Get Building your Wealth: Four Pillars for Investing Success
Get building your wealth: four pillars for investing success is about sharing the most important principles or pillars I’ve learned during the past 17 years when it comes to investing, staying the course, and generating outstanding returns.
However, before we dig into our four pillars, we should first make sure our financial house is in order. We need to make sure we are using a monthly budget and making sure we’re paying our bills on time. It is very difficult to move forward in a meaningful way unless we tackle these upfront and continue to manage these monthly. Our friends over at Rinkydoo Finance have two great articles on these topics.
- Budgeting: How to Organize your Finances: 10 Simple Tips
- Managing Bills: How to Catch up on Bills: 11 Life-Changing Tips
Assuming we’ve got these foundational pieces in place, let’s stand-up these four pillars!
First Pillar: Asset Allocation & Rebalancing
What is Asset Allocation?
I assume that you’ve heard about stocks, and you’ve heard about bonds, and you know that most investment portfolios include a mix of both. The portions or percentages you allocate to stocks and bonds is your asset allocation. The more stock you own the more returns you will earn but the more up and down your portfolio will swing. This variance is called volatility. To pick your best asset allocation you need to know your goals and risk tolerance. Generally speaking the younger you are the more stocks you should own relative to bonds and as you age the bond percentage should rise while the stock percentage drops.
Typical Allocations
Typical industry advice is to take your current age and subtract it from 100 to determine what percentage of stock you should be holding at any given period of your life. This is good advice as you will become more conservative as you age. However we suggest allocating more to stock; instead of 100, subtract your age from 120. This will give you 20% more stock allocation at all stages of life. This will bring larger returns at the cost of introducing more volatility; but we will balance this back once you see our cash allocation which will bring it back to near typical.
Rebalance our Assets
The next tool we will use to enhance our portfolio and asset allocation is to rebalance the portfolio at least once a year but not more than once a quarter. See what happens over time is our allocation to stock and bonds will drift away from our targets as one will typically go up while the other will go down. To bring them back into balance means to rebalance your portfolio. The magic here is that this forces us to sell high and buy low and always keep risk on target.
Automated Rebalancing
Some services, like robo-advisors, will do this rebalancing automatically for you. They will buy or sell the stock and bonds portions for you so they stay on target at all times. You will still need to rebalance the cash portion by selling or buying your robo-portfolio at the interval we suggested above. See our review of robo-advisor services. (Article coming soon)
Another alternative are the all-in-one asset allocation ETFs. These rebalance for you too so you never have to worry about rebalancing. See our review of all-in-one portfolio ETFs (Article coming soon)
Assets
These are the assets classes we invest in:
Equities
- Also known as stocks, these represent ownership of publicly traded companies such as Apple, AT&T, Toyota, etc. This asset class offers great returns over longer periods of time and should occupy the largest portion of your portfolio so your capital can grow.
Bonds
- This represents government and corporate debt. They usually come with a fixed payment over a fixed timeframe and offer stability and income to the portfolio. They are often seen as a stabilizing influence to a portfolio as they tend to increase in price when stocks go down; this is diversification. They don’t offer the same returns as stocks over longer periods of time.
Gold
- When the rich and wealthy fear rising inflation they turn to gold, masterpieces of art, and mansions. Gold will also do well when geo-political events destabilize the world, such as global pandemics or wars. We want a small portion of gold in our portfolio to not only hedge against inflation but also add further diversification.
Crypto
- Bitcoin and Ethereum are both decentralized digital currencies that are taking the investment world by storm. They offer an incredible hedge against inflation as they are deflationary forms of money and their acceptance and adoption is growing each year. You want to have 2% of your portfolio in one or both digital currencies. Can’t decide? Then just go with Bitcoin. Please read more about why you should invest in Bitcoin by reading, Four Reasons You Should Invest in Bitcoin.
Cash
- Cash is an incredible asset that hedges against stock market crashes, rising interest rates, insomnia because you’re too heavily invested in stocks, and opportunity cost by not having dry powder to jump on investment opportunities. However cash is squarely exposed to the following risks: manipulation by central banks, inflation, and poor returns. In the table below you won’t find an allocation for cash because cash is actually our second pillar. We allocate to cash AFTER we have allocated to all other assets first.
Some important points about the above:
- If you can, currency hedge where possible, but don’t stress it if the particular service or ETF you want is not available hedged
- Rebalance once a quarter if you’re in a tax sheltered account, else do it once a year in a taxable account
- When rebalancing a taxable account, try to do it in a way that maximizes tax loss harvesting. You need to read about tax loss harvesting or else you’ll make a mistake and your efforts will be null and void. It needs to be done in a particular manner but it can lower your tax bill.
- Favor longer term bonds over shorter – the cash allocation in the next section will cover our interest rate risk
- Once you’re over the sage of 60 keep those stocks locked at 60% You need this to keep up with inflation and not run out of money. See our article on the best way to get your yield and pay attention to the part where we talk about never running out of money.
Second Pillar: Cash… Lots of Cash
Yes, this pillar could be slotted in under the Asset Allocation pillar, but our cash hoard plays such an integral part of our investing strategy that we keep it separated for emphasis. This is a key component to our strategy and always lets us live to fight another day regardless of market behavior.
Cash also plays the role of enabling your aggressive stock allocation to do its job by keeping it protected and untouched. If you need emergency cash take it from here – not your stocks! Cash also lets you sleep sound at night so you can go weeks and months without checking your portfolio. If you’re checking your portfolio and stocks daily (hourly?), this is a good indicator that you’re way too aggressive, not diversified, and are fearful of losing your money. You should reduce your stock allocation and build up your cash hoard.
Cash lets you be a Predator for Opportunities
Cash also lets us take advantage of market opportunities as they are presented during market corrections and downturns. Often such opportunities provide improved dividend yields which in turn let us build back our cash hoard.
Why Not Short Term Bonds Instead?
The frequent counter argument to this approach is to use short term bonds. We argue back that a carefully selected high interest savings account can beat the total return of a short term bond all while being insured by either the FDIC or CDIC.
Focus on YTM not Yield
When you compare a high interest savings account against a short term bond fund be sure to compare the savings account interest rate against the Yield to Maturity of the bond fund. This is an apples to apples comparison. The fund yield can be easily manipulated to look as though its giving great yield.
Don’t use money market accounts. They are not as risk free as we saw back in 2008 and their yields are almost always lower than short term bonds. See our Cash is King article for more information and possible solutions of where to park your cash. But the short of it is to keep a minimum of 7% of the portfolio value in cash, and a maximum of 14%; I personally strive to maintain 10%.
Overlook Cash at your Peril
Please don’t overlook the importance of holding lots of cash in your investment strategy. I personally attribute this single strategy to my being able to invest successfully over the past 17 years since 2003. I’ve been through 3 market crashes: the financial crisis of 2008, the oil price collapse in 2014, and the COVID-19 pandemic in 2020. In each of these I had the stability and gumption to step in with cash and pick up securities at a discount when everyone was fleeing with fear.
Third Pillar: Time IN the Market
The third pillar is time in the market. The more time you have your portfolio of stocks, bonds, gold and crypto invested in the market, the more time you have to let it compound and grow. We all know the saying – “Its time in the market that matters most; not timing the market”. And its absolutely true. Time is our currency for investing and we spend a little each day – if we keep our portfolio in the market we will get our due reward. Check the following:
If you invested $10,000 in the S&P 500 at the beginning of 1942, you would have $51,651,605.58 at the beginning of 2020. You read that right – $10,000 turns into $51,600,000. It just needs time
Just think about the major geo-political events that took place during this time and all the times investors fled in fear. WW2, Vietnam war, Korean War, Cold War, Kennedy was shot, Persian Gulf war, Inflation in the 70s and 80s, high interest rates, low interest rates, 911, Housing Crisis, Financial Crisis, Oil Shocks, and the latest – COVID-19. Not to mention the numerous stock market crashes along the way. Despite these headwinds the investment returned 516,416% Bonds, Gold, Real Estate – y’all got nothing on this. Okay, maybe Crypto does.
30 Year Time Horizon
Even still, putting aside a portion of capital each month in a portfolio of stocks, bonds, gold, crypto, and cash as we’ve outlined here today is a successful strategy that will yield incredible results over a 30 year time period. Partner this with your efforts for business and greatness and let it grow for 30. I promise you in 30 years it will amaze you just how effective the strategy outlined here today has been. It works because its balanced, intelligent, and harnesses the power of compounding interest and returns.
Fourth Pillar: Mind Your Investment Fees
Lower your investment fees! All fees drag performance down and reduce how much money is available for compounding. There are many investment tools and options out there that have capitalized on the desire for investors to lower their fees. We really have no excuse to be paying high mutual fund fees. Study after study has shown how mutual funds have great difficulty matching or beating the performance offered through low cost index ETFs.
Now, there are commission free trading platforms: Americans can use Robinhood and Canadians can use WealthSimple Trade. If you’re a Canadian, and sign up using my affiliate link with WealthSimple Trade, you will receive $10 extra after depositing and trading $100.
Trading Platform Plus ETFs
You combine one of these trading platforms with a low cost ETF solution and you have a formidable portfolio. We want lots of time in the market. We need years and years of compounding growth working for us. So we need lowest fees possible so we can save our portfolio from the eroding effects of management expense ratios and trading commission fees as we rebalance with our cash allocation. What ETFs should you be using? Read our article on this as it will also show you where you can start buying your Crypto allocation too. Hint: WealthSimple Trade and Robinhood also allow you to buy Bitcoin too! All-in-One solution!!
Back to Focusing on Fees
If you have 100,000 to invest and one option charges an MER of 1.50% while the other option charges 0.20% you will save $59,490.56 in fees over a 20 year time frame. But that is not all — because that money is extracted and not working for you, your portfolio will lose out on $130,495.59 in returns. Calculate the impact using this great MER calculator
Summary
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