I figured out how to invest my money
I spent the last week or so doing this. I learned a lot – my views changed significantly several times, and I realized I disagreed with a lot of what my friends and family were doing. I’m writing about my experience because
- I hope it will be useful to you.
- If I’m doing something wildly wrong, hopefully you will tell me.
I’m not going to describe my finances in great detail both to preserve my own privacy and because my friends’ financial situations vary enormously, so I’m not sure how useful it would be anyway. But, to give necessary context, I have some money saved – not a huge amount, since I’ve spent nearly all of my 20s in grad school, but enough to invest.
I decided that getting my financial plans right was worth spending some time on because making bad decisions is very expensive. Even a 1% difference in returns matters when it affects all your money, even more so when you consider compound interest. My pride was also pricked by the fact that, historically, women haven’t had much knowledge of or control over money. I’ve at times been helpless about money too (for example, when I worked at a small company, I never had any idea how much my stock options were worth – still don’t) and I had a sudden urge not to be. Besides, I’ve always liked learning things which are supposed to be just for men.
So, this week, I bought and finished two classic books on personal finance: Get a Financial Life: Personal Finance in Your Twenties and Thirties, and A Random Walk Down Wall Street. Both these books were originally published more than 20 years ago (A Random Walk Down Wall Street is 45 years old) and were so popular that they’ve gone through many subsequent editions. The editions I read were both published after 2017 and are applicable to present day. I highly recommend both these books. They are much cheaper than a financial advisor, they are highly readable, and reading them may save you a lot of money.
Get a Financial Life: Personal Finance in Your Twenties and Thirties is more pragmatic and targeted at young readers in a wide range of financial situations. It has many useful tips regardless of your levels of savings and debt. A Random Walk Down Wall Street is most useful if you have savings and want to know how to invest them. It does not discuss things like student loans, credit card debt, or how to boost your credit score. It is both an academic book and a practical advice manual. Most of the book is an entertaining historical and theoretical overview of how markets work and all the (often tragic) ways people have tried to get rich by investing. The last part of the book is most useful if you just want practical advice on what to do with your money. Somewhat depressingly, the book is also filled with unnecessary sexual content (the last two paragraphs in my edition are an extended rumination on how “investing is a bit like lovemaking” – perhaps not the most essential idea to close on?) but in general it was excellent.
Reading these books was useful because I learned that my friends, family, and I were doing many things wrong. Here are some specific misconceptions these books corrected. I list them mainly to make the point that reading these books taught me things; I’m sure if you read them, you would learn other things more relevant to your life. When reading everything that follows, please keep in mind that I started learning about this roughly a week ago; take everything with a grain of salt. Please let me know if there are errors and I’ll correct them.
|If you have a credit card, you should spend a large fraction of your credit limit each month to demonstrate you can pay it back reliably.||Spending a very low fraction of your credit limit is best for your credit score.|
|Buying a house is only good for stability and because it makes you feel good; it’s not a good way to invest your money.||Real estate can yield good returns and also diversifies your investments. There are ways to invest in real estate which don’t involve buying a house.|
|Allow experts to charge you substantial fees to manage your money because they can generate higher returns.||There’s no compelling evidence for this. You should invest in low-fee index funds .|
|“Invest in index funds” means you can just buy one index fund: the Vanguard 500.||Nope, you want diversification and it’s more complicated than that.|
|If you get paid in stock from your company, hang on to it after you are allowed to sell it because you like the company.||Holding onto stock in your company longer than you have to is risky because it’s a) correlated with your income and b) stock in a single company .|
|Roth IRAs? Traditional IRAs? Who really knows what’s better.||Roth IRAs are probably better than traditional IRAs if you’re young for multiple reasons.|
|If you aren’t paying off a large loan, the only way to boost your credit score is through a credit card.||If you’re renting a house or apartment, you can ask the owner to submit your payment record to the credit agencies.|
|Buy phone and laptop insurance or extended warranties.||Probably not worth it.|
Prior to reading these books, I thought that investing was simple because you couldn’t beat the market and I should just put all my extra savings in the Vanguard 500 (and maybe buy some bonds). After reading the books, I concluded that investing was more complicated in at least two ways than I had realized. First, the problem of diversification is complex: how do you choose assets which aren’t strongly correlated so you minimize the risk associated with a given return? Second, there are many important details which require time and expertise – like minimizing tax burden or periodically re-adjusting your asset balance – which I’m not interested in thinking about.
After reading all this, I am dividing up my money as follows. If you think this is totally stupid, drop me a line and maybe you’ll save me some money :)
- Cash reserves: enough money for day-to-day expenses (eg, rent) in a checking account, and the remaining cash in Ally Bank, a high-yield savings account. In total I have about 6 months living expenses in cash, plus some extra because I’m considering buying a used car.
- Stocks/bonds: I am putting my money in the robo-advisor Betterment. Basically, it’s a website that asks you some questions about yourself and automatically invests your money for you in diverse low fee funds. There are some things I dislike about robo-advisors (they charge a small management fee; there’s the possibility of conflicts of interest; getting my money out might be a pain) but on balance I was persuaded that the fees are lower and that computers are plausibly very good at the finicky details of investing. IMPORTANT ADDENDUM: I ended up putting some of my stock market money in Betterment, but I also kept a lot in traditional Vanguard funds – 90% in stocks, 10% in bonds, and mixed between US and non-US diversified funds. My reason for not putting everything in Betterment is, basically, that it’s a relatively small and untested company and I don’t want to put all my eggs in that basket.
- Retirement account: I am converting my Traditional IRA to a Roth IRA and investing the money in a Vanguard retirement fund with a target date.
I am now much more confident I have a reasonable idea what to do with my money. I am still not at all confident I have any real understanding of why stocks go up and down or, for that matter, that anyone else does either. There are a couple things that make me skeptical of investment strategies:
- People have looked at many investment strategies and there’s not that much historical data, making me nervous that they’re seeing patterns in noise (overfitting, for the statistically inclined). There are a lot of sentences in A Random Walk Down Wall Street like “strategy X has historically yielded higher returns for a given risk level”, but surely people have examined a huge number of strategies. The author, of course, is aware of this problem, but it still makes me deeply skeptical of any claim that a complex strategy has historically performed well.
- Lots of people who give you advice have conflicts of interest. Some of these are obvious – for example, when an advisor gets paid only when they make trades on your behalf. But even the author of A Random Walk Down Wall Street is himself the CIO of a major robo-advisor called Wealthfront, and in his book he advocates for higher-fee investment strategies which they use. To take another example, when you pay a person/robot to give you advice, they arguably have an incentive to make investing sound more complicated than it is so you’ll be intimidated and keep paying them.
- If everyone pursues an investment strategy, that in itself changes the market, making it unclear how well the strategy will perform in future. (And, of course, many other things can change future market dynamics as well.)
After learning all this, I’ve decided I’m going to drop out of the PhD program to do deep learning for Goldman Sachs, which is probably the most beneficial financial decision I could make anyway. Just kidding, I’m going to keep writing abstruse papers on discrimination and menstruation, because that’s how you really make the big bucks.
Thanks to Nat Roth, Shengwu Li, Miriam Pierson, and Pratiksha Thaker. I kept waking Nat up this week by saying things like, “I don’t understand bonds. Can you explain bonds to me?” I more or less texted poor Shengwu the entirety of A Random Walk Down Wall Street, surely making him regret recommending the book to me in the first place.