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We live in the richest country in world history. Our wealth is enormous and growing. Yet only 5 percent of us manage to become financially independent by age 65.
Those who focus only on net income as a measure of economic success are ignoring the most important measuring stick of financial independence. It’s not how much you make, it’s how much you keep.
The Rule of 72 is very simple: To determine how many years it will take an investment to double in value, simply divide 72 by the annual rate of return.
The habit of buying a new car every few years has the potential to decrease your future net worth more than any other buying habit, including credit card debt.
Treasury issues are considered the safest bond investments, since they’re backed by the full faith and credit of the U.S. government.
Treasury interest income is exempt from state and local taxes.
Even though EE and I Savings Bonds are purchased with after-tax money for your taxable account, they are tax-deferred for up to 30 years.
Investment-grade bonds include AAA (the highest rating), AA, A, and BBB. In addition, Standard & Poor’s assigns bond ratings pluses (+) and minuses (-). A BBB- is the lowest of the investment grade bonds.
These lower-rated bonds are known as junk bonds, high-yield bonds, and non-investment-grade bonds.
Visit https://investor.vanguard.com/home and search for “taxable-equivalent yield calculator” (without the quotes).
Even though bond funds don’t have a maturity date, they do have a measure to help bond fund investors determine if a particular bond fund might be appropriate for them, considering their time horizon and risk tolerance level. The term for that measure is duration.
Bond and bond fund values move in the opposite direction of interest rates.
The gain or loss in a bond’s value is only realized if you sell your bond in the secondary market, prior to maturity. If you elect to hold your bond to maturity, you’ll continue to collect the coupon yield until the bond matures, and there will be no gain or loss.
Mr. Bogle suggests that owning your age in bonds is a good starting point. So, a 20-year-old would hold 20 percent of his/her portfolio in bonds.
Some mutual funds invest in both equities and bonds within the same fund. These funds are known as balanced funds.
These offerings invest in other mutual funds, normally from the same company, and usually include stock, bond, and money market mutual funds—thus the name funds of funds.
Annuities are an investment with an insurance wrapper.
Because of their high costs and surrender fees, and the decreased tax benefits of annuities in relation to more tax-efficient investments available, annuities really don’t have much to offer most investors.
Exchange-traded funds (ETFs) are basically mutual funds that trade like stocks on an exchange.
Unlike regular mutual funds, which are priced at net asset value (NAV) only once a day at the close of business by the fund company, based on the value of the securities owned by the fund, ETFs are priced continuously throughout the day, by an open market system, as are stocks, whenever the stock market is open.
There are some downsides to ETFs. First, you have to use a broker each time you buy and sell, and that usually means you’ll be charged a commission for each transaction.
It’s important to note that Vanguard offers their low-cost ETFs commission-free, eliminating the previously mentioned downside associated with having to pay commissions to buy and sell ETFs.
I Bonds are issued with a fixed rate that is guaranteed to provide a real return equal to the fixed rate of the bond at the time of issue.
The higher the I Bond’s fixed rate, the lower your tax bracket, and the longer the holding period, the better the odds are that you’ll realize a higher after-tax real return.
Unlike I Bonds, where the Treasury sets the fixed rate, the guaranteed rate on TIPS is established by the marketplace at the Treasury’s TIPS auctions.
When you own TIPS in your taxable account, the major downside is that you have to deal with the issue of paying annual taxes on some income that you won’t receive until maturity.
one of the greatest gifts you can give your children is to be financially independent in your old age, thus ensuring that you won’t become a financial burden to them.
To overcome any recency bias, you need to be aware of and understand the powerful magnetic market force known as reversion to the mean (RTM).
Index funds outperform approximately 80 percent of all actively managed funds over long periods of time. They do so for one simple reason: rock-bottom costs.
Once you’ve narrowed the field, you will find two basic types of index funds to choose from: index mutual funds and exchange-traded funds, also known as ETFs.
It’s common for actively managed funds to have great before-tax returns and not-so-great after-tax returns, due to the trading that goes on in actively managing the funds.
Asset allocation is the process of dividing our investments among different kinds of asset classes (baskets) to minimize our risk, and also to maximize our return for what the academics call an efficient portfolio.
Efficient Market Theory. EMT can be described as “an investment theory that states that it is impossible to ‘beat the market’ because existing share prices already incorporate and reflect all relevant information.”
Professor Malkiel describes a random walk this way: One in which future steps or directions cannot be predicted on the basis of past action. When the term is applicable to the stock market, it means that short-run changes in stock prices cannot be predicted.
Harry Markowitz is credited with being the father of Modern Portfolio Theory (MPT). This is a watershed concept that has changed the way knowledgeable investors structure their portfolios.
One of Markowitz’s greatest contributions to investors was his recognition that a mixture of volatile noncorrelated securities could result in a portfolio with lower volatility and possibly higher return.
The Vanguard Group did a similar study using a 40-year database of 420 balanced mutual funds. It found that 77 percent of the variability of a fund’s return was determined by the strategic asset allocation policy. Market timing and stock selection played relatively minor roles.
Knowing your risk tolerance is a very important aspect of investing, and one that the academics have studied extensively. Their experiments prove that most investors are more fearful of a loss than they are happy with a gain.
One of the chief advantages of an asset allocation plan is that it imposes a discipline that will help you to resist the temptation to sell funds in underperforming asset classes and to resist chasing the current “hot” fund.
When setting up an asset allocation plan, investors should ask themselves: “Can I sleep soundly without worrying about my investments with this particular asset allocation?”
“Never buy anything whose price you can’t follow in the newspapers—and you shouldn’t buy anything too complex to explain to the average 12-year-old.”
Many investors believe that overweighting value and small-cap stocks may result in less volatility and higher long-term returns. This can be accomplished by adding a value and/or a small-cap fund to a total market index fund.
Real Estate Investment Trusts (REITs) are a special type of stock. REIT funds often behave differently than other stock funds. This characteristic of noncorrelation can make them a worthwhile addition to larger portfolios. We suggest that REIT funds not exceed 10 percent of your equity allocation.
a foreign stock investment is really two investments—one in stocks and one in currencies. Both elements provide additional diversification to a domestic portfolio.
We believe that investors will benefit from an international stock allocation of 20 percent to 40 percent of their equity allocation.
We also suggest a broad-based, diversified bond fund such as Vanguard’s Total Bond Market Index Fund. This is an intermediate-term bond fund that seeks to match the returns of the Barclay’s U.S. Aggregate Float Adjusted Index—a commonly used proxy for the broad investment grade U.S. bond market.
our guideline portfolios do not contain high-yield bond funds.
If you decide to include a Vanguard TIPS fund in your portfolio, you can choose between VIPSX ($3,000 minimum) with its higher expected risk and return, and VTAPX ($10,000 minimum) with its lower expected risk and return.
A Young Investor Using Vanguard Funds Total Stock Market Index Fund 80% Total Bond Market Index Fund 20%
A Middle-Aged Investor Using Vanguard Funds Total Stock Market Index Fund 45% Total International 10% REIT 5% Total Bond Market Index Fund 20% Inflation-Protected Securities 20%
