For savings, I like having money in buckets. I’ve got immediate savings at the bank in a savings account and I’ve got money at an online broker. The savings account money is just cash; it’s the money I may need to fix the car, pay a medical bill, payoff the credit bill if we overspent that month, etc. The money at the online broker is for longer term goals and is invested in as easy and straight forward a way as possible: five to six index funds, which really could be two or three.
There are two things I want to discuss here: asset allocation and dollar cost averaging.
Asset allocation is process of dividing up the money you have to invest into asset classes, such as stocks, bonds, cash, commodities, and other investment vehicles. My preference is to invest in index funds or ETF’s, typically from Vanguard because it is a non-for-profit and it has low fees. I don’t have the time to research stocks or bonds, so index funds are the right choice for me. This style of investing is also known as the “Lazy Portfolio”. I’m not sure who coined the term, but there is a lot out there on this style of investing. I found this wiki article this morning on Lazy Portfolios:
They can get complicated, but to get started all you need are two or three funds or ETF’s. If I were starting today, I would go with Vanguards Total World Stock Index and a Vanguard Total Bond Market Index. So that’s what you buy, and here are some thoughts on allocation. There was an article in the Wall Street Journal on owning a portfolio of 80% equities and 20% bonds vs. owning 50% equities and 50% bonds. The 80/20 outperformed the 50/50 portfolio in an up market, but not by much. The 50/50 is less risk. Another way that’s easy to remember is your age minus 100. So If I’m 35, then that’s 35% bonds and 65% equities. This comes down to your risk tolerance, and bonds are viewed as less risky than stocks. I’m leaning towards being more risk adverse. There’s nothing like having money when you need it.
Dollar Cost Averaging is a method for getting your money invested. For example, you take $1,200 in January and invest $100 per month for the full year in the same ETF. What you’re done is acquired the EFT at its average price for that year. This method removes some risk by letting you buy more shares when the EFT drops in value and buy fewer shares when it increases in value. Most 401k’s and other qualified retirement plans use this method, investing money at each pay period over the year. It removes the concern over market timing: the “am I buying at the right time” concern. This is a long term investing strategy, which is why it is good to have some cash saved for immediate needs.
In sum, buy index funds, split the money 50/50 between stocks and bonds (for simplicity), and invest evenly over a long-term time horizon.
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