An Investment Rule for Young People
Posted February 13, 2012on:
“Only a fool invest without rules” – Jason Zweig
A client of mine asked me to teach his young son how to save and invest. The following are some rules I wrote down for him.
1. How much to save?
This is just a rule of thumb. If you start investing in your 20s, you need to put aside 10% of your income; if you start in your 30s, 15%; 40s, 20%, 50s, 25%.
The client’s son is a 26-year-old college grad, who is making about $48,000. Based on the rule of thumb, he needs to save $4,800 a year. That averages to $400 a month.
To make saving simple and painless, open a brokerage account, then set up an automatic bank payment of $400 a month to the account.
2. What to invest?
The key is to keep it simple. For folks in their 20s, the rule of thumb is 80% equity and 20% bond. For folks in their 30s, 70% equity and 30% bond, etc. For this client’s son, I suggest the following asset allocation implemented with low cost index funds:
20% Vanguard Aggregate Bond Index Fund (BND)
20% iShares Russell 2000 Value Index Fund (IWN)
20% Vanguard MSCI EAFE Index Fund (VEA)
20% Vanguard MSCI Emerging Mkts Index Fund (VWO)
20% Vanguard REIT Index Fund (VNQ)
3. How to invest?
After you have invested for a period of time, these five funds will have different values. Also cash would have accumulated in the account as $400 is added every month.
Check the account every quarter and always use the fresh cash to bring the lowest valued fund to the level of the highest valued fund. For instance, the lowest value fund VEA is $4,700 and the highest valued fund VWO is $5,800. Cash in the account is $1,200, so use $1,100 to purchase VEA to bring it up to $5800.
Repeat the above process every quarter, and you will end up always buying the cheapest asset.
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