Mid-Layer 2: Investing toward Financial Freedom
Mid-Layer 2 is all about investing toward financial freedom by incremental investing in additional to your retirement plan – NOT replacing it. This is a passion area of mine and an area that I’ll spend a lot of time and many blog posts, but this post will serve as an introduction into investing into taxable brokerage accounts.
Opening a taxable brokerage account
A taxable brokerage account is similar to a 401k account except that it’s not through your employer and generally it has no tax advantages. There are plenty of brokerage companies out there and you can find pros and cons lists all over the internet, but most importantly you should consider a reputable company that has low fees and FDIC insured. Fidelity is a popular example of company where you can open a taxable brokerage.
Types of Investments you can purchase in a taxable brokerage account
There are quite a few types of investments available, but I’ll highlight the most common places you may consider for getting started.
Exchange Traded Funds (ETFs)– these funds trade exactly like individual stocks except that they are a basket of stocks, similar to mutual funds. There are all sorts of ETFs and they track different benchmarks (S&P500, Chinese Stocks, Technology Stocks, Fixed Income/Bonds etc.). Legendary Warren Buffet advises people who don’t want to spend 6-8 hours a week on their investments to dollar cost average into index funds that track the total market as a way to diversify without needing much education or management of the portfolio. These are great tools starting out, especially funds that track the S&P500 because you’ll get instant diversification.
Individual Stocks – You can buy and own a piece of a company that is traded publicly. For that piece of ownership investment, you should expect to get value paid back to you in the form of the stock increasing in price and/or dividends which are regular payments to you. There are thousands of publicly traded companies that you can invest in and a simple google search can help you figure out which ones you would be interested in. There are pros and cons of all asset classes, but generally the pro is that over long periods of time stocks tend to rise, but over short periods of time can be very volatile and risky. You should only invest in stocks that you plan on educating yourself on continuing to track on a semi-regular basis.
Fixed Income / Bonds – There are both single issue bonds and also ETFs and other funds who manage a handful of fixed income / bonds. The difference between Bonds and Stocks are that investment in fixed income will have both a defined duration of the Invesment (e.g. 10 years) and you’ll know how much you’ll get back at the end of the 10 years (e.g. $1,000) and your regular payment throughout the 10 years based on the yield (e.g. $50 payment every year for 10 years). Generally speaking, these instruments are more conservative than stocks, but should have some place in a diversified portfolio because they are less volatile than stocks and other asset classes.
Real Estate Investment Trusts (REIT) – REITs are funds that hold only investments in real estate. Different REITs have different themes (e.g. investment in Hotels, Office Buildings, Self Storage, Industrial, etc.). Historically, these are also less volatile than stocks and typically pay a higher dividend.
Cyrpto – This is a new and emerging area that is extremely volatile and any money invested in these “coins” should be okay to lose. That being said, a truly diversified portfolio may benefit from having some speculative investments if you have the stomach / emotional balance to deal with losing all of your investment. Most people I’ve seen recommend less than 5% of your portfolio in speculative investments.
Diversification and Compounding
No matter what you invest in, the most important concepts in this section are diversification and compounding. Historically, they are the magic to truly invest your way to financial freedom without risking too much.
Diversification is important over long periods of time because different asset classes serve different purposes and are in favor at different times and economic cycles. You may know that one person who made a fortune on a single stock or investment, but what you don’t hear are all the people who lost their life savings trying to do the same thing. My personal portfolio is not only a mix of asset classes, but is also diversified within that asset class. I have single stocks and bonds, multiple ETFs with different themes and also some speculative investments in new and emerging companies and crypto. I don’t necessarily recommend you take my approach, but I do think you should strongly consider the benefits of a diversified approach to your investing.
Albert Einstein described compound interest as the 8th wonder of the world because your money makes money and snowballs over long periods of time. According to the Nerd Wallet compound calculator, $1,000 invested now will be worth $2,594 in 10 years using a 10% rate of return. And that is by doing nothing and just letting your money compound. Compounding is why it’s so important to start investing as early as you can so that you give your money as much time as possible to compound. Even if you aren’t early, you can still benefit from compounding if you just start now.
Wrapping it up
This is truly my favorite layer of the pyramid because of how much it’s accelerating my path to financial freedom. It’s also something that I can manage on my smartphone or computer in very little time since I also have a day-job. I highly suggest a diversified approach to your investing in this level, especially as you’re starting out, and starting as early as possible after you achieve a strong base and have started your retirement savings.
