In today’s capitalist society, Americans cannot stop spending money. I think the late George Carlin said it best – “We buy $h*t we don’t need, with money we don’t have, to impress people we don’t like.”
In fact, according to a new study, most Americans have less than $1,000 in their savings account and some don’t even have one. Yet somehow, many consumers blame the economy or high taxes for their financial troubles.
But I’m not here to tell you that buying cheap food at the grocery store, stopping your Starbucks habit, or cutting off your cable service is going to make you rich. While saving a few thousand dollars a year can amount to a lot over the course of 30 years, it’s what you do with that money that really counts. The passive income you earn and the investment gains you reap, year after year, compounding for decades, is how you can become a millionaire and retire early.
Investment Management
A decade ago, investors only had access to traditional discount brokers such as E*TRADE and TD Ameritrade, and wealth managers such as Vanguard and Fidelity. More than likely, your employer’s 401K program is invested with either Vanguard or Fidelity, and that’s great considering companies are able to negotiate lower fees and commissions for their employees.
However, most investors also have their own private portfolio held with a brokerage house. I personally have a TDA account, although in retrospect, it was a mistake to open an account with them. While I love their platform, their fee of $9.99 per trade is just too high for me. In an average year, I make about 50 trades and pay a $3 to $5 premium in fees compared to other discount brokers. The problem with this is that fees and trading costs are known to hurt performance and returns in the long-run, and while that total isn’t going to make or break my retirement nest egg, it’s money that I could just as easily save.
Nevertheless, most Americans aren’t stock-pickers. In fact, evidence shows that active portfolio management results in lower returns, which is why most financial advisors are more than happy to recommend passive index funds as they collect their fees for “managing” your money.
Fortunately, with the proliferation of the internet and the need for simplicity and low-cost alternatives, several new investment managers have come on to the scene, the biggest of which are robo-advisors.
What Are Robo-Advisors?
Robo-advisors are online wealth managers who offer investment advice free of human intervention or error. Companies like Wealthfront or Betterment ask investors a series of questions regarding their financial situation, risk tolerance and investment goals, and then recommend a diversified portfolio of ETFs. In addition to rebalancing and tax-loss harvesting features, the biggest selling point for these new services is the less than 0.25% commission charged.
If an investor is interested in diversification and avoiding a replication of their 401K account, the ETF options at both Wealthfront and Betterment are certainly worth considering. However, another firm takes control, simplicity and allocation to new levels.
Themed Investing
Even as an investor with a degree in financial analysis and work experience in private equity, I sometimes ponder the most effective way to invest in growing trends. While there may be an ETF or mutual fund for every industry or commodity, there isn’t always a security that offers exposure to a niche or sub-industry. This is where Motif Investing comes into play.
Motif Investing is an online brokerage that allows you to build themed-portfolios of up to 30 stocks and ETFs for as low as $9.95. Each “motif” functions as a customizable, low-cost ETF and has been built to represent a specific investment opportunity. For example, the motif named “Social Networking” is comprised of exposure to Facebook, LinkedIn, Twitter, Youku, Weibo, Zynga, King Digital, Yelp, etc. A few of the other popular choices seem to be “Biotech Breakthroughs”, “Chinese Solar”, “Couch Commerce” and “Democratic Donors”.
Although Motif Investing offers a great alternative to traditional investing methods, its service isn’t for everyone. As always, research thoroughly before making a decision and be comfortable with your strategy.
Life Insurance Is Not An Investment
After discussing new innovations in the investment world, I think it is important to also address a troubling historical trend – life insurance as an investment. Some unethical financial planners are touting life insurance as an alternative, guaranteed investment opportunity.
If you are unfamiliar with the different types of insurance, permanent life insurance is a financial product that offers insurance coverage as well as a cash value feature. In the case of whole and universal life insurance, a portion of your premiums is used to cover the cost of coverage and the balance is funneled to a cash account.
For whole life insurance, companies pay you a guaranteed rate of interest on your balance; whereas with universal coverage, carriers invest your funds in a number of securities. This may sound like the best of both worlds on paper, but the reality is that the cost versus benefit makes other investments more attractive. Generally speaking, both whole and universal life are 5 to 10 times more expensive than a traditional term life policy and therefore don’t justify the cost of coverage or returns.
Ultimately what ethical advisors recommend for the vast majority of Americans is to maximize coverage with a cheap term life insurance policy, and invest the difference saved from premiums in an index fund.
The Bottom Line
To enjoy financial independence, you need to invest. To invest, you need to save money. To save, you need to be conscious of your spending and grow your income. You don’t need to take huge risks or do something drastic to build your net worth. In the end, it is the culmination of doing many little things right and leveraging the power of compounding interest to maximize your gains.
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