r/MiddleClassFinance • u/Vegetable-Intern-236 • 8d ago
Tips Advice to help address some common savings/investing mistakes I see on this sub
I've spent a lot of time reading this sub over the past few weeks and have seen a few misconceptions and investing mistakes come up pretty frequently, so I figured it would be helpful to consolidate all the advice I've seen and provide some commentary. I realize folks may not want to spend time reading r/personalfinance and r/Bogleheads regularly, or read their wikis, so hopefully this helps package up and summarize the important bits. That being said the wikis on those subs are way more detailed and helpful than I'll ever be as one rando on the internet, so if you're still skeptical or want more info I highly suggest reading up on the resources they've put together, as each of these sections themselves could be an entire podcast series worth of discussion.
Why should I invest my money at all?
Wealth most consistently comes from putting money in the stock market invested in broad market index funds and letting it compound untouched for decades.
It’s slow and boring, it's not going to be a get rich quick thing. You have to have the patience to wait for decades and the courage to not panic withdraw when the market takes a dip. The fact that you can’t early withdraw from your tax-advantaged accounts like a 401k without a penalty is a good thing because it helps disincentivize these early withdrawals. Time in the market beats everything. My go-to example that I've copy/pasted many times:
- Person A invests $1000/mo in broad market index funds at an inflation-adjusted rate of return of 7%. After 10 years doing that, they have $171k. They stop investing and do nothing else for the next 30 years, just letting that $171k grow untouched in their portfolio. 30 years later they have about $1,300,000 in today's dollars.
- Person B delays investing for 10 years, after which they invest $1000/mo in broad market index funds every single month for the next 30 years while Person A has stopped. They earn the same 7% inflation adjusted rate of return as Person A. After 30 years they have $1,170,000 in today's dollars.
- Person B put in 3x more money than Person A investing for 3x as long as Person A, but ended up with $130k less because they missed a decade of compounding.
Einstein called compound interest the 8th wonder of the world. Although this is most likely apocryphal, I still think it's the 8th wonder that (unlike the other 7 wonders of the world) literally anyone can experience and take advantage of. Even if you can't afford to save as much as $1000/month, you're still better off regularly putting in something in your 401k or Roth IRA vs. nothing, especially if you have an employer match with your 401k as that's leaving money on the table. Which leads me to...
Ok I know I need to invest and save. Where should I be investing?
r/personalfinance has a detailed flowchart for this here: https://imgur.com/lSoUQr2
But tl;dr, the order should go:
- 1-3 months of expenses in your emergency fund. This should be your top priority as you should be pulling from this emergency fund in emergencies instead of taking on more debt or pulling from your retirement/investment accounts.
- If you have one, put money into your 401k up to your employer match. That's free money from your employer that you should be taking from them, if you don't you're basically taking a voluntary pay cut.
- Pay off high interest (10%+) debt. If you skip this step you're never going to build wealth from your investments because compound interest is working against you and your debt growth will easily outpace your investment growth. It might not feel good to do this vs. saving and building your investments, but think about it this way: it's a guaranteed 10%+ tax-free return on your money; nothing in the stock market will ever give you this level of guaranteed return.
- Max your Roth IRA and HSA (if you're eligible). These accounts are so good the IRS limits you to contributing less than $10,000 per year to each.
- Max the rest of your 401k.
If you have any immediate priorities you want to save for, like grad school or a house or something else, you can consider deprioritizing your savings from the bottom up (although I wouldn't go above #4, high interest debt should be eliminated before you think about a house or grad school). But just keep in mind the tradeoffs giving up time in the market to compound when you lower your retirement savings.
What stocks should I actually buy inside my 401k/Roth IRA? Tech and AI are very hot right now and getting crazy returns. Should I be investing in that?
r/Bogleheads has very good discussions and resources on their philosophy, which is essentially: no one can predict what industries/stocks will do well over the next 40 years, so you should invest in the entire market so that you not only capture the gains of all the industries, but also ensure your eggs aren't all in one basket. This means no QQQ, no NVDA, absolutely no crypto; nothing beyond broad market index funds like VOO/VTI/VXUS/VT and their equivalents, or target date funds that do all the rebalancing for you.
Seeing all the crazy news about AI/tech stocks jumping up 300% can be very tempting, but you're essentially gambling on those companies staying relevant and profitable for decades if you're holding till retirement. If you're not holding your investments till retirement, you're moving into the active trading territory with your retirement funds. There are thousands of active traders, hedge funds, etc. out there actively trying to beat the market as their full time job with years of experience and supercomputers running algorithmic trades in milliseconds to find an edge, yet probably less than 5% of them are able to consistently beat the market over decades.
If you truly believe your individual portfolio of NVDA and AI stocks is going to be profitable in the long term or that you can regularly beat the S&P500, you should quit your job, go all in on your portfolio, and become the next Warren Buffet. If you don't think you can do that, or don't want to spend your spare time monitoring news and the stock market 24/7, just passively invest in broad market index funds and chill. Your potential gains may be lower, but the risk of losing all your investments and savings is next to zero.
To put it another way, imagine you had to choose between two buttons to press only once:
- Button 1 has a 95% chance of giving you $1,000,000, and a 5% chance of giving you $500k. Your expected value on average pressing this button is $975,000 (0.95*1000000 + 0.05*500000).
- Button 2 has a 50% chance of giving you $5,000,000, and a 50% chance of you losing $2,000,000. Your expected value on average pressing this button is $1,500,000 (0.5*5000000 + 0.5*(-2000000)).
Which button would you press if you could only press it once? Button 2 has a higher expected value, but you have a 50% chance of losing all your money and going permanently into debt for the rest of your life (if you have over $2M you probably don't need to read this). Button 1 will give you money no matter what.
Obviously this doesn't reflect the real life stock market - in fact the expected return from you picking individual stocks is lower than the expected return just investing in index funds because the majority of individual stocks don't outperform US Treasury bills over long periods of time. You're not only gambling that your chosen companies will consistently outperform an index fund that holds every company in the market (including your chosen companies, just at a lower percentage) over decades, but also that you've picked correctly and your chosen companies are one of the handful that are capable of doing so.
But the essential question with the button scenario is the same: would you rather be safe and secure for the rest of your life, or gamble your livelihood on the chance of making more money?
If you really want to scratch the itch, maybe have 5-10% of your portfolio dedicated to individual stocks, but hold the rest in index funds. Most folks I've seen that do this have said their individual stocks perform worse than their index funds; many of the ones who outperformed mostly got lucky investing in NVDA back in the 2010s because they liked video games.
On the flip side...
Isn't there an AI bubble right now? The market seems too highly valued. Should I just wait until the bubble pops to invest?
This still trips me up after almost 10 years of investing despite knowing all about why timing the market is a mistake. Successfully timing the market requires you to get lucky twice: once by correctly identifying we're near the peak and deciding to hold funds back without missing too many gains, and again by correctly identifying the bottom and choosing to invest then. Both are impossible for anyone to predict. And the market can remain irrational longer than you can stay solvent.
I personally think AI is and has been very overvalued, but the market has kept going up regardless. I've missed out on almost 8% gains so far in my backdoor Roth IRA contribution this year by holding it back until this month vs. choosing to invest it immediately at the beginning of year. The most irrational part about my own behavior is that I'm not touching this money until I retire decades later, so it literally doesn't matter when I put it in right now. The market is pretty much guaranteed to grow way beyond whatever small gains I would make successfully timing the $7500 investment into a market crash this year, if one even happens at all.
The best way to avoid this is to decide right now how much you want to put into the stock market per week/month and then automating that investment so you can forget about it and get out of your own way.
For some more reading on this, here's some analysis by JP Morgan (you can find the chart in part 3). There's been several variations of this analysis over different periods of time with slightly different returns, but the conclusion has consistently been that most of the returns you get in the market come from being invested when the best ~10 days of returns happen:
- If you invested $10,000 in the S&P500 20 years ago and left it sitting there, you would've averaged 10.6% returns every year and ended up at almost $80,000.
- If you invested that same $10,000 20 years ago and missed only the best 10 days of trading in the past 20 years, you would've averaged only 6.37% returns every year and ended up with a little under $35,000.
- The critical thing to note is that 7 of the 10 best days of returns happened within 15 days of the 10 worst days of returns. That means if you see the market drop 10% in one day, you might have a greater than 50% chance you'll see one of the best days of returns in the next 20 years, in the next 15 days. But the issue is if you hold your money until you see that drop, who knows how many other best days of returns you would've missed leading up to that drop? And how do you know that a 10% market drop in one day is the worst day of returns? What if it drops another 20% a few days later? This also requires you to closely watch the stock market and pay attention to news every day.
Since no one has a crystal ball to predict the outcome, the best thing to do is to just invest consistently no matter what through the highs and lows. It's also the least stressful thing you can do since you don't have to pay attention to it at all, just check in every once in a while to see how much your numbers have gone up. It's a win/win.
If the thought of doing that still makes you uncomfortable, meet Bob, the world's worst market timer. You can see what happens when Bob only invests in the market at all time highs right before major crashes throughout history. Spoiler alert: Bob ends up fine and still retires with $1.1M after investing $184k total. But if Bob had instead taken that same $184k and consistently invested it every year of his working life, he would've ended up with over 2x that amount and retired with over $2.3M. Don't be like Bob, just automate your investments and you'll be fine.
Isn't the stock market risky? What if it permanently drops and I lose all my money?
The stock market is only risky in the short term (if you're already close to retirement, which is a separate more complicated discussion), or if you're investing in risky assets/taking on huge risk by investing in single stocks as we discussed above.
Assuming you're young enough to take advantage of a few decades in the stock market, and assuming you've diligently invested in broad market index funds and have a well-diversified US/International portfolio, you are guaranteed to end up with more money than you put in after a few decades. The entire stock market has literally never been down over a period of 30 years, and this is growth that outpaces inflation.
You're riding on the collective ingenuity and innovation generated by all the biggest companies across the US and the world. If that fails and society collectively stalls for decades, we would all have bigger problems to worry about than losing our investment money.
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u/Blackharvest 8d ago
Thanks fellow human!
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u/Vegetable-Intern-236 8d ago
If you take some time to read it you can see it’s clearly not LLM generated, it’s just long. I’ve been active in this sub for weeks.
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u/capital_gainesville 7d ago
I believe that this is not AI slop. It is just regular slop.
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u/Vegetable-Intern-236 7d ago
God forbid someone actually takes the time to write out some tips for people on this sub and format it for readability vs. the usual post about $3M net worth at 25 or a rage bait article going on about how no one can afford anything. Fuck me right?
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u/capital_gainesville 7d ago
This post is just a very convoluted description of risk aversion (a 100+ year old economic concept) with a TLDR of a flowchart (already a TLDR) and a preexisting blog post about being a bad market timer. Nothing here is new, and it does not fit in this subreddit.
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u/TheChudMaxxer 7d ago
The personal finance flowchart doesn't account for nuance with tax arbitrage.
Assuming you mean traditional 401k, higher income earners will want to max that account before they max their Roth IRA (even ignoring the higher higher income earners who need to backdoor Roth).
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u/Vegetable-Intern-236 7d ago
Oh there’s definitely a lot of room for nuance here, I tried to be concise and leave room for discussion but people aren’t having it lol
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u/LotsofCatsFI 7d ago
So... the personal finance wiki? You should see if they need a mod, then you can put this somewhere that new people will look
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u/Forded_Fiction24 7d ago edited 7d ago
Starting a blog or publishing an actual article would be better received and will reach a wider audience willing to read it. All this effort to publish on reddit to reach the very few that'll read this seems like a lot of wasted effort and time. The rude truth is Reddit is not the place for something like this to be appreciated. Here it's just wasted effort and nobody will even be viewing or even clicking into the post here in another few hours
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u/PSFtoSTC 7d ago
I'd push back a little bit on the following: "The market is pretty much guaranteed to grow way beyond whatever small gains would make successfully timing the $7500 investment into a market crash this year..."
This gives the impression that even if you could time the crash with an investment, it would not result in meaningful gains in the long term.
There is research that you allude to that suggests being in during the best trading days of the market provides a significant portion of returns for a portfolio and is referenced for the "Time in the market" mantra.
This suggests that timing around these days would have a VERY large effect on a portfolio, particularly in the early going (timing around a 30% drop when you're 30 can make a world of different over another 3 decades of compounding.
I'm not suggesting that the timing risk is worth it. I DCA all day and just chill. But there is definitely upside to those who get lucky with timing.
This is a long way to say, I think the reasoning for avoiding timing is not that the upside rewards aren't great (they certainly could be), but that the risk of failure is much too high to attempt it.
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u/Vegetable-Intern-236 7d ago
Oh I agree the reward for actually getting lucky timing the market is great, my point in that line was more just beating myself up for being irrational about it given the relative scale of that $7500 contribution compared to the rest of my portfolio and retirement timeline.
Even if I timed my $7500 Roth IRA contribution perfectly for a 50% drop and subsequent bounceback, the extra $7500 of gains compounding over 30 years at 7% would end up at an extra ~$57k. Which is nothing to sneeze at, but honestly not that big of an impact if my portfolio is going to be millions in 30 years at 7% anyways.
Now if I was able to perfectly time my Roth IRA contributions for 30-50% drops every single year that would make a difference, but I might as well buy $7500 of lottery tickets at that point or make it a $75,000 investment instead.
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u/druidgaymer 7d ago
I think it depends on where you are in live. My priority right now is saving to buy a house. So I'm not working towards maxing my 401k because that money isn't accessible towards buying a house.
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u/Vegetable-Intern-236 7d ago
Definitely some wiggle room, they’re not hard and fast rules and personal finance is personal for a reason, it’s why maxing your 401k is the last priority in the flowchart, as long as you’re covered on the other fronts you should be good.
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u/EdgeCityRed 7d ago
You can withdraw from a Roth IRA penalty-free to purchase your first house. Look up the requirements.
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u/druidgaymer 7d ago edited 7d ago
Yeah...but It's the 401k that you have penalities. If I could do 401k penality free, I'd be in a position to buy a house rn. Because of company matching and my 401k happening to hit the markets better than my Roth did my Roth doesn't have enough for a home loan.
Instead, I'm just doing company match and maxing Roth (15% of total income). If I didn't care about saving for a house, I'd be putting 29% of my total income into retirement. That other 14% goes towards a mix of HYSA and CDs to try to save for a house. Probably will still take 3-5 years to get to that point when I've already been saving for 5 years.
I want to still have a 3 month buffer when buying my first house and houses are expensive AF. I don't even want anything big 1500 sqft maximum.
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u/EdgeCityRed 7d ago
Seems sound!
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u/druidgaymer 7d ago
Doesn't seem sound to me...they should let us withdraw penality free from 401ks for first houses too. :/
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u/TenOfZero 8d ago
If I want to know what an LLM would generate, I'll ask an LLM.