How I Would Invest If I Couldn't Buy Individual Stocks
Diversification, Asset Allocation and Low-Cost Index Funds Would Be Key
Investing is really simple, especially if you focus on buying a collection of low-cost index funds or mutual funds from a company such as Vanguard, which operates in a mutual fashion so most savings go to clients rather than to private owners. Here are my thoughts on asset allocation for investors who don't want to deal with choosing individual stocks or bonds.
If I had to start completely over and wasn't allowed to own any private businesses that provide me with a constant stream of cash to redeploy, like the companies I control, or even pick individual stocks, what would I do? How would I structure my money so that I could at least enjoy the benefits of compounding and watching my net worth grow, while reducing risk? Stocks are great but you don't have to invest in individual stocks to get rich.
For the past few days, I've pondered that question because I realized that this is the condition that many of my readers find themselves in every day. You don't want to learn how to read an annual report or dig through a 10K. You don't want to have to study dividend payout ratios or interest coverage ratios. How, then, can you take advantage of the long-term wealth building opportunities that stocks, bonds, and real estate offer without thinking about your portfolio more than a few times a year?
Building a Portfolio Can Be Simple
As I've explained over the years, at its core, investing really is simple. In fact, investing is so simple that it comes down to only a handful of basic rules that I wrote about in If You Are a Long-Term Investor, You Can Ignore the Economy. These rules are:
- Spend less money than you earn
- Avoid debt
- Keep enough liquidity and cash on hand to pay your bills for six months or longer in case you lose your job
- Invest the most money you can without taking away from the lifestyle you want now. Finding the right balance between present consumption and future wealth is something only you can answer for yourself.
- Focus on avoiding losses and lowering risk.
Wall Street likes to make it more esoteric than it is but that is only so the wealth management companies can charge you higher fees.
A Look at Some Basic Portfolio Asset Allocation Models
As I thought about the answer to my investing question, I went over many of the so-called asset allocation models that I've written about in finance essays (some of which are reproduced in the asset allocation section of my personal site), including ones such as the Talmud asset allocation model, which is based on the ancient recipe of 1/3 real estate, 1/3 businesses, and 1/3 cash.
Finally, I came to the conclusion that the best choice is a mutual company, such as Vanguard, which is owned by the fund shareholders and offers rock-bottom expenses so most of my money stayed in my pocket and didn't go to fees. If I were young and didn't need the cash, I'd probably put:
- 5% of the portfolio in silver and gold
- 5% of the portfolio in cash and cash equivalents
- 20% in high-grade bonds that matured no more than 8 years in the future
- 30% in high quality, dividend paying blue chip stocks here in the United States
- 20% in high quality, dividend paying international stocks not hedged back to the dollar so I had some form of dividends coming in from other currencies
- 20% in high-grade real estate investment properties
Almost all of this I'd do through Vanguard, and just regularly index so that I had money taken out of my paycheck for decades, ignoring market fluctuations and buying even more during crashes. For high-quality blue chip stocks, I'd look at things like the Dividend Appreciation Index Fund (ticker symbol VDAIX), which only invests in companies that are found in the Dividend Achievers Select Index. These firms have raised their dividends in each of the last 10 years. The expense ratio is only 0.35% and the minimum investment is only $3,000.
The fund's biggest holdings consist of McDonald's, IBM, Coca-Cola, Pepsi, Chevron, ExxonMobil, Procter & Gamble, Johnson & Johnson, Wal-Mart, and United Technologies.
Plus, Vanguard wouldn't charge me transaction fees on a lot of their funds (or even stocks, depending on the asset size of the total account). Such a setup should produce satisfactory results over a 30, 40 or 50 year period with hardly any effort or upkeep.