Host Jon Luskin, CFP® and the do-it-yourself investor community ask questions to financial experts – live.
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JL Collins is the author of The Simple Path to Wealth and creator of an online content provider, known for his Stock Series, a series of blog posts that makes complex investment concepts accessible to the beginner investor. JL advocates for an impressively simple approach to investing that relies entirely on exactly two index funds – Vanguard’s Total Stock Market Index Fund (VTSAX) and Vanguard Total Bond Market Index Fund (VBTLX) – to achieve total market diversification. JL talks about his investment approach and a range of other topics including market volatility, fixed income investing, tax-advantaged accounts and early withdrawals, Black Monday and humble pie, why average investment returns are anything but, inflation and deflation, investing versus speculating, cryptocurrency, and how to talk to someone about making the switch to an index fund investment strategy.
JL believes that Vanguard’s Total Stock Market Index Fund (VTSAX), or a similar total stock market index fund from another provider, is the only equity exposure a US investor needs. While there is certainly money to be made in international businesses, JL argues that US investors don’t need to hold an international fund because VTSAX is cap-weighted; the largest companies – which are international companies – account for most of the money invested. Essentially, we get international exposure by investing in US-based companies that do business internationally. JL concedes that this will not always be the case. While the US has dominated the global economy since the end of World War II, the rest of the world has been slowly catching up (and we’re all the better for it). Eventually, US investors will have to seek international exposure to ensure sufficient diversification. For non-US investors, where VTSAX is not available due to financial regulations, JL says a global fund is still needed. That would be the overseas equivalent of the Vanguard Total World Stock Index Fund (VTWAX).
For more conservative investors, as well as those on (or soon to be on) a fixed income, Vanguard’s Total Bond Market Index Fund (VBTLX) is the second and only other fund that needs to be considered, argues JL. First, a total bond fund has more diversification, holding thousands of bonds of all kinds of maturities. With bonds consistently hitting maturity, there is always capital to invest in new bonds, allowing investors to earn higher yields when investing in a rising interest rate environment. Second, a total bond fund allows an investor to take advantage of corporate bonds and their slightly higher return, by bearing credit risk.
JL and I then discussed tax-advantaged accounts, and how to prioritize which account to fund first. When there’s an employer match for your 401(k), the decision is usually quite simple: invest in your 401(k) to take the free money. Aside from that, the decision depends on some predictions or assumptions about the future. (A health saving account (HSA) can be an exception.) The best approach will vary depending on where you are in your career and at what phase of wealth accumulation you’re in. The rule of thumb approach: if you’re young or plan to earn more in the future, your tax bracket in retirement may be higher, in which case you should prioritize contributions to Roth accounts. By contrast, prioritize traditional contributions if you’re in your peak earning years. That way, distributions are taxed when you’re in a lower tax bracket. Some speculate that tax rates will be higher in the future. By that logic, it is always better to favor making Roth contributions.
In our discussion, JL fielded a couple of questions from listeners onboard with his investment strategy, but were looking for advice on how to discuss that strategy with the uninitiated, or even those skeptical of the stock market in general. The most important message is that there will be ups and downs, and they need to be okay with a temporary drop in their portfolio’s value of 20, 30, or even 50%. The market will eventually come back up. But, if you’re not willing or able to ride that out without panic-selling, then JL’s strategy is not a great fit. This is a hard concept to accept, and not everyone is ready for it. JL even struggled with it early in his investment career following Black Monday, when the Dow Jones dropped 22.6% in a single day: October 19, 1987. He held out a couple of months, but eventually cashed out in December of that year, fairly near the bottom. Everyone makes mistakes.
Another issue with indexing for many new investors is understanding that ‘average’ returns are only average in how they rank relative to the market’s overall return. In any given year, active managers fail to beat the market ~80% of the time. And the longer the timeline, the higher that figure climbs. So when looking at an investment strategy that tracks the S&P 500 and consistently matches its return, not only is it above average in any given year, but after several consecutive years – or even decades – the end result is truly exceptional and anything but average.
Switching to a simple, index fund-based investment strategy can often mean ending a friendship with your investment advisor. Many investment advisors’ primary skill is developing and nurturing that relationship, rather than maximizing your financial situation, says JL. Making that switch is not easy, and investors often accept high fees and underperformance to maintain that relationship. Helping investors understand exactly what that relationship is costing them is an important step that often requires repeating.
Regarding cryptocurrencies, there are two points to consider. The first is their utility as an investment, which JL points out is more akin to gold because its value is based on speculation rather than being a money-generating asset. With gold and crypto, you are buying it, hoping that somebody will pay you more for it in the future. Currencies and commodities have a real return of zero – before costs. Stocks, on the other hand, represent companies that make products, provide services, etc. They increase in value due to the revenue those companies generate, not just how their value is perceived. The second point is that cryptocurrency is a currency, and it is far too volatile to serve that role in any practical way presently. That volatility is akin to hyperinflation or deflation. When inflation rises dramatically, and people know it will be worth less tomorrow, purchasers can’t wait to spend it, and sellers are loathed to accept it, which drives up inflation even more.
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