INTRODUCTION
Disclaimer – I am not financially associated with any broker or fund product mentioned in this post. I am completely speaking from my own experience. There is always risk of losing all of your investments if said financial instrument is not FDIC insured. Only stocks, options and ETFs are included in these discussion for the sake of convenience.
Firstly I am an endodontist, a type of expert dentists specialize in saving teeth. Perhaps the words “root canal dentist” ring the horror bell. Certainly I could open another myth buster post to rightfully savage the reputation of endodontic treatments, but this is just to provide a little background on myself. I am a complete novice retail investor with no professional background in finance or economics. I am playing with my own money – savings and IRA. The purpose of this post is to offer some basics of beginner investing and asset management from my own experience, maybe some tricks or techniques in trading and more importantly, the avoidable pitfalls of retail investing that I have encountered.
I started investing with Betterment in 2018, which I used as a passive investment tool for about a year before transferring all my securities to Robinhood and Merrill Lynch last summer as I became familiar with active management of my own portfolios. I use RH for stocks and options trading and ML for my IRA account. Over the past year, the RH account has generated 64% return – with a gain of $63.4K and my IRA account saw an accumulated annual return of 47% with a gain of $27.5k.
The overall market rally since 2016 has contributed much, if not all, of the gaining. I never would have achieved this rate of return had it been the dot-com burst years or subprime mortgage crisis years. However, not much of risk taker myself, I have always approached the market with the respect it deserves. I do not condone reckless trading, or any type of leveraging gamble in the market. Personally I rarely use any margin. COVID crash was a “come to Jesus” moment. Past year in the market has been such a humbling experience.
CHAPTER ONE
Setting up a safety net account
The first question to ask oneself is “what is the goal of this account?”. Setting a clear goal precedes any strategy. It also correlates with level of risk tolerance. Achievable gain and manageable risk are both sides of the same coin called investment.
Before even considering opening a trading account, one should set aside enough money as a safety net for fiscal emergencies only. This is to guarantee that you will survive financially – stay solvent – even if the reasonable worst happens to your portfolio (COVID crash – losing 30% in one month). The amount for such “rainy day” fund varies. The rule of thumb is to allocate enough overhead expense for two to three months, which should include mortgage and car payments, essential insurances, food/groceries and discretionary spending according to your own lifestyle.
The goal of a safety net account is to keep up with inflation and the risk tolerance for this account should be risk-averse to risk-neutral.
Certificate of Deposit (CD) account and (relatively) high interest savings account is the easiest choice for ultra-low risk investment. However, as the Fed and Congress throwing the kitchen sink at the economy, the rates is at historical near zero while trillions of stimulus money is circling in the system. That provides a grim outlook of accelerating inflation in the next couple of years. Worse still, the measly interest gain is taxable as ordinary income at your tax bracket (for tax implications of investment please refer to link tax implications of investments, post tax return is the real return, y’all).
A relatively safe cash alternative is medium to long term treasury and municipal bonds. These securities are tax-exempt federally, although you still might need to pay state tax sometimes. My personal favorite tax-exempt bond ETFs are MUB, IEF and HYD. These all share great characteristics such as good trading volume, low fee and monthly dividend payment. Especially IEF and MUB are considered safe-heaven assets with minimal risk. The prospects of HYD weighs heavily on junk bonds, making it similar as stock index in term of risk and return. Still, historically in the medium to long term, these ETFs are performing better than any CD or savings account when you income is high enough into the 35% to 37% tax brackets.
If exposure to the stock market is preferred, index fund investing is also a great strategy. In fact, it is the only strategy that guarantees the portfolio outperforms the market (by a small margin, and the margin is called dividend reinvesting). Warren Buffet and John Bogle (the founder of Vanguard) provided the snake-oil investment strategy of “buy SP500 index funds and you will never lose”. This is actually how most 401k and retirement accounts are managed in the US. Stock index fund ETFs such as VTI and SPY, both cap-weighed ultra-low cost funds, are a great way to start investing while the overall risk is still considered relatively low.
Another category to consider is previous metal. Gold future has been on a tear since last year. All the recession talk, the pandemic, the free money, ultra low interest rate are all pushing gold price towards all time high. With the convenience of ETFs, we do not need to open a commodity trading account in order to gain exposure to gold. IAU and GLD both are physical gold bullion backed ETFs exclusively tracking near term gold future. Including 10% of gold ETF in your portfolio during this uncertain time could hedge the risk of the broader stock market.
Allocating your safety net account to these three asset categories essentially summaries how passive investment works. Robot brokers such as Betterment and Wealthfront, run-of-the-mill money managers and financial advisers love to use this big three composite. By changing the ratio of each component based on the risk-reward preference of each individual client, most brokerages charge 1% of the total portfolio FMV annually – me be Chinesey but this is highway robbery – 1% fee with a 20-30 year compound is too much money down the drain. BM and WF as robot advisors their fee is at 0.35% to 0.75%. Still, if you understand how ETF works and figure out your goal and risk tolerance, it is really not that much different to simply use a commission-free platform such as RH or ML for your investment needs.
Of course a lot more financial instruments could be considered – P2P lending and REIT etc. Nevertheless, gains from these securities are almost always taxed as ordinary income. With the rates being so low, there won’t be much upside to begin with while the messy near-future economy outlook just screams delinquencies and defaults – if we learned anything from MBS in the financial crisis.
AMATEUR INVESTMENT 