How I Invest
One of the most common questions I receive from readers like you—especially since Grow (Acorns + CNBC) published my story last week—asks me how I invest.
All this theoretical investing information is fine, Jesse. But can you please just tell me what you do with your money.
That’s what I’ll do today. Here’s a complete breakdown of how I invest, how the numbers line up, and why I make the choices I make.
Of course, please take my advice with a grain of salt. Why?
My strategy is based upon my financial situation. It is not intended to be prescriptive of your financial situation.
I’ve hesitated writing this before because it feels one step removed from “How I Vote” and “How I Pray.” It’s personal. I don’t want to lead you down a path that’s wrong for you. And I don’t want to “show off” my own choices.
I’m an engineer and a writer, not a Wall Street professional. And even if I was a Wall Street pro, I hope my prior articles on stock picking and luck vs. skill in the stock market have convinced you that they aren’t as skilled as you might think.
All I can promise you today is transparency. I’ll be clear with you. I’ll answer any follow-up questions you have. And then you can decide for yourself what to do with that information.
Are we clear? Let’s get to the good stuff.
How I Invest, and In What Accounts…?
In this section, I’ll detail how much I save for investing. Then the next two sections will describe why I use the investing accounts I use (e.g. 401(k), Roth IRA) and which investment choices I make (e.g. stocks, bonds).
How much I save, and in what accounts:
- 401(k)—The U.S. government has placed a limit of $19,500 on employee-deferred contributions in 2020 (for my age group). I aim to hit the full $19,500 limit.
- 401(k) matching—My employer will match 100% of my 401(k) contributions until they’ve contributed 6% of my total salary. For the sake of round numbers, that equates to about $6,000.
- Roth IRA—The U.S. government has placed a limit of $6,000 on Roth IRA contributions (for my earnings range) in 2020. I am aiming to hit the full $6,000 limit.
- Health Savings Account—The U.S. government gives tremendous tax benefits for saving in Health Savings Accounts. And if you don’t use that money for medical reasons, you can use it like an investment account later in life. I aim to hit the full $3,500 limit in 2020.
- Taxable brokerage account—After I achieved my emergency fund goal (about 6 months’ of living expenses saved in a high-yield savings account), I started putting some extra money towards my taxable brokerage account. My goal is to set aside about $500 per month in that brokerage account.
That’s $41,000 of investing per year. But a lot of that money is actually “free.” I’ll explain that below.
Why Those Accounts?
The 401(k) Account
First, let’s talk about why and how I invest using a 401(k) account. There are three huge reasons.
First, I pay less tax—and so can you. Based on federal tax brackets and state tax brackets, my marginal tax rate is about 30%. For each additional dollar I earn, about 30 cents go directly to various government bodies. But by contributing to my 401(k), I get to save those dollars before taxes are removed. So I save about 30% of $19,500 = $5,850 off my tax bill.
Editor’s Note: The original version of this article incorrectly stated that 401(k) contributions are taken out prior to OASDI (a.k.a. social security) taxes. That claim was incorrect. 401(k) contributions occur only after OASDI taxes are assessed.
Many thanks to regular reader Nick for catching that error.
Second, the 401(k) contributions are removed before I ever see them. I’m never tempted to spend that money because I never see it in my bank account. This simple psychological trick makes saving easy to adhere to.
Third, I get 401(k) matching. This is free money from my employer. As I mentioned above, this equates to about $6,000 of free money for me.
Roth Individual Retirement Account (IRA)
Why do I also use a Roth IRA?
Unlike a 401(k), a Roth IRA is funded using post-tax dollars. I’ve already paid my 30% plus OASDI taxes, and then I put money into my Roth. But the Roth money grows tax-free.
Let’s fast-forward 30 years to when I want to access those Roth IRA savings and profits. I won’t pay any income tax (~30%) on any dividends. I won’t pay capital gains tax (~15%) if I sell the investments at a profit.
I’m hoping my 30-year investment might grow by 8x (that’s based on historical market returns). That would grow this year’s $6000 contribution up to $48000—or about $42000 in profit. And what’s ~15% of $42000? About $6,300 in future tax savings.
Health Savings Account (H.S.A.)
The H.S.A. account has tax-breaks on the front (36.7%, for me) and on the back (15%, for me). I’m netting about $1300 up-front via an H.S.A, and $4,200 in the future (similar logic to the Roth IRA).
Taxable Brokerage Account
And finally, there’s the brokerage account, or taxable account. This is a “normal” investing account (mine is with Fidelity). There are no tax incentives, no matching funds from my employer. I pay normal taxes up front, and I’ll pay taxes on all the profits way out in the future. But I’d rather have money grow and be taxed than not grow at all.
Summary of How I Invest—Money Invested = Money Saved
In summary, I use 401(k) plus employer matching, Roth IRA, and H.S.A. accounts to save:
- About $7,100 in tax dollars today
- About $6,000 of free money today
- And about $10,500 in future tax dollars, using reasonable investment growth assumptions
Don’t forget, I still get to access the investing principal of $41,000 and whatever returns those investments produce! That’s on top of the roughly $25,000 of savings mentioned above.
I choose to invest a lot today because I know it saves me money both today and tomorrow. That’s a high-level thought-process behind how I invest.
How I Invest: Which Investment Choices Do I Make?
We’ve now discussed 401(k) accounts, Roth IRAs, H.S.A. accounts, and taxable brokerage accounts. These accounts differ in their tax rules and withdrawal rules.
But within any of these accounts, one usually has different choices of investment assets. Typical assets include:
- Stocks, like shares of Apple or General Electric.
- Bonds, which are where someone else borrows your money and you earn interest on their debt. Common bonds give you access to Federal debt, state or municipality debt, or corporate debt.
- Real estate, typically via real estate investment trusts (REITs)
- Commodities, like gold, beef, oil or orange juice
Here are the asset choices that I have access to in my various accounts:
- 401(k)—my employer works with Fidelity to provide me with about 20 different mutual funds and index funds to invest in.
- Roth IRA—this account is something that I set up. I can invest in just about anything I want to. Individual stocks, index funds, pork belly futures etc.
- H.S.A.—this is through my employer, too. As such, I have limited options. But thankfully I have low-cost index fund options.
- Taxable brokerage account—I set this account up. As such, I can invest in just about any asset I want to.
How I invest and my personal choices involve two layers of diversification. A diverse investing portfolio aims to decrease risk while maintaining long-term investing profits.
The first level of diversification is that I utilize index funds. Regular readers will be intimately familiar with my feelings for index funds (here 28 unique articles where I’ve mentioned them).
By nature, an index fund reduces the investor’s exposure to “too many eggs in one basket.” For example, my S&P 500 index fund invests in all S&P 500 companies, whether they have been performing well or not. One stellar or terrible company won’t have a drastic impact on my portfolio.
But, investing only in an S&P 500 index fund still carries risk. Namely, it’s the risk that that S&P 500 is full of “large” companies’ stocks—and history has proven that “large” companies tend to rise and fall together. They’re correlated to one another. That’s not diverse!
To battle this anti-diversity, how I invest is to choose a few different index funds. Specifically, my investments are split between:
- Large U.S. stock index fund—about 40% of my portfolio
- Mid and small U.S. stock index fund—about 20% of my portfolio
- Bond index fund—about 20%
- International stocks fund—about 20%
This is my “lazy portfolio.” I spread my money around four different asset class index funds, and let the economy take care of the rest.
Each year will likely see some asset classes doing great. Others doing poorly. Overall, the goal is to create a steady net increase.
Twice a year, I “re-balance” my portfolio. I adjust my assets’ percentages back to 40/20/20/20. This negates the potential for one “egg” in my basket growing too large. Re-balancing also acts as a natural mechanism to “sell high” and “buy low,” since I sell some of my “hottest” asset classes in order to purchase some of the “coldest” asset classes.
Any Other Investments?
In June 2019, I wrote a quick piece with some thoughts on cryptocurrency. As I stated then, I hold about $1000 worth of cryptocurrency, as a holdover from some—ahem—experimentation in 2016. I don’t include this in my long-term investing plans.
I am paying off a mortgage on my house. But I don’t consider my house to be an investment. I didn’t buy it to make money and won’t sell it in order to retire.
On the side, I own about $2000 worth of collectible cards. I am not planning my retirement around this. I do not include it in my portfolio. In my opinion, it’s like owning a classic car, old coins, or stamps. It’s fun. I like it. And if I can sell them in the future for profit, that’s just gravy on top.
Summary of How I Invest
Let’s summarize some of the numbers from above.
Each year, I aim to save and invest about $41,000. But of that $41K, about $15K is completely free—that’s due to tax benefits and employer matching. And using reasonable investment growth, I think these investments can save me $15,000 per year in future tax dollars.
Plus, I eventually get access to the $41K itself and any investment profits that accrue.
I take that money and invest in index funds, via the following allocations:
- 40% into a large-cap U.S. stock index fund
- 20% into a medium- and small-cap U.S. stock index fund
- 20% into an international stock index fund
- And 20% into a bond index fund
The goal is to achieve long-term growth while spreading my eggs across a few different baskets.
And that’s it! That’s how I invest. If you have any questions, please leave a comment below or drop me an email.
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