On a Letter From A Younger Friend

A younger friend of mine sent me an email asking for investment advice.  Here is the redacted version of it:

 

I’m not sure if you are aware of a blog called mrmoneymustache.com. The guy who runs the blog retired in his late twenties just working a software development job. Granted, he was really fortunate to have graduated college and started his career in the dot-com bubble, but he didn’t have a really high-paying job by any means during that time. Anyways, his main strategy was saving 70-80% of his income and investing heavily into Vanguard index funds. He stopped contributing to his 401Ks early on and started putting the rest of his savings into taxable accounts with Vanguard (index funds) in order to retire early and withdraw his 4% from his portfolio every year for living expenses. I think it’s a pretty interesting blog and might be worth checking out if you had the time. I’d be really interested in your general thoughts about him and his blog and if you think he gives wise investing advice.

[Wife] and I both have IRAs ([Wife] has a traditional 401k and I have a Roth). [Wife] actively contributes to her 401k every paycheck and I think it has about $XX in it. I put the max contribution amount into my Roth every year, currently $XXXX, and it is at about $XX. I always hear it’s important to max out your tax deferred and tax free accounts before opening a taxable account. I think we’re at the point where I want to start investing in a taxable account. I like Vanguard and their low expense ratios and I know index funds outperform actively managed funds in the long-term.

 I was thinking about opening a vanguard taxable account and starting off small (5-6k) with my investments into VTSMX and VFWIX with a 50/50 split. Do you think this would be a wise move? I don’t want our money sitting in savings accounts and not even keeping up with inflation. I almost feel like it’s foolish not to invest as much as possible.

Anyways, looking forward to your response and thoughts on MMM and his blog.

Thanks Dave!

First, I want to commend you for making an effort to save and invest early.  Most people don’t do that, and it is a major reason why they never become financially secure.

Second, I want to thank you for introducing me to Mr. Money Mustache.  As one that has sported a full beard for the last 20+ years, I can appreciate the name.  He saved lots of money in his twenties, and invested it in stock index funds at Vanguard.  I am a Vanguard fan also, though I use them less often now, because my stockpicking has done well.

MMM reminds me of a more severe version of Dave Ramsey, minus the Christianity.  If you can deny yourself in the early years, work hard, keep expenses down, and build up a nest egg early, wow, do it.  Most people can’t do that.  You and your wife have already accumulated more than most have at similar ages.  Keep it up.  Having a bias against unnecessary spending is a good thing.  When my kids ask me why we don’t get new cars, I tell them that they run, and I will drive them until the cost of maintaining them is greater then the cost of buying and maintaining another car over the long run.

It is wise to avoid too much debt, and wise to pay it down early.  I have been debt-free for the past 11 years, including the mortgage.  Excluding the mortgage, 22 years.  It changes you, and frees you, because when you don’t have worries over paying debts, you don’t have the same degree of concern of are you going to run into financial trouble.

In inflation-adjusted terms, you are roughly as well-off as my wife and I were when we were your average age.  Good job, and keep it up.

Third, you are young, so investing 50/50 in US/Foreign Total equity index funds from Vanguard is fine, especially the Foreign part of it.  I say that because the US Stock Market is priced to deliver 5.5%/year returns for the next 10 years.  Foreign markets offer more return now.  When MMM was investing his savings the market was priced to earn 9-13% or so per year.

This brings up another point.  I don’t like earning nothing on my money, as it is with most banking and savings accounts, but sometimes that is the best option.  In September of 2000, the US stock market was priced to earn -2%/year returns for the next 10 years.  That was a time to throw stocks out the window.  I didn’t do that, and my value investing made money in 2000 and 2001, though I got whacked hard in 2002.

Not every moment in the market offers the same degree of opportunity to make money.  To the degree that you can, be ready to invest when markets have fallen, and things look bad.  If you want to be clever, after a severe fall invest after the S&P 500 is higher than its 200-day moving average.

But investing regularly to some degree immunizes market environments.  You will invest in good times and bad.  In the end, the discipline will benefit you.  You have saved, invested, and did not panic when things went bad.  You lived to prosper when things went good.

But, you might tilt your US assets to the US value index fund, and if Vanguard has a foreign value index fund, you might do that as well.  Value outperforms over the long haul, so do that if you can.  If small stock valuations weren’t so high now, I would tell you to look for small cap value, but I won’t, it doesn’t make sense now.

Fourth, yes, start the taxable brokerage account with your excess money.  I started mine at age 29, and the economic help it has been to me has been significant.  I would not have been able to start my business in 2010 if I had not done that.  Or survive the low earnings years 2008-2012.

Fifth, all that said, I have one more insight to add.  I’m sure that MMM enjoys his life and works, even though he is “retired.”  The Bible warns us about not wearing ourselves out to get rich, in Proverbs and Ecclesiastes.  Hey, it is nice to live off of a passive income, but the Lord made us to work six days, and rest on the seventh.  Work is an ordinary part of life even if you are managing your assets, and it is to be enjoyed.

What MMM suggests may be harder to bear than many people are capable of bearing.  We should appropriately enjoy life and not be misers.  The Larger Catechism in talking about the Eighth Commandment encourages us to enjoy what God has given us.  As we prosper, we should thank God for it, and enjoy it.

You have a wonderful wife, and that is reward enough.  But save and invest in good times and bad, and it will work out far better for you than those that don’t do so.