GreanBrain wrote: ↑Mon May 06, 2024 5:19 pm
Background: US-based, turning 30, employed, ~40K investment
Nice work!
Keep it up though – I would recommend aiming for $500k-$1M.
GreanBrain wrote: ↑Mon May 06, 2024 5:19 pm
One thing that I'm convinced of is that I should be investing in index funds and should be looking for a low expense ratio. But when I'm comparing funds on Vanguard and Fidelity, I notice that many funds with low expense ratios (<0.04%) have very similar annual returns. A lot of discussion has been focused on the importance of a low expense ratio, but is that the only most important factor we think about when choosing funds? Should I also consider other factors like return? But when I look at multi-year returns, these numbers are so close that I'm not sure how to choose. I am curious about any suggestions from this community.
IMO expense ratios are not the only or even main factor to consider, they're just one aspect.
The first thing is to work out your goal. Do you want to retire early with a modest lifestyle to pursue your (mainly non-financial) interests?
Based on your goal, you can then engineer a solution that is most likely to succeed. Most likely means, e.g., 85% or higher probability of success. (Nothing in life is totally risk-free.)
Empirically and theoretically, the best strategy that has worked under the greatest variety of conditions over recorded history is low-cost index fund investing. Simply buying and holding the whole market (or as much as you can in cap weights) allows you to capture the returns of the market. Market returns have beaten inflation by 2-6% over recorded history.
Any deviation from the market portfolio means that there is some sector, category, methodology, etc. which you think will offer superior returns to the market. So far, practically no other strategy has been discovered that will consistently succeed (there is new research into "factors" but more on that later).
Index funds win both empirically and theoretically. Empirically: historical data going back 200+ years, based on data-sets such as DMS, demonstrate solid market returns. Theoretically: multiple theoretical frameworks including "efficient market" hypothesis and "behavioural finance" converge on this.
Fees are important because a big aspect of the inflation-beating property of stocks is the compounding of returns, which is heavily affected by small percentage changes in returns such as fees. Mathematically, compounding works as an exponential function, which means even a seemingly small change in an initial value can generate a massive change in the resultant curve. This principle is expounded in the "rice/wheat and chessboard problem", a famous riddle that dates back to ancient times.
https://en.wikipedia.org/wiki/Wheat_and ... rd_problem. So even a 0.5% higher fee can have a big negative impact on your future returns if it is not compensated by equivalent gains. As mentioned earlier, there are almost no methods of investing that offer higher returns than the market, so any fees above the minimum are usually unlikely to be compensated.
Exception to the above rule:
Now it is possible to earn a very
very small premium (I believe in the vicinity of 1-2% higher) by investing in a manner in which you are always buying stocks which the market
systematically undervalues. This means stocks which are always cheaper and always offer a higher expected return for a reason which is demonstrated to be persistent and not related to pricing at just one point in time or one market cycle etc. (Basically cheaper for a reason which is unlikely to change tomorrow, next year, next decade or next half-century).
A tiny handful of strategies have been discovered through rigorous research and modelling, known as the "Fama French Five Factors". Of the 5 factors, the most accessible to retail investors like us is small-cap value. Small, profitable and cheap companies tend to deliver a small premium over the market and this is demonstrated pretty much in the whole historical record.
Theoretically, there is some debate over why this is the case, but there seems to be a consensus that it's because they're "riskier" (finance-speak for more volatile). So you are "earning" the premium of small value because you are taking more risk, which is the same principle index funds rely on. You can access small cap value through ETFs from Dimensional Fund Advisors and Avantis among a few others, with minimal fees (relative to the product you're getting).
Some videos on this:
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https://www.youtube.com/watch?v=2MVSsVi1_e4
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https://www.youtube.com/watch?v=dSyB5CjALYk
Now whether you want to take more risk to get higher return via small value is up to you.
The approach I think about is utility-based. I divide my investments into two categories:
1. High utility + Low risk: One to cover basic essentials like food and clothing, maybe shelter
2. Low utility + High risk: One to cover nicer stuff like an occasional restaurant trip, air conditioning, etc
I would use a safer portfolio (e.g. index funds, TIPS) to cover the essentials (1), which will be more reliable and less volatile.
I would use a "riskier" portfolio (e.g. small-cap value) to cover nicer stuff (2), for which you are Ok with the risk of going without.
If you live by the ERE philosophy, you can reduce (1) by a great degree.
Sorry if this was a bit of an essay, I hope it helps. All the best with pursuing your dreams!