Over the past few months, we (Nick and Adriane) have had a surprising number of discussions about investing with friends, family, and colleagues. In the course of those conversations, we’ve discovered a remarkable amount of uncertainty, anxiety, and confusion about investing. This is both understandable, and unfortunate, because honestly the research is incredibly clear on the best way to invest. So with that in mind, we’d like to offer some completely unsolicited advice.

Legal disclosure: We are not Certified Financial Planners, and have no government licenses for providing investment advice. With that said, we are also not novices — Nick has a BA in Economics from a top liberal arts college, a Masters in Economics from the top economics department in the country, and a PhD in Political Economy from the top business school in the country, and Adriane has a BA in economics from a top undergraduate universities in the country, a Masters in Economics from the top economics department in the country, and a PhD from the top Political Science program in the country. And we’ve also had friends with similar background — including a Wharton Business School professor — read this over. So evaluate that as you will.

Also, a note on risk: Investing has risks, and as every investment ad you’ve ever seen will remind you, past performance is no guarantee of future returns. With that said, past returns are probably the best data we have to go on, and they suggest while the stock market can be volatile over the short term (3-5 years), it’s a very good and pretty safe investment over the long term (10-20 years) if you diversify your holdings, as suggested below.

How to invest well in three easy steps

The research on investing is really, really clear: no one can consistently pick stocks that will outperform the overall market, so focus on matching the market and minimizing how much you lose on taxes and fees.

This, thankfully, is really easy to do:

Put your money into one or two diversified index funds (single funds that effectively buy you a little bit of every stock in the stock market) that charge really low fees.
- There are a couple of these, but the absolutely leader in the world of low-fee index funds is Vanguard, and you certainly won’t do better than investing with them. Also, don’t pay someone to make this investment for you — they will charge you money and that defeats the purpose. Just go to vanguard.com.
When you have a chance to put money into an IRA or 401K, do it.
If you’re in a position to save, set up an automatic transfer from your bank to Vanguard to move a little money from your bank account into those funds every month. Other than that, don’t touch your money until you retire or want to buy a house. Never sell if the market is on a downswing — if anything, that’s the time to put in more money because stocks are cheap.

Yup, that’s it.

There’s more below if you have questions, including advice for people whose retirement funds are managed by their company, and some important notes on real estate (which is its own animal). But provided you’re under 50, if you just open an account an Vanguard, put your money in their S&P 500 Index Fund or Total Stock Market Index Fund, and put all the money you legally can into your retirement funds every year, you’re ~90% of the way to optimal investing.

For what it’s worth, we aim to keep about 70% of our money in Vanguard’s Total Stock Market Index Fund and 30% in Vanguard’s Total International Stock Market Fund. And that’s all we do.

What the Research Says

Investing in diversified funds that buy a little of everything then focus not on picking winners but on minimizing costs is known as “passive investing”.

There are two principles behind passive investing: (a) there’s no evidence anyone* can consistently pick stocks that will outperform the market (here, here, among many others), and (b) the fees people spend chasing stocks that will outperform the market make a big difference in overall returns. So just put your money in and do nothing so you don’t incur fees.

How big are fees? Fees usually come from two things: the hidden fees in the funds you buy, and the fees you pay to whoever is managing your money.

The average hidden fee in a mutual funds (referred to as the “expense ratio” of a fund) is usually about 0.7%, although there are funds out there that charge 1% or more. When you combine that with a management fee (if you’re paying someone to take care of your money) of something like 1% of assets, and you’re now losing 1.7% of your return. By contrast, if you put your money in Vanguard, you end up paying ~0.15% or 0.04% (fees go down if you invest more than $10,000).

That means if you hire someone to manage your money and they don’t put it in Vanguard funds, they have to earn returns that are 1.6% above the market just to break even. And like I said, there’s no evidence anyone can consistently pick stocks that outperform the market even before fees.

That may not sound like much, but if you were to invest $50,000 and save it for 30 years, Vanguard’s fund (7.18% growth) would give you back $400,297, while a 1.6% lower return (5.58% growth) would get you only $254,929. Yeah, compound growth is crazy.

And people are noticing. The Wall Street Journal just ran a long series on the movement of money into Vanguard and passive investment funds, which includes this wonderful chart that compares Vanguard’s passive funds to other funds over thirty years:

OK, but my company manages my retirement fund!

Yeah, this complicates things a little, but only a little. Basically, if your company manages your retirement fund, then they probably offer a little menu of mutual funds you can put your money in. Look at that menu, google the stocks, and figure out which has (a) a diverse portfolio (all the stocks in the S&P500 or all stocks in the stock market), and (b) the lowest “expense ratio” (that’s the term for fees). Then pick that one. Hopefully one is Vanguard.

But while your company’s control means you may not get the best choice of stocks, remember that retirement funds are GREAT from a tax perspective, and many companies will match money you put in your retirement, meaning if you put $100 into your retirement fund a month, your employer will put in $100 too. That’s 100% return instantly. So put in all the money they’ll match.

If this is true, why does my wealth management guy says he can do better?!

Here’s the problem: the financial services industry makes its money by charging you to manage your investments. So they have to say there’s stuff they can do to get you better returns, or there would be no reason to pay them.

(Also, many people who give stock advice also get kickbacks — it’s completely legal for them to tell you to invest in Mutual Fund A because its the best, then accept a share of the money you invest as a “referral bonus”. Sigh. The Obama administration make some progress on this, though the Trump administration would like to rollback back what it can.)

If you want to be mad at financial services but also laugh, just watch John Oliver.

But some people seem to outperform the market!

Yup. Warren Buffet gets amazing returns, and some hedge funds do consistently outperform the market. But they reason they’re able to do so is that they’re playing a game that mortals don’t get to play. They get inside information, use their huge wealth to negotiate special deals, or leverage small imperfections in the market that are real, but small enough that they can only enrich a small number of investors, meaning they’re only offered to a small number of very very rich people. If you have less than ~10 million dollars, just think of those people as being in a different world.

Don’t believe me? Just ask Warren Buffet himself, whose investment advice to his own children is to just buy the Vanguard S&P 500 Index.

But my financial planner showed me how (s)he can beat the market!

Did (s)he? A common trick is to say “we want to invest in this set of stocks. If we look back at the last decade, we can see they outperform the market”. But it’s easy to pick stocks that outperform the market in retrospect. The real question is “what were your after-fee returns over the last decade on the stocks you held at the time”?

When and How To Use a Financial Advisor:

As noted above, most people in the financial services sector should probably be avoided, but there is a growing industry of “fee-only” financial advisors worth considering hiring if you:

want to pay for a little peace of mind by making sure you aren’t missing anything (like a type of retirement fund you could be putting money into)
Are nearing retirement and want to figure out how best to start unrolling your investments to avoid taxes.
Are considering buying a house

So if you want an advisor, here’s what to look for:

Willing to sign a fiduciary agreement: a fiduciary agreement is a legally binding promise to provide advice on what is best for you, the client. If someone refuses to sign a fiduciary agreement, run.
“Fee-only”: I think the best approach for making sure someone is looking out for you is to use a financial advisor who charges a flat fee or an hourly rate to analyze your finances (these people will almost always also sign a fiduciary agreement). It’s clear, transparent, and ensures their only financial incentive is offering you the best advice. There are sites that provide lists of advisors who do this.
Someone whose investment advice is to use low-fee diversified funds. Like I said, the research is clear on this. If they think they can do better, run. I don’t know the person at this firm, but this is the kind of advice you want to see an advisor provide.

In summary, the value of a financial planning comes from figuring out how to minimize tax burdens and figure out how much money you need to save now to retire at a given age. If they focus on specific stock picks or mutual fund options, you don’t want them.

Real Estate

Full disclosure: Nick’s dad is a real estate agent!

If we were to summarize our advice up to this point, it would be “don’t pay people for advice, just go to vanguard.com and buy a diverse low-cost index fund.” The exception to this is buying your house, which is often a very good investment but unfortunately is much more complicated. So a few thoughts on real estate:

Investing in real estate is considerably more complicated than going to the Vanguard website and clicking buy xyz fund. There are many mine fields and legal intricacies involved in purchasing real estate. This being said, real estate can be an excellent investment, with long term predictability similar to the stock market, significant tax advantages, and the power of it being a leveraged investment. So, particularly if you’re at the life stage where you plan to be in one place for a long time, seriously consider buying.
Buying real estate on your own can be quite difficult though certainly possible. However, unless you are willing to put significant time into educating yourself about market trends, legal issues, and building construction you should probably enlist the services of a real estate agent. Keep in mind though that real estate agents, like many financial planners, do not necessarily have your best interests at heart. They get paid when a house gets bought or sold, not when the right house for you gets bought or sold. So choose your real estate agent carefully, and consider getting an independent source (like a fee-only financial planner) to offer advice on what you can and cannot afford.
The place where real estate agents and clients have the most divergent interests is in negotiating the price and closing the deal. A commissioned real estate agent gets ~3% of the closing price of a house. That means (a) they want to maximize the likelihood a deal closes (since they don’t get paid otherwise), and (b) they aren’t as price sensitive as you, the buyer or seller. The difference between paying $400,000 and $375,000 to you (the buyer) is $25,000. But for the real estate agent, the lower price means they’re actually paid $750 less. So real estate agents have an incentive to push you to accept deals quickly, so the deal closes and they get a commission. And yes, there’s research this happens.
Because of these issues of incentive-alignment, referrals from people you trust to other people you trust are really valuable. You can also check your state’s real estate licensing board for any complaints that have been filed against an agent.
One new option are salaried real estate agents, who bill by the hour and aren’t paid on commission. Companies like RedFin, for example, have salaried buy-side agents.
Be cautious in signing exclusivity agreements with one agent or brokerage. Agents often require some agreement before they are willing to invest in your case, but make sure there are terms allowing for you to rescind the agreement unilaterally under reasonable circumstances.