Once you start trying to grow your money in the stock market, one of the very first questions you’ll ask is “what should I invest in?”. Hidden in that question is another one – “how many stocks should I own?”. The answer is likely fewer than you think.
When I started investing I put $100 into an account. I chose 5 different investments and put $20 into each of them. What I didn’t realize at the time is that I was overcomplicating investing. A lot.
In the decade since then, I’ve come to learn how to invest on my own, ditched my financial advisor, and retired early at age 36. This post goes into what investment strategy I recommend for people getting started today.
What Should You Invest In?
Before you think about what you should invest in, it’s a good idea to make sure you have the right mindset. What would have to happen for your investments to be considered a success?
If you’ve been following the recent Gamestop fiasco or even watched ETFs like $ARKK, you might want your investments to return 100% a year or more. Well, I’ve got bad news for you: that’s not going to happen – at least not with any consistency. A select few investors will make out like lottery winners. The vast majority of speculative investors are in for a disappointment.
The sooner you can switch your mindset from “My portfolio needs to double” to “My portfolio should average about 8% a year“, the more investment opportunities you’ll have. If the only investments you look into are the ones that can double in a year then you’re not investing – you’re gambling.
There are thousands of stocks in the market and tens of thousands of index funds and mutual funds. Let’s narrow that down to just the ones that are investments. Investments that you’ll buy and hold for decades at a time.
How Many Stocks Should I Own?
If you have one stock it can go any amount in any direction. If I said I bought some Gamestop stock, your next question would be “at what price?”. I could have bought it at $500 a share or $4 a share. Timing is everything.
In other words, with 1 stock, the price can vary a scary amount. Your investment can go down 100% or up 1,000%. You can lose everything or retire tomorrow.
That’s not investing. That’s gambling.
Investing is purchasing a piece of a company that you believe will grow and provide value, in turn increasing the price of the stock. It’s not as exciting as picking the hot stock in the news, but you also skip the lows.
So how do you do that? How do you invest in growing companies that are needed to provide services that people pay for? Well, one way is to buy a little bit of every single company.
One example is $VFIAX (or $VOO, they’re the same fund) – the Vanguard 500 Index Fund Admiral Shares. This fund invests in 500 of the largest companies in the United States. It invests in Google, Apple, Microsoft, Amazon, Tesla, Visa, Walmart, Disney Netflix, Intel, Starbucks, and hundreds of others.
There are 3 key points about this fund:
- It is market-cap-weighted. It invests more in the largest company and less in the smallest companies. As of 2/27/2021, it invests about 30% in the largest 10 companies and 70% in the other 490 companies.
- It is self-cleaning. This is a rolling list of the top 500 companies. When a company declines, lags behind, or goes out of business it’s removed from this list. If another company grows (like Tesla in recent years) it’s added to the list and you become an investor right away.
- It manages your investments for you. If you tried to invest in 500 companies on your own, that would take an unrealistic amount of work. You’d constantly buy and sell funds to keep your portfolio in sync with the stock market. As a result, you’d pay a bunch of taxes and trading fees. An index fund does it all for you.
500 companies is the baseline for how many different stocks you should invest in. This gives you a diversified portfolio of US stocks – spanning every market sector (information technology, consumer spending, financial companies, and more).
Every investing company (Vanguard, Fidelity, etc) has an S&P 500 index fund to invest in – and most of them are nearly identical. Vanguard has $VFIAX and $VOO. Fidelity has $FXAIX. There are other funds like $SPY and $IVV. All are trying to invest in the same 500 companies while keeping expenses and taxes low. If you’re unsure which to pick, you can look up it’s FI Score in the Minafi Fund Directory.
500 funds are a good start, but there is one other type of index fund that is even more diversified – total US market funds. The S&P 500 invests in the largest 500 companies, but Total US Market Index funds (like $VTSAX and $FZROX) try to invest in almost every publicly-traded company. VTSAX invests in 3,640 companies!
Total market funds are about 80% similar to S&P 500 funds. In other words, 80% of the total market funds investments are in S&P 500 companies. That last 20% invests in medium and smaller companies.
Which is better? It depends on the year. In years where large companies get larger – the S&P 500 wins out. In years when small companies grow big (like Tesla in recent years) a total stock market fund wins out.
I prefer the total stock market fund myself. It gets most of the benefits of a S&P 500 index, while still benefiting from the growth of smaller companies.
Adam says: to learn more about how to invest in index funds, check out my free Minimal Investor Course.
What About Dividend Stocks?
Here’s the thing about dividend stocks (and dividend ETFs and dividend mutual funds): the price factors in dividends. If a fund issues dividends, then the price will have that built in.
In other words, if you have two identical funds, but one distributes dividends, the share price will be different. The dividend fund will be priced an amount lower depending on the amount of the dividend.
Let me repeat that one more time: dividend funds and non-dividend funds that track the same thing perform about the same. If you’re investing in index funds within your IRA, 401(k), or Roth IRA, I wouldn’t recommend chasing dividends. Base your portfolio on your target asset allocation instead.
But wait, there’s more. If you’re in your working years where you have an income coming in, one of the worst things you can do is invest in dividend funds or stocks in your taxable account. You’ll need to pay taxes on those dividends – both federal taxes and possibly state taxes – every year. It’s one reason why I avoided dividends like the plague during my working years.
Because of these taxes, you miss out on compound interest! You’re better off investing in a fund with very low dividends (like $VTSAX) and reinvesting them.
How Much Do You Need?
The following hard numbers assume you’ll need somewhere between $40,000 and $200,000 a year to cover your expenses when you retire. Based on the 4% rule, that would mean you’d need to save up somewhere between $1,000,000 and $5,000,000 to be completely set for life.
Luckily you need a lot less to live a life you truly love. Even having a buffer of a few months expenses can give you confidence to switch jobs – or even change careers!
If the thought of saving up this much money sounds exhausting, focus on what you can control – what you’re invested in today, how you earn that money, and how you spend it.
Phase 1: The Basics – $0 to $100,000
Recommended number of funds: 1 or 2 index funds.
The absolute easiest way to invest is to pick a target-date retirement fund. If you plan to retire around the year 2050, you could pick a fund like $VFIFX (Vanguard Target Retirement 2050 Fund). This fund invests in about 3,200 US companies, 7,300 Non-US companies, about 10,000+ US bonds and 6,000+ international bonds. So by investing in just one fund you’re invested in over 10,000 companies and 16,000 bonds! Still, 90% of your investment is in stocks.
If you wanted to get a little fancier, you could invest in 2 funds – a Total US Index Fund (like $VTSAX) and an international fund (like $VTIAX) Vanguard Total International Index Fund. The Vanguard Target Retirement 2050 Fund invests in these two funds behind the scenes, but you could do it yourself.
Your goals during this phase: Open your accounts, get used to buying and holding, start investing automatically from your paycheck.
Once you start investing, the first thing you’ll need to figure out – even before you buy a single stock – is which account to use. 401(k)? Roth IRA? IRA? You can read my guide for which account you should invest with to get started.
Next, you’ll need to get used to investing in index funds whenever you have the cash. Don’t try to time the market and wait for it to go down to make a purchase. Automate your investments as much as possible. You want your money in the market as soon as it can be for as long as it can be.
Finally, get used to seeing your account balance rise and fall. There will be days it goes down. Expect the value of your account to swing up and down more than your entire paycheck some days. There will be days it grows more too! Get used to seeing your balance rise and fall without selling.
If you want to dig more into these ideas – diversified, tax-optimized index fund investing for retirement – check out my free course here on Minafi.
Phase 2: Growth – $100,000 to $1,000,000
Recommended number of funds: 3 index funds.
Target date retirement funds are amazing to get started. They do everything you need and give you broad diversification. To be honest, you could continue using it until you retire and it would do everything you need. If don’t want to worry manage investments, I’d encourage you to just stick with that fund and deposit as much as you can whenever you can.
There is a way to slightly optimize your portfolio: invest in a US Index Fund, an International Index fund, and a bond index fund. These are the exact same things that the target-date retirement fund invests in. By investing in them manually, you’ll pay slightly less in fees.
If you’re investing with Vanguard the difference won’t matter as much. If the expense ratio of your target-date retirement fund is above 0.50% then this is more important.
There’s a term for a portfolio with these three funds – a three-fund portfolio! The investments in this portfolio are roughly the same as those in a target-date fund but optimized to pay fewer fees.
The amount you invest in a bond fund will depend on how long you have until retirement. If you’re more than 5 years out from retirement, you could skip that step altogether. Once you’re closer, a major market correction could delay your retirement date. At that point having some part of your portfolio in bonds can help.
Your goals during this phase: Learn how to optimize your portfolio for fees, while keeping an eye on diversification. Learn how to use bonds to normalize your returns – even if you don’t actually start investing in them yet.
If you’re investing in multiple accounts – like a brokerage account a 401(k) and a Roth IRA – you’ll also want to learn how to diversify your portfolio across multiple accounts while keeping them tax-efficient.
Phase 3: Retirement – $1,000,000 and Beyond
Once you’re about 5 years away from retirement, it’s a common approach to start making a few changes:
- Lower your risk by moving slightly more money out of stocks and into bonds.
- Optimize your taxes so you’re not overpaying once you start selling funds.
- Move money into funds that will provide tax-optimized dividends live off.
We retired about 2 years ago and now spend about $80,000 a year and pay nearly no taxes. There’s nothing sketchy about this – we’ve just optimized our portfolio to be tax-efficient.
This phase is all about optimizing your portfolio for taxes. For us, that meant investing some of our money in a tax-exempt bond fund ($VWITX) that funds part of our monthly spending. Last year we received a $600 dividend each month from our $300k investment – about a 2.4% dividend while the funds’ value itself grew 4%. That’s nowhere near the performance of a US Stock index fund, but it helps reduce the fluctuations.
At this high a level you might think your investments would change drastically – but they don’t need to. By investing in the entire stock market (in the US and internationally) you’re already investing in everything! You’re good.
If you are investing with a financial advisor, that’s something to look into. It’s why one of the courses in the Investor Bootcamp is how to Ditch Your Financial Advisor. If you have $1,000,000 invested and your financial advisor charges you 1% a year, you’re paying them $10,000 a year (!). Odds are you could achieve the same (or better) market gains just by transferring your entire portfolio to a target-date retirement fund.
Lastly, taxes. With $1 million invested you’ll likely have money in multiple accounts – 401(k)’s, IRAs, Roth IRAs, and maybe a brokerage account. When you need money from these accounts you’ll need to pay taxes (except your Roth IRA). Trying to figure out how much to take out of each account can be a nightmare.
Here’s how I think about this:
- $0 – $25,100: for couples (or $12,550 if filing solo) ca be taken out of your 401(k) or Traditional IRA for free. This is covered by the standard deduction. If you took out exactly this amount and nothing else, you’d pay no federal taxes.
- $25,100 – $105,100: After that, you can sell long-term capital gains up to another $80,000 (or $40,000 if filing solo) and still pay $0 in taxes.
- $105,100+: Lastly, you can withdraw any amount of your Roth IRA and pay no taxes if you’re over 59.5. If you’re younger you can withdraw up to the amount you’ve deposited – also for free. You can also sell long-term capital gains for a lower tax bill than withdrawing from a 401(k) or IRA.
Your goals for this phase: Understand how much you’re paying in fees and optimize it. Also, figure out how you’ll withdraw funds from your accounts in a tax-optimized way.
You may not need to change your investments at all during this phase!
Get Started Today
If you’re looking to invest right now, here’s what I’d recommend:
Sign up and read through my free Minimal Investor Course. It’ll guide you through which accounts to open, how much to deposit into each and how to find what to invest in based on what’s available in your 401(k) or wherever you’re investing.
Set up automatic investments from your paycheck. Don’t even think about it. If you’re watching the price of the stock market, you’re less likely to invest when it’s at or near all-time highs. Here’s the thing though: the market spends 95% of its time near all-time highs! If you’re waiting for it to drop you might miss out on years of growth.
Stick with it. Investing isn’t like buying a lottery ticket. It’ll take years – decades even – to grow your wealth. By investing in index funds (and thousands of different stocks), you’ll get there eventually.
When I started investing I constantly wanted to buy new funds or make changes to my portfolio. I felt like that gave me some sense of control over what I was invested in. Here’s the thing: you’re not in control. The sooner you can internalize that, the less you’ll try to chase speculative investments and the better you’ll position for long-term investment growth.
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