After scouring countless investment websites, one thing’s for sure — there are lots of opinions and advice out there. Yet, there does not seems to be much focused, applied advice. It’s time to change that.
Hopefully by now you’ve signed up and received our strategy (if not, please do so below — it’s free!). I consider this the foundation of a long-term investment plan. The purpose of this article is to show you how to execute the strategy.
Why not just invest in index funds, where I can virtually put investments on “autopilot” and let them achieve market gains? I must admit, for most of my career the vast majority of my investments have been in index funds, which is a good place for anyone to start. I built this strategy with a small portion of my portfolio to see how much better I could do after I recognized how much money I was throwing away.
For one, I recently realized that, had it not been for the Great Recession, my family would be in much worse shape retirement-wise. Since I entered the workforce in mid-1999, the S&P 500 has averaged a measly 2.9% annually, and the Dow Jones has not done much better at 3.4%. Granted, I started near the peak of the “dot-com bubble”, but it’s still a far cry from the average 7% growth rate that many experts advertise for the market over time.
I was fortunate that I had the discipline to continue to invest using dollar-cost averaging as the market crashed from mid-2007 to mid-2009, making significant gains off those investments. Unfortunately many others who did not invest, or worse sold at the bottom of the market out of fear, were not able to take advantage of this opportunity.
Second, I realized that the small part of my portfolio that was being actively managed by an investment advisor was actually doing worse than the market! As many experts who favor index fund investing have explained, the fees that these advisors charge often wipe out any above-market gains that they are able to achieve. If only I was able to find a way to make similar above-market gains without the fees… this brings us to our 4 steps to success:
Step 1: Generate a Consistent Stream of Investment Income
A few of you have expressed that you’re interested in the strategy, but don’t have any money to invest right now. That’s a completely understandable response! What if I told you it doesn’t take as much money as you might think? Here are just a few recommendations on how to free up some extra money and get started today (you can find many more ideas and examples by searching online):
1. Start Small
It doesn’t take much — even $25 or $50 per month is a good place to start if your budget is tight. There are literally hundreds of internet posts that give all sorts of ideas on how to free up a few extra bucks. Some sample ideas:
- “Cut the cable cord” and go with the combination of an over-the-air digital TV antenna and internet TV (Roku, Apple TV, etc.). My cost of TV went down from $115 to $45 per month and I still had access to all the sports and TV shows I wanted to watch.
- Re-negotiate your cell phone plan or switch to a lower cost plan.
- Save money on food by eating out less and using coupons at the supermarket.
2. Pay Off High-Interest Debt, but Minimize Low-Interest Debt Payments
Debt with an interest rate greater than stock market returns should be paid off first, freeing up additional investment funds sooner — there’s no quicker way to throw away money than keeping a balance in these high-interest accounts. Typically, you see this high-interest debt in the form of credit card balances that are carried over at the end of the month. Conversely, you should pay the minimum on low-interest debt, such as car loans and mortgages with interest rates (2% – 4%) far below stock market returns, and invest any additional money in a higher return asset.
3. Automate Your Savings
Do you always seem to find a way to spend all the money you earn each month (me too!)? The best solution is to sock the money away first, whether it’s through an automated withdrawal out of your paycheck, or a monthly transfer out of your bank account. This will guarantee you don’t spend that hard-earned money you had intended to save, and start letting that money work for you!
Step 2: Invest in the Most Advantageous Savings Plan
When deciding which accounts to fund, I recommend following this common investment priority scheme. In it, I assume that most people will make less money when they’re younger than when they retire, and therefore it will be more beneficial to pay taxes now rather than later when you withdraw funds:
1. Get your company’s 401(k) match — it’s free money! Unless you expect to pay significantly less taxes in retirement, only contribute enough to max-out the employer match.
2. Max out your Roth IRA
- $5500 annual limit per person in 2017 if you fall within the income limits ($132k single / $194k married)
- All earnings are tax-free assuming you withdraw after you reach age 59 1/2, and there are no required minimum distributions for life.
- Don’t forget to fund your spouse’s Roth IRA if you’re married, even if he/she does not work.
- Roth IRA contributions are after-tax, so you’re expecting that you’ll pay lower taxes now than in retirement.
3. If your company offers one, invest the remainder of your retirement funds in a Roth 401(k). The major differences between the Roth IRA and Roth 401(k):
- Roth IRA has a low cap compared to the additional $12,000 you can put into a Roth 401(k) ($16,500 combined).
- Roth 401(k) requires minimum distributions upon reaching age 70 1/2.
4. If your company does not offer a Roth 401(k), then I recommend putting any additional retirement funds you wish to contribute into your 401(k). If you don’t have access to a 401(k) or want more control over the available investments, then a Traditional IRA can serve a similar purpose, likely without any matching contributions.
5. Finally, place any non-retirement investment funds in a standard brokerage account through a low-cost brokerage such as TradeKing, Fidelity, Vanguard, etc. While Traditional 401(k)’s and IRAs are tax-deferred, and Roth 401(k)’s and IRA gains are tax-free, everything in a brokerage account is taxed. Contributions go in after-tax, and earnings are taxed either as short-term capital gains (held < 1 year) or long-term capital gains (held 1 year or more).
Step 3: Get off the Bench and into the Game
Alright, you’ve saved up a sizeable amount of money in an investment account dedicated to this strategy, and are ready to take the first step. So, you start doing some research, reading through articles and analyzing charts using our strategy, when it hits you — there is a lot of information out there! Perhaps too much information. This presents a critical point where some people get hit with a wave of anxiety due to what I classify as “barriers to investing”:
- Lack of awareness — you ask yourself, “I couldn’t possibly know everything that is going on, right? There are political factors, economic data, diplomatic influences, and information not available to the public. How could I possibly know enough to make a smart decision?”
- Lack of time — at first you thought this was a good idea, but now you’re not so sure. How can you manage this research on a regular basis and still take care of your job, your family, and the rest of life’s needs?
- Analysis paralysis — you do your best to comprehend large amounts of information on investments you’re interested in, trying to make sense of it all. You see that some analysts are convinced that a certain sector should be bought, while other argue for selling. Who do you believe? How can you make a decision with so much contradictory information?
- New administration — what influence will President Trump and the new Congress have over the economy? Will they end up driving another recession, take the stock market to new heights, or perhaps not have much of an impact at all?
- Market volatility concerns — one day the market’s up, the next it’s down. Is it peaking, or just getting started on a long rally? Do you invest your money now, or hold on expecting a major drop in the market?
If you take nothing else from this post, remember this old adage:
“Rome wasn’t built in a day, but they were laying bricks every hour”
Same for your investment portfolio — take it one step at a time. Yes, there is a lot of information out there, and not much time in the day to analyze it… but would you believe I spend an average of only 10 minutes per week analyzing our ETF list? Worst case 30 minutes, primarily if I’m contemplating buying or selling a fund. The key is to set up a few tools that make your life so much easier. That brings us to Step 4.
Step 4: Execute the Strategy
The best thing we did to simplify the ETF analysis was set up a portfolio with Yahoo! Finance. Once the ETFs are entered into your portfolio, everything you need is just a click away. Combine this data with a simple spreadsheet, and you’re in business!
1. From your Yahoo! Finance portfolio, type the 52 Week High data into your spreadsheet. This is the only thing you’ll have to enter manually.
2. Use the 52 Week High data and/or purchase data to set alerts delivered straight to your inbox. We use the alerts as an indication that an ETF is approaching either a buy or sell point.
3. Click the Download link to get detailed data in an Excel file.
4. Copy the latest ETF prices into a spreadsheet that calculates the percentage difference from the 52 week high. A simple formula for this is:
((Current Price-52 Week High)/52 Week High)*100
Note that you can also customize your Yahoo! view to show this percentage real-time. I do both, getting a quick glance from Yahoo! daily, and recording data using the spreadsheet tracking method weekly so that I can analyze the data over time.
- For ETFs you have not yet bought, look for those that have dropped 25% or more (Buy Threshold).
- For those you own, look for them to approach the 52 week high as an indicator that they’re near the Sell or Absolute Sell Threshold.
5. Does an ETF meet our buy or sell criteria? Great! At this point, you need to do more research, which will inevitably take more time. I primarily use the charts, along with their tools, in Yahoo! as well as their news feed that collects various professional articles about each ETF. Yahoo! also provides information about the fund’s holdings , performance, and some limited financial data. Another good source of information is your brokerage’s research tools, which may give you access to paid articles that Yahoo! does not.
Pulling the Trigger
Let’s sit back and think for a minute about a potential ETF purchase. If you’ve reached this stage, you’ve likely determined that a specific sector has significantly dropped off its high. It should have dropped 25% or more, and shown some signs of reaching or having recently reached a bottom. You’ve read a number of (I recommend at least 7-10) professional articles on the movement of the sector, researched financial data on the major companies that make up the sector, and analyzed any political influences on the sector.
Everything seems to point to an end to the slide with a recovery likely in the near future.
So how much do you invest? My rule of thumb is to invest 10% of your total ETF portfolio per investment, but you can obviously spend what you are comfortable with. For instance, if my ETF portfolio is $5000, I’ll target around $500 per purchase. It’s enough where I can make a profit, but at 10% of my portfolio I can recover any losses in a short amount of time through other successful ETFs.
The only thing I caution is to not throw all your money into a fund you think is an “absolute winner” — if things end up going south, your lack of ETF diversification will result in significant losses with no way to recover other than to wait things out, add more money to the portfolio, or violate our strategy and sell with losses.
Just for a minute, let’s go back to address our fears, or barriers to investing. We’ve found a way to use a few simple tools and cut through the massive amount of information, applying our strategy. For this purchase, we’ve accessed enough information to make an educated decision about an ETF investment, looked at effects of the new presidential administration, and considered the sector’s volatility. And hopefully you’ve seen that this can be done with a reasonable time commitment.
Still not sure if it’s the right move? Go ahead and give it a few days, or perhaps a week. One of the good things about sector ETFs is that, unlike individual stocks, in most cases there will not be major movements in such a short period of time. And finally, if you’re still a bit nervous about taking the plunge, you can always “paper trade.” Use a spreadsheet to log sample purchases and sales, and see how it works for you before committing actual money.
Now it’s your turn — whatever stage you’re in, take the first step towards a more secure future. Start saving money for investing. Start a retirement plan. Then do your research and get into the fight… a fight for your financial security. Because no one deserves to only make 3% over nearly 20 years.
What stage are you in? Are you strapped for cash and need help finding money to invest? Or have you done some research and are ready to commit? I’m interested in your thoughts — please comment below!