From Broke to Rich and Everything In Between | Asset Allocation (Pt. 4)
“It is remarkable how much long-term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.” - Charlie Munger
Over the past several weeks of my blog posts, I’ve been boring readers like you with the most important investing advice you’ll ever ignore.
I introduced the strategy I’m talking about, Asset Allocation, which basically gives you a set of guidelines when it comes to what different assets you should invest in, and how much you should invest in each asset.
I also talked about how and why traditional Asset Allocation strategies just don’t work across all times or for all people.
I’ve touched on how to “crossfade” between assets, and when and why to take more risks.
(Spoiler: We’re in a “take fewer risks” period.)
Then we landed here, where I introduced a term called Affluence Value, how that’s a better measure of your wealth than your Net Worth, and how you can use it to determine what you Asset Allocation strategy should look like.
(Your AFFLUENCE VALUE = Your INVESTABLE INCOME + Your LIQUID ASSETS.)
I told you what you should do in “Stage 1” of your wealth building, when your Affluence Value is Less Than $5,000:
Find Ways to Increase Your Income
Look for Ways to Decrease Expenses (But Don’t Worry About this Too Much)
Start Putting Money Toward a Cash “Start Over Again” Fund
Let’s jump right into the following the second and third stages:
Stage 2: Your Affluence Value is Between $5,000 and $25,000.
Stage 3: Your Affluence Value is Between $25,000 and $100,000.
Stage 4: Your Affluence Value is Between $100,000 and Your Magic Number.
Stage 5: You’ve hit Your Magic Number and you want more.
Stage 2: Your Affluence Value is Between $5,000 and $25,000
At this point, you should be feeling pretty good and substantially more secure…
You’ve done the work to increase your income, you’ve at least looked at your spending habits, you’ve put aside at least 3 to 6 months’ worth of living expenses for you and your family, and you might have begun to contribute a little bit of your investable income toward a retirement fund or investment account.
If you’ve checked all those boxes, you’re doing great, but you’re still nowhere near “rich” and certainly not close to being able to retire comfortably.
So what do you need at this point?
1) Still More Income
You can’t, for example, open a restaurant or create a new line of pharmaceuticals with $25,000. But you probably don’t want to do that anyway. (The margins and risk-to-reward ratios are awful.)
But you can certainly create a second stream of income that can get bigger every year.
The cliche I’m not going to use here is “Invest in Yourself,” because that would be dumb.
That said, someone with $25,000 or less should start accumulating at least $5,000 for a project like this or learning a skill that can help you pull in extra money. If you’re in this camp, choose something you can start for less than a grand in case it doesn’t work out.
Basically, you’re looking for a 5 to 9 you can work in addition to a 9 to 5.
But this 5 to 9… you’ll find it substantially more fulfilling and lucrative if it’s something you control and own.
I can tell you this. The first years are always a struggle, because you have to work against your impulse to engage in leisure and do the hard work of learning the fundamentals of operating and managing your own side business.
But once you figure it out, things get much easier. And it’s even possible to grow your second income stream into a full side business (more on that later).
The main thing here is to get that extra income going. And when you do, put 50–60% of that money into your investment account (with the rest likely going to taxes and operating expenses).
Doing this, you could easily increase your INVESTABLE INCOME by $10,000 per year. Maybe by much more.
Between this $5,000 side business/hobby job fund and your Start Over Again fund, you should have both the “shield” and “sword” necessary for you to confidently increase your wealth.
But what do you do with the wealth you begin accumulating now that your INVESTABLE INCOME has increased?
2) Invest in Safe, Compounding Assets
When you’re just starting out in your wealth building journey, one of the common misconceptions is that you should be taking more risks and being super aggressive in your investments, because you want to do more with less.
This fallacy draws people to crypto, daytrading, penny stocks, options trading, get rich quick schemes, methamphetamine…
But for 94% of people, all of this stuff will make you poorer in the long run.
Or not as rich as you could otherwise be.
If you’ve been cursed with a modicum of intelligence, you might be enticed into thinking you’re in the 6% of people who actually beat the average annual returns of the overall market.
But don’t flatter yourself. Y’ain’t in Mensa. You’re somewhere slightly above average. Maybe.
So sit down and be humble, if you actually want to accumulate wealth.
Stop trying to outsmart the markets and instead safeguard against your own ignorance and arrogance by preserving the wealth you’ve worked hard for.
You can do that by making safety and certainty your main concern at this point.
Try to channel your inner Will Rogers: It’s not the return on your investment you should be concerned about. It’s the return of your investment.
What might that entail?
Firstly, that can be making regular contributions to a dividend-paying ETF of your choice, like I suggested when I launched the Finance Daddy $10 Daily Challenge. (Look at the stocks I recommend here.)
Secondly, it can also mean increasing or maxing out your IRA or 401(k) contributions and investing that money into a low-cost index fund at regular intervals.
Thirdly, for the next few years, if you want to avoid major indexes, I recommend a stock investing strategy based on the investing philosophy of Warren Buffett: Buy a stock that looks decent relative to its value, don’t sell unless the business has dramatically changed for the worse, and reinvest dividends.
This is the kind of thing I do in the Finance Daddy Dollar Trader: Look for undervalued-seeming stocks that hit all the criteria that have been historically associated with long-term growth.
It’s better to buy stocks this way because you limit the number of decisions you need to make to one: Buying.
If you’re trading or hoping to gain money from tech stocks that “go to the moon,” you also need to worry about exit strategies, position sizing, cost of carry, opportunity cost, and more.
Another good reason for investing this way: You can use the assets you accumulate in your IRA, 401(k), or Brokerage account as leverage.
It is relatively easy to use these assets as collateral to “loan” yourself money to fund your purchase of other assets down the line, such as a house or business. (I talk about that more here.)
You can’t count on that if the crappy tech stocks in your portfolio are bouncing all over the place.
For now, those three things are all I recommend when it comes to assets that will help you achieve a compounding effect…
Fixed income instruments don’t provide a return that beats inflation. I don’t recommend treasuries or municipal bonds these days because the yields are too small.
Over the next few years, that could change. For the time being, it’s easiest to build up a solid base of LIQUID ASSETS that also pay you income in the stock market.
Stage 3: Your Affluence Value is Between $25,000 and $100,000
Stage 3 of your wealth-building career is basically the same as above — but now you can start looking at alternative, riskier, and bigger assets.
This is also the point where you can start looking to buy a house, if you don’t have one (and that’s something that interests you).
But keep in mind: to support bigger and riskier assets, you need a bigger, broader, and more solid foundation.
The more you accumulate, and the riskier your investments, the greater the risk to you and your family that you end up losing everything.
So here’s where your priorities should be at this stage:
1) Make Sure Your Start Over Again Fund Keeps Pace with Expenses
At this point, if you’re hustling in a side business, if you’re buying a house (or looking to upgrade), and in general if you’re indulging yourself more because you’re more financially secure…
Now’s the point where you need to reassess your emergency savings.
Look to see if the cash you’ve hidden under your mattress (or in a savings account) is still enough to cover 3 to 6 months of your current expenses.
It’s really easy, as you get richer, to spend yourself poor.
For that reason, reassessing your Start Over Again Fund is also a good opportunity to figure out what, exactly, your monthly expenses even ARE and what you could cut back on.
(For example: Did you REALLY need to order Uber Eats that many times last month? Doubtful.)
But again, don’t be too nutty about pinching pennies. It’s still easier at this point to make more income than to cut costs.
That said, this stage is also the point where part of your Start Over Again Fund should also be something like “Chaos Insurance.”
If your Start Over Again Fund is a lump of cash that protects you from disasters (such as the loss of a job or income stream, or even a true natural disaster) for a few months…
Your Chaos Insurance is your true hedge against complete calamity and bedlam.
You might not be the type of person to worry about societal collapse. In which case: Just keep your Start Over Again Fund in cash and leave it there.
But if you believe there’s a 3% chance that there’s a civil war, or EMP attack against the U.S. that disables bank accounts, or some other enormous calamity that renders cash worthless…
Then it’s just smart to have 3% of your wealth in hard assets that help you sleep well at night.
I call this “Chaos Insurance” because it’s not an investment: Insurance is something you pay for to protect you against the unexpected.
For that reason, don’t bank on these assets appreciating in value and focus on assets that are tangible, portable, and private.
Precious metals hit every item in the checklist.
I’m not a gold nut, but I have a few gold and silver coins hidden away in case I ever need them.
Hopefully, I never do need them and I can simply pass them down to my children.
However, I do think there are other kinds of precious metals worthy of being called “Chaos Insurance” at this stage:
Brass and lead.
Consider buying a gun or non-lethal weapon for home and personal protection. Then spend the money and time learning how to use it well.
That’s the ultimate insurance you can get against true calamity.
2) If you Don’t Have a House, You May Consider Buying a House
I almost considered not including this, but owning a home CAN be a good investment…
I say that with a million caveats, since the U.S. has been in a growing housing bubble for something like 16 years.
Case in point: Say you have about $80,000 in your cash savings and 401(k) that you can draw out as a loan to yourself.
That would allow you to purchase a home for less than $400,000, if you can get a mortgage to cover 80% of the cost.
That prices you out of most of the major cities in the United States.
There’s also a calculus to determine whether it’s more cost effective to rent or buy a home.
That means…
Unless you buy cheap in an up-and-coming area…
Unless you plan on not moving for more years than you might think…
Unless you get a low mortgage rate…
Unless you can avoid the high costs of maintenance or improvement for your home…
Buying a house to live in is probably going to end up being a bad investment.
It will eat away at your LIQUID ASSETS and, potentially, your INVESTABLE INCOME too.
You can certainly offset some of the costs and add to your INVESTABLE INCOME by purchasing with friends or renting one of your rooms on Airbnb…
But I would guess only a fraction of a fraction of the population is eager to do that.
There is only really big advantage of buying a home that then goes on to appreciate in value: You can refinance it to “unlock” some of the equity you have, which you can use to invest in other assets or improve the value of the home.
But that’s often a Faustian bargain that comes with a whole other host of drawbacks and variables (which is why you shouldn’t include it when you tally your LIQUID ASSETS).
All that said, I know that home ownership is one of those “cultural things” that many Americans obsess over…
So if you’re determined to do it, do your damnedest to buy smart and have a long-term plan.
For example: Both my business partner and I bought properties to live in now... with the intent of turning them into rentals in the future.
Once we do, our rentals will subsidize whatever we decide to buy next.
3) Investigate and Put Money Toward Other Speculative Investment Strategies
It’s only once you surpass the $25,000 mark that I think should start playing around with your money and taking on more risk.
Reason being: If you have $25,000 in INVESTABLE INCOME and LIQUID ASSETS combined, you’ve basically bought yourself a year, more or less, if disaster strikes.
That’s a solid foundation that should help you feel comfortable venturing into more speculative and riskier spaces.
(What is a speculation? Any asset you purchase where you estimate its value will go up in the future so that you can sell it at a higher price.)
Ideally, you’re not devoting SO MUCH of your wealth at this point that your speculations will really move the needle…
So what you’re truly investing in, here, is a kind of fun education.
Education in alternative ways you can make money, and more importantly: Education in what you DON’T want to be doing.
That’s important, because any risky strategy is going to cost more than mere money.
You’ll now be on the hook for maintenance as well as the time and attention and energy needed to monitor and manage your investments…
That’s all part of the “cost” of investing.
If you’re poor and you’ve lost money trading (or realized it was way more work than you expected), then you know exactly what I’m talking about.
Here are some assets you should consider speculating in only at this point in time:
Stock trading (such as daytrading, penny stocks, or any stock investing strategy where you plan to hold a stock for less than 12 months, etc.)
Options trading
Cryptocurrencies
P2P Lending
Tax Liens
Alternative investment platforms like Masterworks or Fundrise
And so on.
(I’ll have other reports on how to invest in all of those strategies in the future.)
By far, the most lucrative strategies for me were the small amount of money I invested in crypto (I never put more than 3% of my AFFLUENCE VALUE and it quickly appreciated above that) and options.
Both of which I quit doing years ago after realizing I was making far more money devoting my time to something else.
Regardless, once you start investing this way, I highly suggest putting in no more than you can afford to lose.
With a lot of these assets, the risk rises from 20% or 40% losses at the most (based on history) to 100% losses.
Again, we’re trying to make money, here. Not invite the possibility of losing all of it.
Do all of the above and you’ll solidly situate yourself in the “middle class.”
