock in quick profits.”
Now very few people can actually do this, and many who try it lose literally all their money very quickly. You could be generous and say it's “informed gambling,” but really, it's just gambling.
The reason I put this on this list, though, is to describe what I think many new investors end up doing (at least until they have some big losses). I see many newbies start picking stocks to invest in based on blogs they read, tips their friends give them, or even by just the sway of what everyone else in the world seems to be buying.
In the beginning, sometimes they do well and make some quick money, thereby thinking they are genius investors making prudent decisions! But the reality is, they are just guessing and really have no understanding of what's involved in picking a winning stock (don't feel bad, I don't either).
And while they may not trade on a daily basis, they are getting in and out of stocks frequently and are not committed to a long-term plan. Very often, they usually only talk to their buddies about their wins, and are likely taking a net loss (just like career gamblers!).
All that said, I know a few people who piled a lot of money into Tesla and Apple, and have made enormous returns just by following the herd. But, they were still just guessing. It's a dangerous game when you have a lot to lose.
I personally like to gamble, so I have a “gambling” fund that I do this kind of investing with. Overall, I'm down. But it's money I'm willing to lose for the entertainment of it (if you can call it that – it mostly just gives me grief!)
Okay, So I Still Have No Idea What to Do… Can You Just Tell Me What to Invest In?
Sorry, I can’t. I know… super annoying. The reality is that I'm not a licensed financial advisor, so I can’t give you very direct investing advice. Plus, in order to give advice, I would need to know the details of your personal situation, your goals, your risk tolerance, and a few other things.
What I can say is that, in my opinion, most people should probably be doing the “Bogle” or “Permanent Portfolio” methods. If you are very young, you could consider doing the FI/RE method. If you are in retirement, you’d probably be more inclined toward a Bogle method with a higher portion of bonds, the Permanent Portfolio method, or maybe even the “Dividend” method.
If you decide that you really want to get into investing, and educate yourself, you could consider the “Motley Fool” method. But again, you will be making a lot of calls yourself. I have done this and had lots of ups and downs with ultimately low performance.
Part of the issue with individual stocks is not just picking them – it’s having the disciple to stay the course (assuming you picked a good one), and not do anything stupid, like selling in a downturn (which will usually be far more intense if you are deep in individual stocks). Emotions are such a huge part of investing and they usually cause you to lose big time.
Fine, Then at Least Tell Me How I Actually Invest in One of These Market Methods!
In terms of how you physically get your money into these interest-compounding machines, here are some of the ways.
Do It Yourself
This may be what you do at the beginning because you won’t have much to invest. Actual human advisors (and their firms) often have a minimum investment for managed accounts.
First, you would open a brokerage account, or perhaps a tax-deferred retirement account, like an IRA. These accounts would allow you to buy the various investments that will be part of your methodology and asset allocation.
Basically, you’ll have to figure out your own asset allocation or perhaps invest in a target retirement ETF. But if you are going with the FI/RE method or the Permanent Portfolio, you don’t need to figure out anything. Those methods have predefined asset allocations.
Robo-advisors are a popular new option for having your investments managed. Though not limited to small balance accounts, they are often available to people that don’t have enough to lure in a human.
If you are wondering what a Robo-advisor is, they are software platforms that use digital algorithms and automation to offer financial planning and investment services to investors, without direct human supervision.
When you sign up, they will ask you a bunch of questions to assess your goals and risk tolerance, then the robot will invest your money accordingly and keep adjusting it over time. Robo-advisors will likely employ the Bogle method of investing for you.
The more I think about it, the most I feel this is probably one of the better bets for newbies. I even have this post listing a bunch of Robo-advisors that you can check out!
Through your employer-sponsored retirement plan
If you have a job that offers a 401K, you will usually be at the mercy of the investment options that your plan offers you. This may very well include a target retirement date fund of some kind.
If not, you will again be on your own to figure out your asset allocation (which would comprise the investment options the plan offers). However, you may still be able to attach Robo-advisor oversight by signing up for Blooom, which supposedly works on top of your workplace 401K.
A financial advisor (and their firm)
Once your balance gets high enough, you may qualify for the privilege of working with a real live person (and possibly even get ripped off by them!). Minimum investments can start at 25K and up for this.
Usually, your “advisor” is really just a client relationship manager, while the real investing decisions are made by the firm's investment strategy team.
To get the help of this team you usually give them 1% of your account value annually as a fee. The theory is, however, that they will have earned you more than that 1%, beyond what you would have made through alternative investment management options.
Before you go with this option though, you should read chapter 5 of this book by Tony Robbins and Peter Mallouk. It will help guide you in choosing the right kind of advisor. There are some trap doors here so tread carefully.
A mix of the above
It is possible that you end up using a few of the options above. Currently, I am doing two of these myself. I have two retirement accounts, one of which I manage with the Permanent Portfolio method, while the other I have a firm manage, with the Bogle method.
You could make an argument that by doing this, I am not correctly invested because I have not committed to one strategy – and you may be right. I wanted to see which would do better. Over the last two years, the Permanent Portfolio has done better (that includes the COVID-19 anomaly though).
Closing Thoughts on How to Make Your Money Work for You…
This article showed you that there are very specific methods of how to make your money work for you. I hope it helped get you pointed in the right direction.
Investing is both difficult and scary. And the more money you amass, the more difficult and scary it will get.
For this reason, I think most people will eventually want to work with a financial advisor of some kind, (if only so they don’t blow it all on their own!) But giving over control of your savings to someone you don’t know is scary too!
The truth is that you’ll likely never have a consistently positive emotional experience with investing. When the markets are up, you’ll feel calm and enthused. When they're down, you’ll feel anxious (and strongly suspect you picked the worst advisory firm on the planet!)
But despite the ups and downs, you have to invest your savings, so they are working for you (while you're also working for you). At the end of the day, you've got to play to win.
Glossary of Terms
For those of you who are very new to this, and found much of what I wrote above a bit mysterious, I have defined some of the terms I used in the explanations. I also want to give this credit to the website where I stole most of these definitions!
Asset Allocation: This involves dividing your investments among different categories, such as stocks, bonds, and cash.
Bonds: These are debt securities, similar to an IOU. Borrowers issue bonds to raise money from investors willing to lend them money for a certain amount of time. When you buy a bond, you are lending to the issuer, which may be a government, municipality, or corporation. In return, the issuer promises to pay you a specified rate of interest during the life of the bond and to repay the principal.
Bond Fund: A “bond fund” and “income fund” is a term used to describe a type of investment company (mutual fund, ETF, closed-end fund, or unit investment trust (UIT)) that invests primarily in bonds or other types of debt securities.
Commodities: These are hard assets ranging from wheat to gold to oil. Commodities are traded (bought and sold) on the U.S. commodities markets in Chicago, New York, and Atlanta.
Compound Interest: Interest paid on principal and on accumulated interest previously paid. Effectively, you are receiving interest on interest (that has been reinvested) over time.
Diversification: This strategy can be neatly summed up as “Don't put all your eggs in one basket.” This involves spreading your money among various investments in the hope that if one loses money, the others will make up for those losses.
Dividend: A portion of a company's profit paid to shareholders. Public companies that pay dividends usually do so on a fixed schedule, although they can issue them at any time. Unscheduled dividend payments are known as special dividends or extra dividends.
Exchange Traded Funds: ETFs are SEC-registered investment companies that offer investors a way to pool their money in a fund that invests in stocks, bonds, or other assets. They are funds that are traded just like stocks.
Index: A market index is a measurement of the performance of a specific “basket” of stocks considered to represent a particular market or sector of the U. S. economy. For example, the Dow Jones Industrial Average (DJIA) is an index of 30 “blue chip” stocks of U.S. companies. Other indexes include the S&P 500 Index, the Russell 2000 Index, and the Wilshire 5000 Total Market Index.
Index Fund: An “index fund” describes a type of mutual fund or unit investment trust (UIT) whose investment objective typically is to achieve approximately the same return as a particular market index, such as the S&P 500 Index, the Russell 2000 Index or the Wilshire 5000 Total Market Index.
Mutual Fund: A mutual fund continuously pools money from many investors and invests the money in stocks, bonds, money market instruments, other securities, or even cash.
REITs: A Real Estate Investment Trust (REIT) is a company that owns and typically operates income-producing real estate or related assets. These may include office buildings, shopping malls, apartments, hotels, resorts, self-storage facilities, warehouses, and mortgages or loans. Unlike other real estate companies, a REIT does not develop real estate properties to resell them. Instead, a REIT buys and develops properties primarily to operate them as part of its own investment portfolio.
Risk Tolerance: An investor's ability and willingness to lose some or all of an investment in exchange for greater potential returns. I personally like to describe this as “a person's willingness and/or ability to keep working while the market experiences a significant prolonged downturn.”
Stock: An instrument that signifies an ownership position (called equity) in a corporation, and a claim on its proportional share in the corporation's assets and profits. Most stocks also provide voting rights, which give shareholders a proportional vote in certain corporate decisions, such as the election of corporate directors.
Yield: The annual percentage rate of return earned on a bond calculated by dividing the coupon interest rate by its purchase price.