This thread is designed to discuss investing for people who are not professionals. Your own situation should guide you through this framework and it is not advisable for any one person.
First things first. If you have any credit card debt or similar high-interest-rate personal debt any savings should be used to pay that off.
Second, you should always have a rainy day fund in cash that is equal to the amount of money you will need if your source of income stops and you can’t find a job for a period of time.
Third If you have a known need for a chunk of your savings say a car, house down payment, wedding, college, etc. that will be needed in less than 5 years invest that money in a low-risk investment. It can have some risk but not a ton. Add to these savings to meet your budget.
Fourth after you have funded your nest egg and known soon spending any additional savings should first be placed in tax-advantaged savings vehicles like IRA/401k and 529 plans. The asset allocation methods I mention below apply to these savings too.
So after the above are funded any additional savings go into taxable accounts. Besides the nest egg and the planned spending savings, all of these vehicles are meant to be built properly and added to proportionately and infrequently rebalanced.
Now let’s talk about long-term savings. The goal of these savings depends on your age and ability to generate an income. The various age-tracking funds offered in 401k and other investment plans are conceptually good.
The younger you are the less investment income and the more risk you can take. As you age that need changes. Make sure you pay attention to this but it is a decade sort of thing. So don’t shift much at all.
So what is a good portfolio to own if you know nothing about investing? Here is when we need to get into concepts like why invest at all, what we know about the future, what is diversification, taxes, and transaction costs and fees.
I am going to start with transaction costs and fees. I believe outperforming the market on a risk-adjusted basis is extremely hard. For that reason, I believe that low fees and passive investing are better by far than active investing. You are reading this because you can’t.
Spend the time investing on your own and don’t know enough to outperform. In order to pick an active manager who can consistently beat the market net of fees taxes and transaction costs, you need the same skills to pick that manager you already said you don’t have. Passive mutual funds and cheap fee ETFs will do just fine for your purposes. Passive mutual funds, cheap fees ETFs will do just fine for your purposes.
Why invest at all? Long-term investors receive a risk premium from those who need your cash. Harvesting that risk premium is the way one makes higher returns over decades than holding cash and getting whatever interest accrues in a bank account. Currently zero.
Read my risk premium 101 thread to see why this is the case
What do we know about the future? If you are a market professional you may think you can predict the near-term future. It is arrogant to believe this IMHO because lots of market professionals are trying to eat from the same plate. It’s incredibly hard to be successful at this.
It is a blessing to you if you accept that you don’t know shit about the future and assume that all possible futures are already built into current prices. If you have that mindset all you have to do is create a portfolio that is indifferent to any potential future.
What drives prices over time. Well, that is fairly simple. Growth, Inflation, and specific idiosyncratic risk of a particular asset class or region.
Growth. If you own a lemonade stand and you get more people buying lemonade you are making more money and you are experiencing growth. Growth is good for stocks. However, if you borrowed money to buy the business the lender would have been better off buying a lemonade stand. Growth is bad for bonds/loans because the opportunity cost of having placed money into stocks makes bonds unattractive. (Nitpickers will talk about bankruptcy being less remote when growth occurs but ignore them for the moment)
Inflation is bad for bonds because you receive less valuable money in the future. It can be good or bad for stocks. Good because the earnings you get are inflated. Bad because the wages and input costs inflate and potentially bad if the fed chokes growth to control inflation.
Idiosyncratic risk is good and bad and thankfully diversification can reduce the risk while generating the same return as a concentrated portfolio. Diversification means investing in many different assets from many different countries and regions.
What is most important is you buy a balance of assets some of which perform well in high growth some in low growth some in high inflation and some in low inflation environments. The 60/40 portfolio that most people use is tilted pro growth significantly and is not diversified.
Today finding assets that do well in low growth or low inflation environments is extremely difficult which compounds the problem. Bonds have typically been this asset but low/zero interest rates do not provide enough upside in bond prices to provide investors with balance
My thoughts on this problem will be forthcoming in another 101 but for now, US long-term bonds are ok but still not great for this need. The implication for portfolios is that if you can’t be balanced you should take less risk and expect less return
Balance to an unknown future, passive to reduce taxes and fees, rebalance only when markets have taken your portfolio significantly out of balance and every ten years compare your age to your investments to get safer as time goes on