Investing Basics for High Earning Millenials

Caveats:

  • Don’t rely solely on one opinion, take an aggregate and decide on what’s best for you. Nobody else knows what is best for your risk profile. They really don’t.
  • Your money is yours to lose. Shepherd it well so that it works for you, and not you for it!
  • I’m assuming you’ve worked out a basic monthly budget at this point and have a good idea what you can save.
  • Scheduling monthly or weekly automatic transfers makes investing feel a lot less painful and dollar-cost averages your investments for you.

Good References and Books

The Good

  • You have a very long investment horizon.
  • You’re planking on a mil as the rappers say ie: you have more income than you know what to do with.

The Bad

  • Bank savings and checking accounts do not keep up with inflation.
  • The U.S. stock market is overvalued and primed for flat-negative returns over the next decade.
  • You are probably in debt.

Your enemies are the tax man and changes in the value of your currency (inflation/deflation)

Do everything you can (401k, IRA, municipal bond investing) to avoid the tax man. If you avoid him you can significantly lower your reported income and boost your investment returns. I don’t make the rules here. You’ve already made big strides if you bought a house! Enjoy your mortgage interest deduction and bang on the system!

I worry a lot about out-of-control inflation or deflation. Lots of evidence exists that the Fed has driven the outlandish stock market rallies of the last 20 years by implying that it can protect the free market. This has led to aggressive growth investments (tech and bio stocks) and yield chasing (high yield bonds).I’m worried about a global deflationary cycle. Oil and commodity price declines are typically great for the global economy, but political upheaval tends to follow subsidy cuts, and that’s where all the major oil producers are headed. Meanwhile, all of the central banks are one-upping each other attempting to give their economies a booster shot through incredibly low rates. This is an undeclared currency war.

The way to guard against inflation/deflation historically is holding onto cash against deflation) and investing in stocks and alternative assets (timber, personal loans, other weird stuff) against both deflation/inflation.

Savings in order of importance assuming you have a job

  1. Rainy day funds. Keep 3-9 months of savings in a bank savings or checking account. That includes your mortgage and any other living expenses.
  2. Max out your 401k every year ($18,000 in contributions for 2016).
  3. Set aside another $5,500 cash for your IRA, it still has advantages despite you being in a higher tax bracket.

Once you have 6-12 months of cash savings for a rainy day and are investing tax-free

  1. Pay down your highest interest rate loans early, especially anything >5%. You are basically matching/beating the annual return of the stock market, and it is a guaranteed return on your investment.
  2. Roll some money into yield-bearing assets: CDs through your bank, online lenders like Lending Club, or a municipal bond ETF such as MUB: http://www.morningstar.com/etfs/arcx/mub/quote.html.
  3. Open an individual investment account with Fidelity, E-Trade, or Scottrade and start rolling small amounts of money in.
  4. Start looking at alternative assets you could buy. Want to buy a second house? Ever wanted to get into collectible items?

Roth vs 401K vs IRA

A lot of people have trouble understanding the various retirement investment vehicles out there. The core concept is simple: are you investing pre-tax (regular IRA or regular 401k) or post-tax (Roth IRA or Roth 401k)? While the vehicles differ, the biggest debate is typically pre vs post tax accounts. Which to choose a Roth or a regular IRA/401k?

The answer is that you should be doing both. Nobody knows what the tax code will look like in 30 years and your income could change quite a bit up or down. I live in NYC now. If I move to Denver where cost of living is much lower, I can make half of my old salary, live better, and it still puts me in a lower tax bracket.

And what about startups? If you take a job at a company you really like maybe you get more stock comp and lower cash salary. Maybe you start your own company and pay yourself in company stock gains. It’s too hard to predict, so invest a bit in both pre-tax and post-tax accounts.

People always say taxes will rise, but tax rates haven’t changed significantly in 30 years. Nobody knows what the tax code will look like when you retire or what your income will be in the interim, therefore diversify your tax-free investing strategies between both a Roth and a Standard 401k or IRA.

Me as an example

Lately I am trying to build up cash for the following reasons:

  1. Leaving my job here, building up a war chest to carry me, my girlfriend, and my daughter for 6 months if I am unemployed.
  2. Macro uncertainty.The stock market has been on a tear for the past 6 years. Statistically this is highly improbable. Cyclically adjusted ratios are abnormally high, and profit margins are peaking. Dividend yields on the S&P500 is low from a historical perspective as well. Fundamentally the market looks expensive. Bonds are no better. Fortunately the actual economy appears to be doing fine. People are working. This could be a finance market bubble not a true economy bubble.

I’m currently 50% cash, and don’t like the stock market at these levels, but I need to put it to work somehow until a buying opportunity arises.\

 

So I’m thinking more about preservation of capital than putting risk on at this point in the economic cycle, but I keep investing in my 401k and in Jane’s 529. This might seem odd, but I am skeptical of my own ability to call a market top. If you are 51% right in investing I would like to work for you. I’m not god and I could be wrong about the market, both investments are dollar cost averaged, tax-advantaged, and have very long horizons.

Retirement savings should not be gambled with.  So in short, no matter what the market does keep investing in your tax-free retirement accounts every month, and max out your 401 k every year. If you are in debt start chopping at those student loans.

Alternative Investment Ideas

A basket of personal loans are a safer investment for my spare cash than 2% muni bond ETFs or a volatile stock market. Muni bond ETFs correlate with the stock market, tending to decline alongside. I can’t think of anywhere else to taxably invest over 1-2 years than CDs yielding 1%. Yuck.

LendingClub is quite liquid, the interest after-tax is probably a good 5-7%, and LC loans performed far better than bonds or stocks in 2008-2009.The average return was very low 0.5-2%, but still positive. If the economy is fine I should earn a decent 7-9% annualized return through Lending Club. If things go badly, and maybe my Lending Club portfolio ends down 1-5%, that will still be far superior to the stock market which typically loses 15-30% during recessions. There has been recent bad press on LendingClub, which in my opinion is overblown, but it should be noted. I personally am putting more cash in. I have been investing in the platform for 5 years now and have only seen positive overall returns. LC has recently raised its lending standards, which means a higher potential return to lenders. All good things in my opinion. I’ve taken all of my cash out of my individual stock account and put it into LendingClub for the liquidity. I want to generate at least $800 of interest income per month in case I am not receiving a salary for 6-9 months.

Other ideas:

  1. Invest directly in small businesses via Funding Circle
  2. Join a Venture Capital investing syndicate through Angelist
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Author: secondhandstocks

The genesis for this blog stems from a Marine buddy and I came back from Afghanistan with more money than knowledge, and heedlessly tossed our hats into the stock market ring. A few months later, I remember discovering the classic book The Intelligent Investor by Graham and Dodd, and ravenously devouring my first introduction to value investing. That framework - with some generous additions by Seth Klarman, and Joel Greenblatt among others - guides my investment philosophy. I spent five years working in the intelligence field, both in the Marine Corps and then for a government agency after that. I speak Arabic and Pashto, have programming and analysis experience, and enjoy investing in technology companies as a hobby. I also spent a year on Wall Street working on a #1 Ranked Institutional Investor team, before deciding that that the Sell-Side was not for me.

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