A Software Engineer's Path to Financial Independence and Early Retirement (FIRE)

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8 Critical Decisions for a Successful Investing Strategy

8 Decisions for a Successful Investing Strategy

Disclosure: This post might contain affiliate links. If you click through and make a purchase, I’ll earn a commission, at no additional cost to you. Read my full disclosure here.

After maximizing income and minimizing expenses, the next step in getting to FIRE is to invest wisely. The goal of this post is to teach you how to wisely make the 8 critical decisions for a successful investing strategy. This is a proven way to optimize your investments and minimize risk. Investing is different than gambling, so this post will not show a way to make money fast. However, I will talk about how to increase your money in a way that minimizes risk, fees, taxes and maximizes returns.

Each investor (beginner or advanced) needs to have answers for the following questions:

  1. Investment order: How do I prioritize, which account to contribute my money to (e.g. 401k, pay credit cards, taxable accounts, etc)?
  2. Asset selection: Should I buy stocks, bonds, mutual funds, index funds, cryptocurrency, derivatives, etc?
  3. Asset allocation: What % of my funds should I put in each asset category?
  4. Asset rebalancing: What do I do when my current asset allocation is different than my target one due to stock/bond market fluctuations?
  5. Fund selection: What are the specific funds that I should purchase?
  6. Asset location: How to split my money between each investment account?
  7. Market timing: The current market is at an all-time high/low. Should I invest all my money at once? What if the stock market decreases and I lose my money?
  8. Withdrawal order at retirement: From which account do I withdraw my funds at retirement?

In the following sections I’ll cover each of the above questions.

However, if you just want a quick solution and don’t want to read the full explanation about all the decisions that need to be made, just jump directly to the last section, which talks about My Recommendations.

1. Investment order: How do I prioritize, which account to contribute my money to (e.g. 401k, pay credit cards, taxable accounts, etc)?

Let’s assume that you have $X and you want to invest them. You are not sure exactly what type of account you should add them to. The following list shows my recommended investment order. Max out each investment bucket before going to the next one.

This is my recommendation for the investment order:

  1. Emergency fund: Keep $1k-$3k in a high-yield savings account for emergencies
    • Explanation: Keep a small amount of money in a high-yield savings account (current APR between $1.6% and 2%) or a money market account
    • Benefit: The goal of this money is to cover any short-term emergencies, so the total amount should be around $1,000-$3,000
    • Recommendations: Alliant Credit Union, Ally, Capital One
  2. Employer-sponsored retirement plan (401k, 403b): Get the full employer match
    • Explanation: Most employers will match 50%-100% of the employee’s contributions, up to a specific amount (which could be 4%-6% of the salary or a specific amount, such as $19k)
    • Benefit: Contribute as much money is required to get the full match, as this is a guaranteed 50%-100% return on your investment
    • Pre-tax vs Roth: Some employers offer both a pre-tax 401k/403b option (i.e. you don’t pay taxes when you contribute the money, but you pay taxes when you withdraw it) and a Roth 401k/403b (i.e. you pay taxes when you contribute the money, but you don’t pay taxes when you withdraw it)
    • Recommendation: If you currently are in a high tax bracket, then select the pre-tax option. If you are in a low tax bracket, then select the Roth option. Most high-income engineers should contribute to the pre-tax 401k/403b.
  3. High interest debt (interest rate 7% or more): Pay it all off
    • Benefit: Credit cards have 20%-40% interest rates, so make sure that you pay the full balance every month, in order to avoid interest fees
    • Any other debt with interest rates 6%-7% (which corresponds to the long-term return of the stock market) or higher falls in this category
  4. Health Savings Account (HSA): Max it out
    • 2020 limits: $3,550 for individuals and $7,100 for married couples
    • Benefit: You will never pay any taxes for the money that you contribute to this account, as you have both tax-free contributions and tax-free withdrawals
    • Recommendations: If your employer does not provide an HSA option or if you are not happy with the investment options in your employer’s HSA, then you can open an HSA account at Fidelity or Lively
  5. Employer-sponsored retirement plan (401k, 403b): Max it out
    • 2020 limits: $19,500 (age 49 or less) or $26,000 (age 50 or more). This is the total amount that each person can contribute to their pre-tax/Roth 401k/403b plans during one year.
    • Benefit: Save on taxes (either today or in the future)
    • Pre-tax vs Roth: Use Pre-tax 401k/403b, if you have currently have a high tax bracket, in order to avoid paying taxes to your contributions (you will have to pay taxes when you withdraw the money). Use Roth 401k/403b if you have a low tax bracket in order to avoid paying taxes when you withdraw the money (you will pay taxes in your contributions for this year)
  6. Employer-sponsored After-tax retirement plan (401k, 403b): Max it out and convert to Roth (if allowed by your employer’s plan). This is known as the Mega backdoor Roth conversion
    • 2020 limits: For every employer that you work at, you can contribute $57k (age 49 or younger) or $63.5k (age 50 or older) to their 401k/403b. This is the total amount and includes both the pre-tax/Roth and the after-tax amount, i.e. if you contribute $19k to pre-tax then you can contribute $37k to Roth for that employer (you can still contribute $56k to other employers’ 401k/403b)
    • Benefit: This allows you to convert additional amount to your Roth retirement plans.
  7. IRA (Individual Retirement Account): Max it out
    • 2020 limits: $6,000 (age 49 or younger) or $7,000 (age 50 or older)
    • Benefit: This is very similar benefits to the 401k/403b options, but are not tied to any specific employer.
    • Traditional IRA: If your total income is $124,000 or less (married couple filing jointly) or $75,000 or less (individual), then your contribution to the traditional IRA is tax deductible. Learn more.
    • Roth IRA: If your total income is $196,000 or less (married couple filing jointly) or $124,000 or less (individual), then you can contribute to a Roth IRA. Learn more.
    • Backdoor Roth conversion: If your income is above the Roth IRA limits, then you can contribute to a traditional IRA (without being able to deduct this contribution from your taxes) and then immediately convert to a Roth IRA. This allows you to fully contribute to a Roth IRA regardless of your income
  8. Taxable investing accounts: Open a taxable investing account in Vanguard, Fidelity or Charles Schwab to invest your earnings
    • Benefit: You will not have any tax savings, however you will have full independence to invest your money in any way that you want

Note: You might be able to contribute more than $56k to your 401k/403b accounts each year

One of the misconceptions about the 401k/403b accounts is that most people are not aware of their correct limits. IRS has 2 limits (source):

  1. Pre-tax/Roth contributions: The total amount each person can contribute to all their pre-tax/Roth accounts during the year is $19.5k (in 2020).
    • Example: Let’s assume that you change employers during the year. If you contribute $8k to one employer’s pre-tax plan, you can contribute $11.5k to the other employer’s pre-tax (or Roth) plan.
  2. Total contributions: The total amount that each person can contribute to each employer’s retirement plan is $56k (in 2020)
    1. Example: Let’s assume that you change employers during the year. If you maxed out your contributions to your first employer (i.e. contributed $19.5k in Roth and $37.5k in after-tax), then you can still contribute another $57k in your second employer’s after-tax plan

Additional reading

  1. Bogleheads wiki: Prioritizing Investments

2. Asset selection: Should I buy stocks, bonds, mutual funds, index funds, cryptocurrency, derivatives, etc?

After deciding which account(s) to invest your money in, the next question is what types of assets to buy. There is a lot of hype today about cryptocurrency, IPOs, options, etc. The goal of this section is to help you understand that the more potential return each asset has, the riskier it is. This way you will be able to select assets that provide the highest risk-adjusted return. This is by far the most important investment decision that you will need to make.

High risk, high return assets

In one side of the spectrum, we have very high-risk assets. These are similar to gambling. Let’s say that you go to a casino, sit at the roulette table and bet everything that you have on the number “13”. If you made the correct bet, then you will multiply your winnings by a big factor. However, if you lose the bet, then you lose all your money. This is a high risk, high return strategy.

Some other investment options that fall in this bucket:

  1. Cryptocurrency (bitcoin, ethereum, etc)
  2. Derivatives (options, currency futures, etc)
  3. Single stocks (especially IPOs)

Low risk, low return assets

On the other side of the spectrum we have very low risk assets. These assets are similar to a traditional savings account. If you put your money in those accounts, then you will not lose them and you’ll get a small guaranteed increase (currently around 0-1.7%). However, this increase is lower than inflation (which is currently around 2-3%). Which means that by keeping all your money in a savings account (even a high-yield one), you’re actually losing money

In order to create a solid investment portfolio that can lead you to FIRE successfully, there are 3 types of assets to invest in:

  1. Index funds:
    • Definition: This is a basket of stocks that tracks a specific index (e.g. Standards & Poor’s 500 or Total Stock Market). Owning one stock means that you own a small part of one company. So, by owning an index fund or ETF, you actually own a small part of the whole index (e.g. the whole US stock market)
    • Benefits:
      • Less risk than individual stocks: An individual stock has the potential to increase multiple times, but could also go down to zero. An index fund follows the corresponding index, e.g. the Total Stock Market index funds have the same return as the US stock market, which is around 7% per year
      • Lower fees than mutual funds: The cost of an index fund is less than 0.05% of your assets. This is much lower than the 2-5% cost of a “traditional” mutual fund
    • Recommendation: This should be the core part of your portfolio. It is also the riskiest part, so it will be the driver for the majority of your earnings
  2. Bonds or bond funds:
    • Definition: A bond is a loan to a company or government that pays back a fixed rate of return. By buying a bond, you own a small part of that company’s/government’s debt.
    • Benefits:
      • Less risk that index funds and individual stocks: The only way that you will lose your investment is if the company/government goes bankrupt. Even then, you will have higher chances to get back some of your investment than if you bought a stock.
      • You know exactly how much your return will be: Assuming that the company/government does not go bankrupt and ignoring some other risks, such as currency fluctuations, you always know the return value of a bond. For example, the current return of a US Treasury 10-year Bond is 1.5%, which means that if you buy one today and keep it for 10 years, then your return will be 1.5% per year.
    • Recommendation: A diversified bond fund (i.e. a basket of bonds) should be another big part of your portfolio. For example, you could buy a basket of all the investment-grade US bonds by buying the Total US Bond Market bond fund.
  3. Real estate
    • Definition: This includes owning a house, buying rental properties, buying Real Estate Investment Trusts (REITs), etc.
    • Benefits:
      • Leverage: Real estate allows you to get more leverage than stocks. For example, if you put a 20% downpayment on a $1M house (i.e. you pay $200k) and the value of the house increases by 10% (i.e. goes to $1.1M), then the return on your investment is 50%.
      • Rental income: If you buy rental properties, then you can set your rent to cover your mortgage payment and your real estate taxes. This means that you are using your renter’s money to buy the property (i.e. you are buying properties “for free”)
      • Appreciation: Real estate is appreciating at a high rate (even though it’s lower than the stock market). This means that if you buy a house for $1M today, it might be worth $2M a few years later
      • Taxes and depreciation: When you file your taxes, you can deduct a) the interest that you paid for your mortgage and b) the (theoretical) depreciation of your house. This reduces your taxes
    • Recommendation: It is definitely worth your time to take a look at real estate investing. However, I don’t use it as part of my portfolio, so I don’t have experience in this area. As a result, I prefer not to include it in the discussion below.

Active investing vs Passive investing

You might notice that in the above recommended assets I did not include mutual funds that do active investing. The reason is that these funds have at least 1%-2% in fees, which is 20x higher than the 0.03%-0.05% fees from the index funds (passive investing). There is lots of research showing that the higher the fees of a fund the worse its performance.

Another way to view this is that the stock market is a zero sum game, which means that the market consists of the sum of the cumulative holdings of all investors, so for every position that outperforms the market, there is another position that underperforms the market by the same amount. The aggregate market return is equal to the asset-weighted return of all market participants. However, if we add all the fees from funds (management fees, bid-ask spreads, administrative costs, commissions, market impact and taxes), then the actual return for investors in these funds is lower than the market performance (i.e. their return is equal to “market return – fees”). Since the fees of the active funds are at least 2%, whereas the fees for index funds is 0.03%, by definition this means that on an aggregate level, investors in index funds get a net return that investors in actively managed mutual funds.

But I really want to buy cryptocurrency/options/hot stocks/etc…

My advice is that if you really want to experiment with risky assets, then you should limit these investment to be a total of 5% or less of your portfolio. If these assets really end up having a significant increase (e.g. 10x), then can treat this as a great bonus. If they don’t, then the loss will not impact your portfolio in a significant way.

3. Asset allocation: What % of my funds should I put in each asset category?

The Callan Periodic Table of Investment Returns shows the relative performance of each asset category during the last 20 years:

Callan Periodic Table of Investment Returns. Courtesy of Callan

The easiest way to understand this table is to focus on one specific category, e.g. Large Cap Equity, which includes the large US companies (e.g. Facebook, Apple, Amazon, Netflix, Facebook and Microsoft, which have been performing so well lately). By looking at the table it is obvious that this type of investment was great in 2019, but it under-performed cash in 2018, etc.

The learning from this table is that it is important to diversity your assets and hold as many asset categories as much as possible. This way you minimize your risk of losing money.

In order to decide how to allocate our funds between each asset, we need to determine the following allocations:

  • Allocation between stocks and bonds
  • Allocation between US and international markets

a. Asset allocation between stocks and bonds

At this point we’ve explained that apart from the emergency fund that will consist of a small cash amount in a high-yield savings account, the core part of your portfolio should consist of an index fund (risky asset) and a bond fund (less risky asset). In this section we’ll talk about how much money to allocate in each of the two.

The important part to remember is that the higher your allocation in the stock index fund, the higher your expected return, but also the higher your potential loss. Let’s look at the returns that you’d have in 2008 and in 2013 (i.e. 2 years where the stock market returns were either exceptionally high or exceptionally low) based on 2 allocation examples:

Asset Allocation 2008 return 2013 return
100% stocks -37% +32.4%
50% stocks, 50% bonds -16% +15.1%
100% bonds +5.15% -2.15%

Vanguard also provides a great summary of the average, the best and the worst performance of various asset allocations during the period 1926-2018.

At this point it should be clear that there is no “perfect” asset allocation. It depends on the amount of risk that you are willing to take Here are some guidelines about how to select your own asset allocation:

  1. Answer Vanguard’s Investor Questionnaire to get a high level understanding of your risk tolerance
  2. Calculate how many years you have before you retire. The higher number of years, then higher the stock allocation
    • Before retirement, most people select between 70-100% in stocks and the remaining in bonds
    • After retirement, most people select between 40-60% in stocks and the remaining in bonds

And here are some recommendations:

  1. Warren Buffett recommends a 90% allocation in stocks and 10% in bonds. He wrote in the 2013 annual letter to Berkshire Hathaway investors that upon his passing, the trustee of his wife’s inheritance was instructed to “Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund. (I suggest Vanguard’s.)
  2. John “Jack” Bogle’s (founder of Vanguard) allocations were:
    • Pre-retirement: 80% stocks, 20% bonds
    • Post-retirement: 60% stocks, 40% bonds (which gradually shifted to 50% stocks, 50% bonds)
  3. Jim Collins holds 75% stocks and 25% bonds
  4. Go Curry Cracker holds 100% stocks
  5. I am currently holding 100% stocks

Finally, in the Boglehead forums, user siamond has created a chart showing the performance of each asset allocation strategy from 1926 to 2016 (nominal returns, using US-only assets).

Performance of 10 US-only portfolios (1926-2016). Courtesy of user siamond (Boglehead forums)

At this point you should be able to select the stock/bond allocation that works for you. The exact numbers that you pick will not be perfect, because there is no perfect asset allocation. The important part is to believe in your selected asset allocation and stick to it both in good times and in bad times.

b. Asset allocation between US and international markets

Most investors tend to invest in stocks of their own country. For example, somebody living in Australia would tend to invest 100% on Australian assets (stocks and bonds). And investors living in the US tend to invest 100% on US assets. However, in a global world many believe that it would be better to own a portfolio that owns assets in all countries.

in the Boglehead forums, user siamond has created a chart showing the relative performance of the stock market in multiple countries from 1998 to 2017 (nominal returns, local currencies).

Performance of the stock markets in 10 countries (1998-2017). Courtesy of user siamond (Boglehead forums)

This chart shows that the top performing stock markets are really difficult (some might say impossible) to predict.

User FIREchief (Boglehead forums) gave a great response to above chart:

A person needs to ask themselves which of the following describes their approach:

a) I want to be in everything so that I’m guaranteed to have some in the “winning” bucket each year (it also guarantees a person will have some in the “losing” bucket each year)

b) I want an asset class that is never or rarely at the bottom (which also will likely never or rarely be at the top)

A US Total Market investor should be comfortable with the second statement. A total world investor, the first.

FIREchief (Boglehead forums)

Here are some suggestions regarding how to split your investments between US and international assets.

Stocks (US/International)Bonds (US/International)
Vanguard80% / 20%80% / 20%
Bogleheads70% / 30%100% / 0%
Jim Collins 75% / 25% 100% / 0%
Warren Buffet100% / 0%100% / 0%
Jack Bogle100% / 0% 100% / 0%
Me100% / 0%100% / 0%

In general, be aware that holding international assets is a great way to diversity your portfolio, but has its own downsides. Jim Collins enumerates some of them:

  1. Reduced simplicity: Holding international assets means that you need to own more funds, which makes your portfolio more difficult to manage
  2. Higher risk: currency risk, accounting risk
  3. Higher expenses: International funds have 3x the expense ratios of US funds
  4. Already covered: The large US companies generate 50% of their income from international markets


Let’s say that you have decided to use the following asset allocation:

  1. 80% stocks
    • 70% will be US stocks
    • 30 will be international stocks
  2. 20% bonds
    • 90% will be US bonds
    • 10% will be international bonds

Now you want to calculate how much you want to allocate in each bucket. The calculations are simple:

  1. US stocks: 80% * 70% = 56% of your portfolio
  2. International stocks: 30% * 80% = 24% of your portfolio
  3. US bonds: 90% * 20% = 18% of your portfolio
  4. International bonds: 10% * 20% = 2% of your portfolio

NOTE: If you calculate that one bucket is < 5% of your investments, then you can just avoid investing in that bucket in order to simplify your portfolio, as the impact of that bucket will be trivial to the performance of your portfolio.

4. Asset rebalancing: What do I do when my current asset allocation is different than my target one due to stock/bond market fluctuations?

In the above section we finalized your target asset allocation. However, the stock and bond markets change values every day. This means that one day after you buy these assets, their relative asset allocation will be different than your target one. The difference might be small one day afterwards, but it might be quite different after 1 month or 1 year.

For example, let’s say that your target allocation is 60% US stocks and 40% US bonds. However, 3 months after buying those assets, the US stock market is making continuously new highs, so your current investment is 80% US stocks and 20% US bonds.

So what do you do?

The answer to the above question is that you need to rebalance your assets, i.e. you need to invest more money in the assets that have lower asset allocation than your target one. In our previous example, it would mean that you need to buy more US bonds.

Where can you find the money to buy the assets required for rebalancing?

  1. Sell assets that have higher allocation than your target one
    • Consider the tax implications, if you decide to sell assets from your taxable accounts.
    • It’s typically easier to better to just sell assets from tax-advantaged accounts (401k, IRA, etc)
  2. Use cash (e.g. upcoming paychecks, modify the automatic allocation of future investments, etc)
    • This option might be slightly slower (because you need to gather the extra cash first), but it would definitely be a better option that selling assets from taxable accounts (i.e. option #1)

How often to rebalance?

There are 2 options regarding the frequency of your rebalances:

  1. Rebalance when the delta between your current asset allocation and your target asset allocation is more than a specific %, e.g. 10%
    • In that particular case, if your target allocation for US stocks/bonds is 60/40, then you would rebalance anytime that the allocation becomes 50/50 or 70/30
    • I recommend setting a rebalnce % target between 10-20%, as it is not worth rebalancing if the actual difference is e.g. 5%
  2. Rebalance 1-4 times per year, e.g. once a year, or once every quarter, etc
    • This depends on how busy you are and how often you want to do the actual rebalancing
    • In most cases, even once a year would be enough

5. Fund selection: What are the specific funds that I should purchase?

At this point we’ve finalized that we need to buy index funds or ETFs for 4 asset classes:

  1. US stock market
  2. International stock market
  3. US bond market
  4. International bond market

a. US stock market funds

The US stock market consists of ~4000 stocks that can be split into multiple categories (large/small, value/growth, multiple sectors, etc). The optional way (i.e. minimum fees, minimum taxes, minimum risk) to invest in a basket that holds all the stocks in the stock market. This called the Total Stock Market fund (or TSM fund).

If you don’t have access to a TSM fund (e.g. in a 401k or HSA, which provide limited investing options), then you can instead buy a fund that holds the largest 500 stocks in the stock market, also known as a Standard’s & Poor’s 500 fund (or S&P 500 fund). These 500 stocks are ~80% of the market capitalization of the US stock market (which has 4000 stocks) and the difference in performance between the Total Stock Market fund and the S&P 500 fund is trivial.

There are 2 variations of these funds: a) the index fund and b) the ETF (Exchange-Traded Fund). The differences between the two relatively small:

  1. ETFs trade throughout the day while index funds trade once at market close
  2. ETFs are often cheaper than index funds if bought commission-free
  3. Index funds often have higher minimum investments than ETFs
  4. ETFs are more tax-efficient than mutual funds (exception: Vanguard index funds and ETFs have identical tax efficiency)

In general, you can think of the 4 variations (Total Stock Market fund vs S&P 500 fund, index fund vs ETF) as interchangeable, so pick the variation that works best in your investing account.

In order to buy a fund you need to have an investing account in a brokerage firm. Some of the most popular brokerage firms are: Vanguard, Fidelity, Charles Schwab. Each company has its own version of the above funds, as is shown in the following matrix:

index fund
S&P 500
index fund
S&P 500

IMPORTANT: Any of the above funds is fine. Also, it is possible that you might have different funds in different accounts (e.g. you might use VTSAX in your taxable account with Vanguard, FXAIX in your Fidelity 401k and SWPPX in your Charles Schwab IRA). The important part is for the total allocation in all the above accounts to be equal to your desired allocation for the US stock market.

b. International stock market funds

Similar to the above section, the following matrix shows the Total International Stock Market funds for the 3 major brokerage firms.

Index FundETF
Charles Schwab SWISXSCHF

c. US bond market funds

Similar to the above section, the following matrix shows the Total US Bond Market funds for the 3 major brokerage firms.

Index FundETF
Charles Schwab SWAGXSCHZ

d. International bond market funds

Similar to the above section, the following matrix shows the Total International Bond Market funds for the 3 major brokerage firms.

Index FundETF
Fidelity FBIIX
Charles Schwab

Alternatives: Funds that combine multiple asset classes from Vanguard

If you want to invest in the above asset classes, but prefer to hold a smaller number of funds, then you have the option to buy Vanguard funds that combine 2 asset categories. In this case, you will simplify your portfolio, but you’ll have to accept the % split that has been defined by Vanguard. Vanguard is the only company that provides a wide list of these types of funds.

Index FundETF
Total World (US and international) stockVTWAXVT
Total World (US and international) bondBNDW
Balanced US fund (60% US stock, 40% US bond)VBIAX
All asset classes: LifeStrategy funds<multiple funds>
All asset classes: Target Retirement funds <multiple funds>

6. Asset location: How to split my money between each investment account?

Now that we’ve picked the exact funds to buy, as well as the % of our money that we will invest in each fund, the next step is to determine which account to buy each fund from, e.g. taxable, 401k, etc. Our goal is to minimize the taxes that we need to pay.

There are 3 types of investing accounts that we can open:

  1. Taxable: Personal investing accounts, checkings/savings accounts (for cash)
  2. Tax-deferred: Traditional 401k/403b/IRA
  3. Tax-free: Roth 401k/403b/IRA

The following matrix shows the recommended asset location:

US stocksAnywhere1. US TSM/S&P500 funds are very tax efficient, so it’s ok to have them in taxable accounts
2. If possible, try to put some of them in your tax-free accounts, since they are your highest-growth funds
International stocksTaxableYou can get tax credit for foreign taxes paid from these funds
Bonds (US, international)1. Tax-deferred (if there are good fund choices)
2. Tax-free (otherwise)
1. These are your least efficient funds. Place them first in these accounts.
2. If possible, leave space in tax-free accounts for high-growth funds (i.e. US stocks)
CashHigh-yield savings or CD

Additional reading

  1. Bogleheads wiki: Tax-Efficient Fund Placement

7. Market timing: The current market is at an all-time high/low. Should I invest all my money at once? What if the stock market decreases and I lose my money?

We’ve finished explaining which assets to buy, how much to invest in each asset and where to place it. The last step is to actually implement this strategy and buy the assets. However, the most frequent fear that a new investor has is that the market is “too high” or “too low” and that the investment will lose value shortly afterwards.

Let’s start by looking at the price of S&P 500 from 1925 to today. As we explained above, this index includes the largest 500 stocks in the US stock market,

S&P 500: 1925 to present. Courtesy of http://stockcharts.com

Now let’s look at the Dow Jones Industrial average fro 1900 to present.

Dow Jones Industrial Average: 1900 to present. Courtesy of http://stockcharts.com

The most important thing to observe from the above charts is that the trend in the US stock market for the last 100+ years is to go up. Yes, for small durations it is possible that the value decreases. However, the US stock market always recovers and the price increases. The reason is that the US economy is the largest economy in the world and is quite healthy. So, as long as you trust that the US economy remains healthy, then you should not be afraid of investing in the US stock market. After all, when you buy a US Stock Market fund, you buy shares from all the US companies.

However, if you are really afraid of losing money, then there are 2 tools that you can incorporate to your investment strategy:

  1. Modify your asset allocation to include more bonds
  2. Use Dollar Cost Averaging (DCA) instead of investing the full amount that you have

a. Modify your asset allocation

If you are in the accumulation phase and you have a long time until retirement, then there is no need to worry. You should be aggressive with your allocations (choose a high % of stock) and accumulate as much as possible. After each market recovery, the value of you investments will grow much higher than before.

If you are near your retirement phase or have already retired, then it makes sense to have a large % of your investments in bonds. This way, if the stock market falls, your portfolio will not take a big hit. For example, let’s assume that you pick an allocation that is 50% stocks and 50% bonds. If the stock market falls 50%, then your portfolio will decrease by less than 25% (because the value of your bonds will increase).

b. Dollar Cost Averaging (DCA) vs lump sump investing

Another strategy to overcome the fear of a sudden drop in the market is to gradually invest your money over a longer period instead of investing the full amount that you have saved. For example, you might decide that over the period of 1 year you will do monthly investments equal to 1/12 of your amount. If the stock market crashes after your first few investments, then you can either buy stocks at lower prices or even wait for the recovery.

Vanguard analysed this scenario in US, UK and Australia using multiple asset allocations (stocks/bonds: 100/0, 60/40, 50/50, 0/100) and found that for all the above combinations approximately 66% of the time it is better to invest the lump sum. The following graph from their paper shows the results:

Lump Sum (Immediate investing) vs Dollar Cost Averaging (Systematic investing). Courtesy of Vanguard

However, an astute reader might also point out that this research ignores the cases where the stock market is overvalued. In that case, the possibility of a crash might be higher. Fortunately, the blogger A Wealth of Common Sense has done the corresponding calculations and found that when the market is really high (CAPE > 32x) then the lump sum is better 60% of the time, as is shown in the following table:

Lump sump vs DCA when the stock market is overvalued (CAPE > 32x). Courtesy of A Wealth of Common Sense

So, the end result is that it’s better to invest everything at once instead of doing Dollar Cost Averaging (DCA).

Time in the market beats timing the market.

Additional reading

  1. Jim Collins:  There’s a major market crash coming!!!! and Dr. Lo can’t save you
  2. A Wealth of Common Sense: The Lump Sum vs. Dollar Cost Averaging Decision

8. Withdrawal order at retirement: From which account do I withdraw my funds at retirement?

At some point in your life, you’ll be able to have a large enough nest egg that will allow you to retire. Your funds will be split into multiple types of accounts. The goal of your withdrawals will be to minimize taxes on those withdrawals. That’s why you want to withdraw funds from taxable accounts first, in order to let the funds from the tax-advantaged accounts to grow as much as possible.

The most tax-efficient withdrawal order is:

  1. Taxable accounts
  2. Traditional 401k/403b
  3. Traditional IRA
  4. HSA
  5. 457b
  6. Roth IRA
  7. Roth 401k

My recommendations

In this example, we’ll assume that you have $100k cash and want to invest it.

  1. Asset allocation
    • The simplest asset allocation is to be 100% in US stocks.
      • Simplest portfolio (one fund): You can pick any of the funds in this section. If this matrix seems complicated, then just open an account in Vanguard and buy VTSAX.
      • No need to rebalance
      • Tax efficiency: These funds are very tax efficient, so that can be all your accounts (taxable, tax-free, tax-deferred)
    • If you want to be more conservative, but not sure what to allocation to select, then just answer the Vanguard’s Investor Questionnaire and follow the advice from your answers
  2. All 3 brokerage firms (Vanguard, Fidelity, Charles Schwab) are great, but if you don’t know which one to pick, then select Vanguard
  3. All the money would be invested as a lump sum in VTSAX (or equivalents) in the following accounts:
    • High-yield savings account (cash): $3k
    • 401k: $56k ($19.5k pre-tax + $36.5k mega backdoor Roth)
    • HSA: $3,550
    • IRA: $7,000
    • Taxable: ~$30k

And a last closing thought:

The best time to start investing was 20 years ago. The second best time is now.

About Me

I am an engineer with 15+ years in the tech industry, including roles at Google, Amazon, and Microsoft. I've been a Software Engineer, Product Manager, and Technical Program Manager. I also have an MBA from Kellogg School of Management with Majors in Finance and Marketing.

What drives me? A passion for empowering engineers to achieve Financial Independence and Retire Early (FIRE). I reached FIRE, when I turned 40 years old. Whether it's through personal finance strategies or career insights, I'm here to guide you on this path. Have questions or need advice? Feel free to reach out!

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  1. Wow – great megapost covering A to Z with investing! Regarding the order of investments for taxable accounts, I like to recommend (for homeowners) installing rooftop solar panels. The ROI on our system in our last house was similar to a 60/40 stock/bond portfolio, without the volatility.

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