I’m going to break from the pattern for a moment here. Up to this point, everything I’ve written has dealt specifically with getting along in the shipboard environment. This post is different, as it directly addresses personal lifestyle choices and has little to do with direct military performance. Since this blog is supposed to be a collection of useful tips for young Naval Officers just beginning their careers, I think a post on basic financial literacy is appropriate.
As a species, newly-minted (okay… single) officers have the tendency to spend money like complete idiots for the first few years. Eventually we figure out that despite our best efforts, we’ll probably live past 30, and it is this epiphany that drives most of us to get serious about savings and investing. (Ironically (guys), its around this time that we discover that the high-quality female population is far more turned on by guys that have their shit together than by guys with flashy cars). When we’re sixty, we’ll realize that the initial Three Years of Stupid have cost us hundreds of thousands of dollars, but that’s fine. The memories we’ll have of playing Call of Duty in an immersive 3D home theater are well worth it.
I’m not saying that you should be boring and forgo the joys of your long-awaited ensign pay. What I am saying is that sooner or later, you ARE going to want to start accruing long-term wealth, and it’s in your interest to get ahead of the curve. You won’t just benefit from this when you’re sixty– you’ll immediately enjoy the satisfaction and confidence that comes with a solid long-term financial plan. That, and you’ll finally be able to understand what the hell the smug portfolio braggart guys are talking about without faking it.
If I were to try to summarize everything I’ve learned about investing in one or two pages, it would come down to the following nine takeaways:
1. Identify your time horizon is and invest accordingly. Most people screw this up, saying they want long-term results but obsessing over short-term noise. This usually leads to confused behavior which adheres to no strategy whatsoever and only loses money. The ability to delay gratification is imperative. For fund-buying decisions, your time horizon should be years or decades. For individual stocks, one to five years at least. Don’t buy anything you wouldn’t be willing to ignore for at least a year.
The demand for instant gratification regularly destroys investors.
2. Ignore Technical Analysis, charting, buy and sell “signals,” and the like. These are tools for the short-term trader, and are mostly nonsense. It’s like the astrology of investing. Almost nobody has gotten rich like that and of those who’ve tried, most lost a ton of money before giving it up.
3. It is impossible to consistently predict short-term movements of the stock market. The long-term trend of the stock market is upward, and it severely outperforms every other asset class.
(The above three points are all ultimately the same: The most successful investors invest for the long term. Ignoring the short-term to invest for the long-term is counter-intuitive. Short-term movements obsess us because they make sense, at least in the way that gambling makes sense. If we can just be right more often than we are wrong, then we should profit overall. If we can pull that off successfully, and keep doing it for long periods of time, then those short-term returns should accumulate into superior long-term returns, right?
Well, no. The difference is in what we can and can’t predict. Short-term movements are essentially random, but long-term trends are much more predictable. Sometimes great investment theses take many years to play out, but result in awesome returns when they do, returns which can blow away years of incremental, marginal profits from short term trading. Tax laws also favor the long-term investor.)
4. Avoid actively-managed mutual funds- they historically underperform passive index funds for a variety of scientific reasons you can read elsewhere. The TSP is an excellent vehicle for passive indexing. Vanguard is another. Once you’ve established some solid retirement vehicles in passive index funds, THEN consider investing in individual stocks.
5. Understand that diversification goes beyond owning several stocks. If you own twenty stocks but they’re all technology stocks, you are not diversified. Likewise, if you own twenty stocks but they’re all large-cap value stocks, you are not diversified. If you own twenty stocks but have no real estate, bonds, or cash reserves, you are not diversified.
6. The more systems you can set up for automatic investment, the better. Passivity is hard but is conducive to long-term success. Micromanagement leads to bad performance. Automatic investments force you to adjust your spending habits without even noticing it. Another great reason to use the TSP.
7. Taxes matter. You don’t need to be a tax expert to understand these basics:
- A Roth IRA protects the money in it from capital gains taxes (effectively, income tax on the growth). Over the long term, this is awesome.
- A Traditional IRA reduces your taxable income by the amount of your contributions, but the growth is taxed. This can be nice in the short term, but a properly-invested Roth will probably save you more money over the long term. Which (traditional or Roth) is better depends on several factors, including what the IRA is invested in, what the tax rate for your income level is when you start drawing from it, and what you would do with the money you save on taxes if you went with traditional).
- If you buy and sell a stock in less than a year, you’re taxed at a much higher rate than if you hold it for at least a year. If you take a loss, you can also deduct it at a higher rate. Knowing this, all else being equal, its best to keep your winning stocks for at least a year, and sell your losing stocks before you’ve had them for a year.
8. Don’t mess with options or penny stocks– you will lose your ass. Options can actually be a great tool for managing risk if used correctly, but its complicated and requires significant study to get the hang of. Its very tempting to use them stupidly, and most people give up on options after losing thousands this way. Penny stocks are a scam in which you get someone else rich by setting your money on fire.
9. The guarantee of a dollar tomorrow is worth less than a dollar today. You can calculate its value like this: PV=FV/(1+r)^t
Where: PV= Present Value
FV= Future Value
t= time in years before value will be recieved
r= Annual rate of return at which the dollar could be invested today
This illustrates whats known as the “time value of money,” which is the foundation of the entire financial world.
The points above can be applied to pretty much anyone, civilians included. If you begin to educate yourself about the investing world, you will probably find them reiterated over and over. You won’t find many books that address your specific situation, though (here’s one). As a military officer, there are several things about your job which make your investment conditions different from that of civilian young professionals:
- You have much better short-term job security than the average civilian at your experience level. This means you can afford to invest with higher risk.
- You have much more disposable income than the average civilian at your experience level. This means you can afford to invest at a higher rate.
- You have access to the Roth-TSP. This means that when combined with a Roth IRA, you can contribute up to about $24K per year to accounts that grow tax-fee. Its hard to convey just how awesome this is.
- You do NOT have an option for employer matching contributions to a retirement account. What you have instead (for now) is the prospect of a retirement pension which begins paying out immediately upon retirement, instead of when you turn 60 like every other retirement pension in the world.
- If you do choose to stay until retirement, having the pension may mean that you can tolerate more risk than Joe Civilian. A conventional thumbrule for asset allocation is “100 (or 120) minus your age is the percentage of your assets which should be invested in the stock market.” If you’re pulling the retirement pension, you can probably be much more exposed to the stock market, since you’ll still have an income if a short-term market downturn temporarily obliterates your account.
- If you have kids and are eligible, transferring your GI Bill to them is a major financial decision you don’t want to put off.
Here’s the Bottom Line (this is what I do):
1. First, start some monthly allotment into the TSP; for long-term growth, I recommend some combination of the C-, S-, and I- funds, with the Roth-option. As you can afford it, increase this allotment up to the maximum allowed.
2. If you still have money left over after that, open a Roth IRA with a passive index fund through Vanguard. Increase your contribution to this until it is maxed out. If you’re married, open two Roth IRAs and max them both out if you can.
3. If you STILL have money left over after that, read this book, then buy individual stocks diversified over a variety of industries and market caps. This is when it gets fun. If you’re putting a lot of money into this, I recommend The Motley Fool’s Stock Advisor service.
4. If you have real estate, don’t make the mistake of neglecting retirement investments to pay down your mortgage as fast as possible– over the long term, a passively invested stock portfolio will almost always earn more in dividends and growth than what it costs to carry mortgage debt.
5. If you have kids, don’t forget about their college– better start that early. Consider a 529– it’s kinda like a Roth for college– and of course the GI Bill.
One final point of basic financial literacy. When you get a big bonus, don’t go “splurge” on something just because you’ve got the money to burn and want “something nice.” That’s a short-term impulse, and is how poor people stay poor. Use it to open up an investment account.
DISCLAIMER: The above is anecdotal advice based entirely on my own study and experience. I am not an investment professional, I’m just some schmuck with a warfare pin. If you have any questions about anything I’ve written or believe I have stated something in error, or if you would like me to go into more detail on any of the above, feel free to write me or leave a comment.