Any time you talk about money, you risk sounding like a jerk. I’m going to take that risk in this post. I’ll start out by talking about a couple ways I shot myself in the foot financially and what I learned as a result. Your mileage may vary. Before we start, you might want to review this financial advice from Scott Adams.
You are probably a bad stock picker
I moved to Silicon Valley in 2000, near the end of the dot com craze. Back then, an online broker was offering $400 for free if you opened up a stock trading account with a starting balance of $1000. As a grad student, I had a ~$14,000/year fellowship, so that was two weeks worth of salary for free. Thinking that I was investing with “house money,” I signed up.
All the business magazines recommended Cisco as a safe, conservative stock. So I bought shares of Cisco at about $60/share. Can you guess what happened next? The dot com crash happened, and shares of Cisco plummeted to $12/share. Shaken and nervous, I was able to sell at $18/share after a mild bounce.
Despite what all those business magazines said, the first stock I picked to invest lost 80% of its value almost immediately. On one hand, losing several hundred dollars of my own money, in addition to the “free” $400, was an expensive lesson. On the other hand, what a great lesson–I suck at picking stocks!
It turns out, almost everyone sucks at picking stocks. And the very, very few people who can do it well probably won’t take your money. If I could encourage you to read just one short article about picking stocks, read this one about why it’s a fools game. I may add a lot more references here–I’ve read a lot of books about this over the years–but if you’re trying to pick individual stocks then you’ll probably get creamed. Like, “amateur football player against professional NFL football players” creamed.
No one cares about your money as much as you do
On to my next mistake! I was very fortunate to join Google when it was small, so I did well in Google’s IPO. Research says that if you buy nice things, you adapt to those nice things pretty quickly and then you’re not much happier. I tried to avoid that trap by stashing my money somewhere and not thinking much about it. That’s not the mistake, by the way. I still think it’s pretty good advice if you win the lottery to park your money and take some time to get used to the idea.
My mistake was where I parked my money. Google worked out a deal with “full service” broker to give us free accounts. When I talked to this broker, they recommended that I part my money in “commercial paper.” I didn’t really know what commercial paper was, but the broker said it was safe, easy to pull my money out, and it would provide about 4-5% return on my money.
That worked great for a few years until the entire world financial system almost fell apart. In the early days of the financial crisis, I called my full service broker to make sure things were fine. I remember the phrase that the broker used was that “lightning would have to strike” for there to be any problems. It turns out, lightning did strike, and then the broker said that I couldn’t get my money back–the commercial paper market was completely locked up. The money was still all there, they claimed, but I couldn’t withdraw any of it.
In this case, I lucked out. Someone else filed a class action lawsuit against the financial company, and the financial company returned peoples’ money relatively quickly after that. How many stories have you read about a rock star or athlete who trusted their manager and got burned? It’s your job to pay enough attention to your finances that you don’t get burned. Don’t expect your stockbroker, bank, financial advisor, or really anyone handling your money to care about your money as much as you do.
Wall Street is not your friend
Fred Schwed wrote a book called Where Are the Customers’ Yachts. The title comes from a story about how brokers and bankers all seemed to have yachts, but somehow none of their customers did. Schwed wrote that book in 1940. Things on Wall Street aren’t really any better today.
Honestly, I consider this lesson pretty self-evident after the financial crisis. We’ve learned about companies packaging up toxic assets and betting against their customers. We’ve seen multi-billion dollar settlements for fixing foreign exchange rates and LIBOR (a rate that banks charge each for short-term loans). We’ve seen companies trading against consumers’ interest in dark pools with high-frequency trading. We’ve learned that Wall Street traders think of us as muppets, or worse.
Wall Street excels in taking simple financial instruments and making them more complicated. In that complexity, there’s plenty of shadows for financial companies to hide things that take advantage of you. If it sounds too good to be true, look out. If you don’t understand everything going on with your money, you’re increasing your risk.
So far, this has been a downer, so let’s talk about some positive lessons.
Think about working for equity vs. salary
As I mentioned in my post about Kevin Kelly’s talk at XOXO, there are many different kinds of success, and you should pick your own. One common financial aspiration is to make enough money that you can live off the interest and dividends from that money.
If you’re an employee working for salary, it’s going to be hard to reach that level of independence. That’s one reason I worry about franchises, because it tilts the playing field toward more employees and fewer independent businesses. You can try to radically lower your financial burn rate, and some people do, but few Americans have taken that step. Of course, starting a business completely on your own can be stressful and scary too.
One reason I like startups is that they represent a middle way: you can get some equity or ownership in a business that might turn out very well, but you also get a salary. You can pick your startup to match your personal profile of risk: from founder all the way up to companies with hundreds of employees or more. Especially if you’re young, it can be a good idea to try some more adventurous things like a startup.
If you’re investing, prefer index funds
Okay, let’s suppose you do win the lottery or do well at your own business or startup. Now what? Well, you could double down on new businesses like Elon Musk, but my advice would be to set aside enough money that you can live off the interest or dividends.
It turns out that investing in low-cost index funds in a diversified portfolio is a really good idea. In fact, it outperforms the vast majority of “active” investors. Simple is usually better, like many things in life. I’d also recommend investing in a bond index fund. Bonds tend to do well when stocks do poorly, and vice versa, so investing in both will tend to reduce your risk.
If you’re a regular person working for salary, you might want 60% of your money in a stock index fund and 40% of your money in a bond index fund. If you’re young or adventurous, you can tilt toward more stocks. You want to invest so that you can sleep well at night without moving your money around based on what you see or read in the news.
If you’re fortunate enough to win the lottery, you might want an allocation more like 80% bonds and 20% stocks, or 70%/30%. After all, it’s pretty safe to protect your money and live off the dividends/interest.
Don’t get paralyzed over choosing your allocation between stocks and bonds. There’s a great book called The Lazy Person’s Guide to Investing to walk you through some easy ways to structure your investments. Honestly a 50/50 mix of stocks and bonds (the so-called “Couch Potato Portfolio”) will beat many “active” portfolios where you or someone else tries to pick stocks.
For that matter, you can buy a Vanguard LifeStrategy fund that will give most of what you need with a single purchase. Such funds tilt toward stocks when you’re younger and then transition toward bonds as you get older. You can pick whatever retirement target would make you feel most comfortable in terms of risk.
Prefer credit unions over banks
Earlier, I basically said much of Wall Street is like carnival sideshow designed to separate you from your money. So is there anybody on your side? Well, credit unions can be pretty cool. Credit unions are like banks, except instead of trying to turn a profit on you, credit unions are controlled by their members. That means that they can often provide better rates, have better policies, and generally will try to exploit you less often than megabanks will.
Note that not every credit union is perfect. I once belonged to a credit union that started adding a $1 monthly fee that went to a foundation that the credit union ran. The foundation funds a bunch of semi-random things ($3M for a walkway?). I called up and asked how to remove the fee. “You can’t remove that charge, the foundation fee is mandatory,” came back the reply. I closed my account with that credit union and now I don’t pay that fee.
Do your research on any financial institution’s fees, prices, and policies. In the worst case, check out their website–if the website looks clunky or hard to use, consider skipping that organization. If a company supports two-factor authentication, that’s a bonus point in their favor.
Prefer Vanguard over almost anyone else
Instead of a regular stock broker, I highly recommend Vanguard. Go with Vanguard whenever you can.
In the same way that credit unions are controlled by their members and usually better than banks, Vanguard is owned by their clients and provides a much better deal than almost any other financial company. Even better, their incentives are aligned with yours. Vanguard provides well-balanced indexed funds at a very low cost. You can also buy stocks through Vanguard. At some point, I may write more about Vanguard, but I consider them one of the only companies on your side in the financial world. Check them out.
You probably don’t need a “assets under management” financial advisor
There’s another way that some people take advantage of you: some financial advisors charge outsized fees for what they do. Many financial advisors charge a percentage of “assets under management” (AUM). A 1% fee of assets under management might not sound like much, but that 1% can take a serious bite out of your returns. Instead, I recommend making an appointment with a fee-only financial advisor. Or if you put enough money into Vanguard, they may provide access to a financial planner. A good financial planner can help you determine your risk tolerance and other special factors and recommend a good portfolio allocation for you.
Some newer firms like Wealthfront, Betterment, and Personal Capital offer to provide “robo-advisor” services for lower fees than a human financial advisor. But you’re still paying ~0.25% of your assets for things like rebalancing your portfolio when you can do it yourself in 15 minutes a year.
I use such a simple plan that I don’t pay a financial advisor. I just buy low-cost stock index funds (US and rest-of-world) and bond index funds (US and California). Don’t let anyone make you feel like you need to pay a financial advisor. Remember: they don’t care about your money as much as you do, and with a little reading, you can understand the simple strategies that make up almost all of a diversified, low-cost, low-risk portfolio.
Consider municipal bonds
I have some friends who have left California and moved to lower-tax or no-tax states. For the most part, I don’t mind higher California taxes–I rationalize it as a “sunshine” tax for warm, beautiful weather. Plus California provides the atmosphere where things like Silicon Valley can happen.
But there is a simple trick to minimize your taxes: buy municipal bonds for the state where you live. For example, Vanguard offers municipal bond funds for many states, including a bond fund for California. The interest from a California municipal bond fund is tax-free at the federal and state level. If you’re in a high tax bracket, getting interest tax-free is like getting a much better interest rate.
Bonus tip: tax loss harvesting
I’ve described a pretty simple way to park your money that reduces cost and risk. If you’re willing to do more work, you can try tax loss harvesting. Full disclosure: I don’t do this myself because I consider it a hassle and a lot of paperwork, but it’s relatively straightforward.
The idea of tax loss harvesting is that instead of buying an index fund, you buy individual stocks. If your stock broker gives you 100 free trades, you could buy (say) 75 individual stocks. Then, when one stock goes down, you can sell it at a loss and buy a similar but different enough stock that you don’t violate wash sale rules. You can use the losses to reduce your taxes. This technique is legal and it probably will save you money, but I prefer the simplicity of owning 3-4 index funds.
Bonus tip: prefer donor-advised funds to foundations
If you do win the lottery or succeed at a startup, you might want to use your money to support things that you believe in. I’ve explored both private foundations and donor-advised funds and I’d definitely recommend donor-advised funds in most cases.
A private foundation sounds cool, but the reality is that it takes a lot of time, work and paperwork. You have to file separate taxes, which can be a big hassle. You can find organizations to handle the paperwork and taxes for you (we had a good experience with Foundation Source), but then you’re paying someone a chunk of money to do taxes instead of spending that money on things you support. Foundations also have to give away 5% of their assets each year.
With a donor-advised fund, you don’t have to worry about taxes or paperwork. You don’t have to give away 5% of the fund’s assets each year either. In my experience, donor-advised funds tend to have lower fees. You can donate appreciated stock to a donor-advised fund pretty easily and get a tax break that year for donating to charity. A donor-advised fund isn’t quite as flexible as a foundation, but in my experience you almost never used that extra flexibility. Most of the time you’re looking to donate money to nonprofits or charities, and donor-advised funds work well for that. And as you might expect, Vanguard can handle donor-advised funds for you.
I hope some of the mistakes I made and the subsequent lessons are helpful. If you take this post along with Scott Adams’ financial advice, I think you’ll be more prepared than most people. Are there other financial lessons or advice that you would add? Let me know in the comments.