How do I determine the right investments that match my goals?
I am a 24 year old single male. I have set aside several thousand dollars that I would like to make a sound fiscal decision with. To keep it concise, my goal is to aggressively grow this money in order to provide as substantial as possible of a supplementary income stream in the coming years. I have a moderate-high tolerance for risk, and am planning on contributing to this account with a percentage of my salary. My understanding is that mutual funds are a great base to start, and I have found several that seem to align with my goals, however, I have no idea what the metrics are by which these are measured, thus, I have no idea what makes a "good" mutual fund. How should I proceed to invest?
Congratulations for recognizing that you are looking to aggressively grow your money over the long-term and that you have a moderate-high risk tolerance. That's most of the battle. Over every long-term time horizon, stocks have provided the best returns. Given your age and risk tolerance, I suggest looking beyond our borders by considering an allocation to the emerging markets and Europe as well as the U.S. If you're feeling especially aggressive, the frontier markets which are countries that are emerging into the emerging markets.
There is no perfect allocation. However, I would certainly overweight the U.S. with at least 50% of your money. Even though I think the emerging markets may offer the highest return during the 2020s, I would still limit that allocation to 20% max unless they fell at least 25% first. Here are a few possible allocations.
- 50% U.S., 20% emerging markets, 15% Europe, 15% Japan
- 60% U.S., 20% Europe, 20% emerging markets
- 50% U.S., 10% emerging markets, 15% Europe, 15% Japan, 10% frontier markets
Regarding metrics, I would not complicate this nor worry too much about it. You can simply use the major indices for each market. In the U.S., that's the S&P 500. In Europe, it's the MSCI Europe. In Japan, it's the Nikkei. For frontier, it's the MSCI Frontier.
I would also use low cost index funds or exchange traded funds (ETFs) to express your allocation to each area of the world. Whether that's Vanguard or Fidelity or Ishares or State Street, you won't find huge differences.
Finally, I would choose a frequency to invest the money you have saved as well as future contributions. That's called dollar cost averaging or investing the same amount at regular time intervals. I would consider either monthly or quarterly.
It sounds like you are off to a great start. Before looking into investments, I strongly suggest setting aside at least 3x your total monthly expenses in an FDIC insured savings account (emergency fund). The next step requires determining the purpose of the money. If you plan on using it in the next few years (e.g. for a down payment on a house, down payment for a car, grad school, traveling, etc) I would not suggest investing it in stocks. You risk having a liquidity event during a market decline (selling stocks at a loss).
If you determine the funds are purposed for long term growth (i.e. retirement) you should consider funding a Roth or Traditional IRA. Investments within these types of accounts typically grow more quickly than investments within standard brokerage accounts due to several tax benefits. The downside is, you are penalized for withdrawals from these accounts before age 59.5.
If you've decided to invest for the long term, I strongly recommend implementing a well diversified portfolio. This can be a daunting task, as it requires numerous steps. You must fund a brokerage account, create an appropriate asset allocation, research funds, place buy orders for said funds, and rebalance the account consistently. One great mutual fund analysis website is Morningstar. I suggest looking at funds with low relative net expense ratios. If you prefer not to spend time performing the due diligence, there are several robo investment platforms which will create a low-cost, diversified portfolio for a fee (see Betterment or Wealthfront).
There are numerous paths you can take and a lot of variables at play. Ultimately, no one can give you specific advice without knowing the details of your situation. The above progression is a generic outline of a typical investor at the beginning stages of the wealth accumulation process. I hope this helps as you embark on your personal financial journey!
Chris Cyndecki, CFP®
First thing's first, pay attention to mutual fund cost. Mutual fund cost consists of two parts: load and expense ratio. Load is a one time charge when you buy or sell a mutual fund, you never need to pay a load since there are plenty of no load mutual funds. Expense ratio is an ongoing charge of a mutual fund. Always go for the lowest cost since it is found to be the biggest factor determine a mutual fund expected return. This basically means you should go for index funds. I recommend Vanguard. Typically, you pay about 0.1% expense ratio for a Vanguard Index fund, you will likely pay 10x that for an actively managed fund. I have an article about general investment rules of thumb for young people, you can read it here.
Two metrics I would suggest looking at are the costs and the standard deviation of the funds you are considering. Some mutual funds can cost as much as 2 to 3% per year. Look to see if there is an ETF on the market which is similar to the mutual fund you are considering. Compare the costs and fees of both. ETFs tend to charge lower fees than mutual funds. Paying lower fees usually means more profit for you.
Standard deviation is a measure of how much the returns vary from the average return. A higher standard deviation means you will get larger up months, but also larger down months. Be sure you are comfortable with the size of a down month that your fund could return. Are you comfortable wth a 2x standard deviation move? If you are comfortable with losing that amount of money on your investment, and know you will not sell out of it when it is down (the worst time to sell), then you can comfortably add that fund to your portfolio.
There are a couple of ways to look at this, as a math equation to solve or as a life equation to solve. Goal-matching can be looked at either way, it really depends on you.
1) Math Equation - You can plug in all the variables and receive "your number" based on a variety of internet calculators that utilize a time value of money, factoring in the real rate of return (investment return divided by inflation) with compounding, your contributions, etc. This will get you in the ballpark and you could satisfy your required rate of return with a variety of low cost mutual funds. CAVEAT; what happens if you get married and have kids, change jobs, have a medical emergency, etc.? There are all these variables that the math equation will just miss in my opinion.
2) Life Equation - In this format, you will likely have to employ a financial professional that is a fiduciary. This ensures that you have a financial plan created that will be adjusted as your life situation changes. I like to tell my clients to commit to the plan AND the "process", since your destination to successful retirement income is not a straight one. It has curves and the like, so you need a plan that takes that into account. The investment strategy is an accessory (not the focus) in this approach.
You may look at these books before getting started: 'The Aspirational Invstor' (Chhabra) and 'The Investment Answer' (Murray).
I hope this helps.