What's the Best Way to Invest your Money?

If you thought this article was about the next “hot” investing tip, you’re not in the right place. There are plenty of outlets you can visit to learn about the “latest and greatest” investment ideas including portfolio allocation, adding a particular sector or type of investment to your portfolio, or even specific securities.

If you’re reading a reputable outlet, the ideas will be grounded in research and likely have a track record of some level of success in certain past market/ economic conditions. I read investment news all the time and encourage others to read reputable outlets as well. Having said that, it’s important to remember that not every investment idea is “the best way to invest your money”.

Most people begin their investing questions with the word “what”. What type of security? What company? What portfolio allocation? What type of account? What type of advisor/ money manager? What investment platform?

To get to the "what" I believe we must...

Start with Why

WHY do you want to invest in the first place? Why are you choosing to forego use of this money today in favor of using it in the future? It costs you something to give up using your money today so you can use it later. What is the reason you are willing to make this trade off? If you aren’t clear on why saving/ investing is important to you, you are less likely to stick to your plan.

Typical answers to why people want to invest are along the lines of: to use in retirement; to send a child to college; to buy a house; to start a business/ non-profit; etc. All of the answers boil down to a single concept:

You are investing to cover a future need/ desire that your future income alone will not satisfy. Simplifying further: You are investing because you have a financial goal.

Define the goal

Every goal should be: Specific, measurable, achievable, relevant, and time bound (SMART).

For example: You want to retire in 10 years and be able to spend at least $80,000 per year to maintain your current lifestyle.

This is a SMART financial goal. It tells us specifically how much we need and by when. We’ll assume it’s achievable for this example. And I've never spoken to someone who doesn't plan to retire at some point so the goal is most definitely relevant. Money is always measurable and we included the criteria “to maintain your current lifestyle” because numbers are hard to "feel" but you know what it means to maintain your current lifestyle.

Assess your current situation

Next we need to determine what resources you already have/ will have available to support your goal.

Going back to our retirement example - for most Americans retirement funding comes from: 1) Social Security; 2) Retirement savings; 3) Pensions

If you plan to retire from the military or government, you will likely have a pension. You likely have some amount of retirement savings in Thrift Savings Plan (TSP), 401ks, and/ or Individual Retirement Accounts (IRAs), etc. Social Security, as widely reported, is not fully funded. However, you are still likely to receive some portion of your benefit.

For an education goal you may have a 529 account, Post 9/11 GI Bill benefit, or other savings. For most other goals you may have a savings or brokerage account.

Identify and Close the Gap

The difference between what you need and what you have/ will have (pension/ Social Security) is “the gap”. To close the gap, you need to save a certain amount of today’s money to be used for your future goal. For many goals, particularly for retirement, it would be nearly impossible to save enough of your income today to fully fund your retirement needs later.

Let’s pretend your goal is to have $500,000 in 10 years and that you have $100,000 right now. You have a $400,000 gap. To close the gap through only saving, you would have to save $40,000 per year to get to your $500,000 goal. Yikes! Most of us would have a very difficult time saving $40,000 per year for the next 10 years.

Investing can help you grow your money so that you don’t have to save $40,000 per year to get from $100,000 to $500,000 in 10 years. If you can find an investment that averages about 7.8% of growth per year, then you could invest your $100,000 and add $20,000 for the next 10 years to come up with roughly $500,000. Saving $20,000 takes commitment and some sacrifice but it’s certainly more achievable than saving $40,000.

What is the best way to invest your money? Part 1 Answer

What investment averages about 7.8% of growth per year? As it turns out, a diversified portfolio of stocks and bonds can average about 7.8% per year. Depending on the source of information, portfolio composition of stocks to bonds between 40% stock and 60% bonds to 60% stocks and 40% bonds can average between 7-8% per year.

It’s important to note that we rarely see “average” years. We see great years, ok years, and horrible years. Even if you pick a portfolio allocation that historically averages about 7.8% per year, there’s a good chance you’ll see returns of 25%, 15%, 10%, -1%, or -10% (or worse) in any given year. If you stay invested through all of the ups and downs FOR A PERIOD OF YEARS, you’ll likely achieve returns close to the historical average.

If you do not have the discipline to remain invested through horrible years (like 2022 was!), then you will most likely NOT achieve the historical average - the average growth we needed to close our gap. You will end up with a shortfall.

Which brings us to:

Part 2 Answer

If you need to turn $100,000 into $500,000 over a period of 10 years and you can add $20,000 per year then you need an average return of about 7.8%. That’s the “cold, hard fact”. Another “cold, hard fact” is that stocks and bonds fluctuate up AND DOWN. And no one can predict the future. Investing is full of “cold, hard facts”.

In fact, most people think investing is only about facts. That would be true if humans were robots without emotions. But humans are very emotional creatures so investing is only partially fact driven. It’s also emotion and behavior driven. Not everyone can psychologically withstand losing money in a down market even if they rationally know historical averages are on their side.

Therefore, in addition to finding a portfolio that can potentially yield the return you need to meet your goal, you need to understand how much fluctuation (ie - “risk”) is associated with the investment/ portfolio. And, you must be very honest about whether you can remain invested in both good years and bad years.

If you know (or even suspect) that you simply can’t mentally withstand downside risk of more than, say 10%, then you need to rule out any portfolio that exposes you to more than a 10% loss. This may mean you have to accept a lower average annual return which, in turn, could mean you must save more per year to reach your goal.

The Bottomline

The answer to “what’s the best way to invest your money” isn’t as simple as: pick stocks, bonds, REITs, etc; add crypto; you only need passive ETFs; only use investments that have low or no fees; etc. You can always find an advocate for one or more of these types of investments or investment philosophies. And, there’s a ton of good research for why you should pay attention to some of these thoughts. However, I believe:

The best way to invest your money is in a well diversified portfolio that can realistically provide the growth you need to meet your financial goal(s) with as little risk as possible and no more risk than you can withstand.

It’s not a satisfying or direct answer until you do all the work necessary to:

1) Identify why you’re investing;

2) Know how much money you need and by when;

3) Know what resources you have/ will have for your financial goal(s)

4) Identify the gap between what you have and what you need

5) Determine how much you can save from current income sources toward the goal(s)

6) Determine what return you need to close the gap

7) Determine how much risk (fluctuation) you can tolerate

THEN you can go look for the right portfolio of investments that…

…can realistically provide the growth you need to meet your financial goal(s) with as little risk as possible and no more risk than you can withstand.

NOTE: The examples outlined in this article are very simplistic. There are other factors you should consider, like inflation, current market/ economic conditions and others. Therefore the example offered should not be applied to your personal situation.