Some ideas that I use for investing. Part 1.

Introduction

A simple way to invest is to split my money 50-50 between stocks and bonds – that is what I do with my 401k (retirement plan). For my other savings, I loosely stick to this 50-50 split, but I do pick specific stocks and I do that following certain rules.

Overall, there are two goals to how I am investing. My main goal is to avoid losing money. This is the majority of my strategy. My secondary goal is to invest in things that, in the long term, I think will do well. I use certain rules to identify what I think will be safe and will do well.

In short here is why I think it is very important not to lose money:

When things are going well with the economy, it is nice if my investments are doing well. However, I am more likely to have a job and so are my family. So getting a good return on my investments is nice but not essential.

When things are going badly with the economy, it is pretty annoying to lose money. On top of losing money, I have a bigger chance of losing my job and I need the money more than when the economy is going well.

In short, it is often better for me to avoid losing money when things are going badly then to make a lot of money when things are going well. Furthermore, if the economy is doing badly then many things gets cheaper to buy (e.g. houses, stocks), so if I haven’t lost too much money, I am in a good position to buy things.

The Ben Graham 50-50.

Ben Graham wrote a book called The Intelligent Investor. One of the investing strategies discussed is to invest 50% of money in stocks and 50% in bonds. Here is why I think this is a reasonable thing for me to do:

  1. Why not put more in stocks? Many people recommend putting much more in stocks. For example, Warren Buffett has suggested putting 90% in stocks (the S&P500 and 10% in bonds (although he doesn’t do that with his company’s money). I think that is a bad idea. With 90% of my money in stocks, the stock market could very well fall right before I need the money (say, for a mortgage down-payment or for a wedding or for retirement). Is it really worth rolling that dice to get some upside?
  2. Why not put more in bonds – wouldn’t that be safer? Keeping money all in bonds (or cash) also has risks, such as inflation or an increase in interest rates. If I had all of my money in bonds (especially of mixed or long durations) right now when the interest rates are near zero, the value of those bonds would plummet if interest rates rise to even 3 or 4%, never mind 10 or 15%. I’m not saying that will happen, it’s just a risk I don’t want to take.

When I look through the last 150 years, pure stock and pure bond portfolios have each had large falls. With a 50-50 portfolio, there are significant dips, but not nearly as bad. The other nice thing about holding a constant split of 50-50 is that when stocks down up relative to bonds, I’m buying more stocks. If bonds go down relative to stocks, I’m buying more bonds. By definition, I’m buying low and selling high.

Technical note: For stocks, a simple approach I use is to buy an index fund like SPY. For bonds, a simple approach I use is to buy a broad based bond index fund (that has bonds of different durations/lifetimes). This means I don’t have to think about what specific stock or bond to buy (and risk being wrong).

Avoiding risks I may not be able to avoid with just stocks and bonds.

There are things that can happen that are bad for both stocks and bonds. For example, very strong inflation of the US dollar might be bad for US stocks and US bonds. These are the kinds of things that are quite unlikely to happen, but if they do happen they are possibly very very bad for stocks and bonds. Gold, since it is limited in supply, tends not to devalue when there is inflation, so I have a small amount of gold (via an index fund) – roughly 5% of assets. The reason for just holding a small amount is that the risk of needing the gold is low, but it’s good to have a bit.

Side note: I also have about 5% bitcoin. This is maybe crazy. However, I see some analogy to gold in that the supply of bitcoin is limited and it takes work/money to increase that supply.

Other side note: I have considered investing in a real estate (REIT) index fund. I don’t consider that I understand them much and I don’t have any at the moment.

Loose 50-50

With non-retirement savings, I am a bit loose on the 50-50 rule. When I feel that equities are expensive I move towards holding more cash or bonds. When I feel equities are cheaper, I move more towards equities. This is subjective and I need a few more decades of experience. Interested readers may wish to Google the “Buffett Indicator” and also “Tobin’s Q” to read about some other indicators of whether stocks are expensive. One indicator that I look at is how much profit US corporations are making relative to their value. For example, in 2019, US non-financial corporate business made about $1 trillion dollars of profits after tax. At the end of 2019, those corporations were valued at about $34 trillion dollars. That return is about 3% when I look at profits divided by value. I don’t like 3% per year. I didn’t think that was a lot of compensation considering that the stock market can fall by a lot more than 3% (especially back in mid 2019 when I could get ~2% return on short term bonds).

As a side note, the market has fallen now since the onset of COVID-19. That has reduced the market value somewhat, but corporate profits are going to fall as well. Discussion question: Is the stock market really much better value right now than at the end of 2019?

Summary:

Simple Ben is 50% stocks, 50% bonds.

A little more complicated is adding in a little gold, (or bitcoin because I’m a little crazy).

A little more complicated again is increasing stocks versus bonds when I feel stocks are cheap and reducing stocks when I feel they are expensive.

THE END OF PART 1.