- In this video, I'm going
to show you four things that you need to consider before
investing your next $1,000, but technically, I guess you
need to consider these things before investing any amount of money. Knowing this will help prevent you from making an irreversible mistake that could cost you the sweet, sweet cash you've worked so hard for. Understanding when you are
going to need the money you are about to invest is one that I see trip up a lot of people. You think stock market and picture this. So it feels like a no-brainer
to just invest the money, when in reality you
should also be taking this into account as well. Timing is everything with investing, and getting the timeframe
wrong could cost you money that you cannot afford to lose. I have a patent pending 3 Bucket Guideline for thinking about whether
or not to invest money based on when you need it. The first bucket is for
money needed anywhere between zero and five years. I personally think there's a 95% chance that you should be
arrested and thrown in jail if you invest money that you
need within this time period. But lucky for you, I don't make the rules. Since 1926, the stock
market ended the year with a negative return at 27% of the time, and it wasn't uncommon
to have multiple two and three consecutive years
with negative returns. The largest one year drawdown
was 43% back in 1931, followed by 37% in 2008 and 35% in 1937. If we move further out this range, 6% of five-year rolling periods since 1926 ended with a negative return as well, with the largest drawdown being 8%. You could absolutely be
one of the lucky people who got a 28% average annual return during the five-year rolling
period that ended in 1999. But you could also be
one of the unlucky people who got a negative 8%
average annual return during the five-year rolling
period ending in 1932. In my opinion, the juice
isn't worth the squeeze when we're talking about investing money for short periods of time,
like zero to five years. Your money is probably better off in a higher interest
savings account instead. For the people thinking about investing in the second bucket, I
think there's a 60% chance that they should be
arrested and thrown in jail. It is the six to seven year range. I put this in the gray area of
possibly invest. Here's why. Over the past 92
seven-year rolling periods, there was only one that
ended in a negative return. I know 1% of seven-year rolling periods, it doesn't seem like a lot, but remember that there's no free lunch when you invest in the stock market. You still would've had
to endure multiple years with negative returns within different
seven-year rolling periods. From 1928 to 1934, five of those seven years were in the red. From 2002 to 2008, two of the seven years
ended in a negative return, but those two years were large drops. Behaviorally, could you
stomach sitting there watching your money disappear? In theory, most people would say, "Yeah, I can definitely handle it," but reality is a whole different story, especially when the money might be needed for a very emotional purchase, like a home or a car
or your kids' college. "Sorry, kids, you can't go to college 'cause daddy over here decided
to gamble all your money in the stock market." - Good, great, grand, wonderful. No yelling on the bus. - When you get to this
six to seven year bucket, I always like to say that
if you invest the money, you have to be willing to adjust your plan if things happen to be down
by the time you need it. If not, then a higher
interest savings account is going to be best. I'll show you a real life example of how to adjust your plan in
just a minute, so hang tight. The third bucket is the
eight to 10 year range, and I'd also put this one in the gray area with a little more nuance. There's only a 10 to 20% chance these investors should be
arrested and thrown in jail. Over the past 89 10-year rolling periods, we didn't see anyone end
with a negative return. As with all other rolling
periods we've talked about, you still would have to endure two, three, and sometimes four consecutive
years with negative returns. So your personal risk tolerance needs to be taken into account here. But you'd also need to be able to handle some 10-year rolling periods
with smaller returns. There were a few times since 1926 where the average annual
returns were less than 5%. So if you're someone who
is trying to do the math on how much your money would turn into over the next 10 years,
then I'd highly recommend not using the most recent
10-year rolling periods to determine that number. Instead, you're probably better off picking a middle of the
road average annual return as well as an optimistic
and pessimistic return to see the different outcomes. The compound interest calculator
on the investor.gov website lets you do this exact thing. You could do a projection
assuming a 7% annual return with a plus and minus 2% variance. Of course, I hope you get returns on the higher end going forward, but if it doesn't work out like that, then how screwed are you going to be when you need this money in 10 years? And if you don't need the
money for more than 10 years, then I think 99% of people would agree that you could probably just invest it. Here's what I mean when I say that you have to be
willing to make adjustments if you invest the money and
things aren't going to play. Since 2018, I've been
investing every single month for my next car. All of the detailed math is
broken down in another video, which I will link in the description. Below the TLDR is if I buy
a car every seven years, then as long as I invest $250 per month, then I'll have enough to pay cash for it. I revisit the plan each year just to make sure everything
is going accordingly. Now, earlier last year, the
math told me that I was behind based on updated car market conditions. So I either had to make an adjustment to how much I was investing every month, or I had to add an extra year onto when I would buy my next car. I decided to make an adjustment by investing a lump sum
of $1000 into the account as well as increase my
monthly investment to $275. A change in market conditions and your returns could throw
this whole plan out the window. If the money is needed for
something like a home purchase and your significant other wants to buy in, say, seven years,
then would you be okay with pushing out that home
purchase for another year or two so your investment account
can hopefully recover? The last thing you want
is to invest the money, not run the upside and downside
numbers by your partner, then have to break the
news to them in seven years when he or she was
expecting to buy a home. "Oh, hey, sweetheart,
about that house I told you we could buy this year,
yeah, that's not happening because I decided to gamble
with some of our money." Probably not a smart thing to do if you wanna stay in that
relationship, and if you don't, then I guess this is one
way to get rid of them. After you figure out the when,
then you need to figure out where you're going to invest the money based on your planned asset allocation. Asset allocation is going to tell you how all of your money is broken down at the individual investment level. So if you have a million dollars invested, then this might be how
the money is broken down across different types of stocks, index funds, bonds, and cash. Here's the problem though,
most people have no idea how their money is broken down and they don't have a
target asset allocation that they're trying to achieve. Vanguard reported that research has shown if you have a diversified portfolio, a whopping 88% of your experience can be traced back to
your asset allocation. This would be an example of a simple, globally
diversified asset allocation. As time goes on, those
percentages will go up and down because of the price of each investment within those categories will change. If this is what your asset allocation looks like after one year and you want it to be closer
to your target allocation, then one way to fix it is to
put the new money you invest into the categories that have dropped. So in this case, I might
throw the next $1,000 I invest towards the US stock funds to get the allocation back
up to these 70% target. Now, if all of your investments
were in one account, then this would be easy to do. But if you're like me
and most other people, then over the years you've
accumulated multiple retirement and taxable investment accounts. When this is the case, you wanna think of your overall asset allocation across all of your
investment accounts combined. A few years ago, I personally got annoyed that there wasn't a way to
manage all of my investments across all of my accounts to make sure my overall asset allocation wasn't too far out of whack. So I created a tracker
for myself to handle that. If you want a free copy of the spreadsheet as well as a private video
where I walk you through it, then I'll have a link in
the description to get it. Once you figure out your
investing time horizon and where the money needs to go based on your asset
allocation, you've gotta decide whether you wanna lump sum
invest or dollar cost average. Lump sum investing just means that you invest the full amount one time, then move on with your life. Dollar cost averaging means taking that large chunk of money, then spreading it out over
a certain amount of time. Sometimes we are forced
to dollar cost average based on when we are paid, and sometimes we have a chunk of cash that could all be invested at once, so we need to decide what we wanna do. When I have a larger chunk of money like I did at the beginning of this year with my $7,000 Roth IRA contribution, I chose to invest all of it at once, yes, even though the stock
market is pretty close to historic all time highs. Let me show you why this is my preferred
method whenever possible. PWL Capital released a paper comparing dollar cost averaging
versus lump sum investing to see which one ended up better off. They did this for different
10-year rolling periods across six different stock markets, going all the way back to 1926. Based on what I mentioned
earlier in the video, you already know how
I feel about investing for less than 10 years, so this data is relevant
for my diversified, long-term index fund investors out there. The rules were that they either invested the lump sum all at once,
or they took that lump sum, then dollar cost averaged
it out over 12 months. Roughly two thirds of the time lump sum investing would've
left you with more wealth compared to dollar cost averaging. The average annual return
difference between the two showed that lump sum
investing came out ahead by the percentages you see on screen now. But this is just the average. They dug down into the
details a little bit more to give us additional insight into the range of
possible return outcomes. They found that in the
bottom 10% of outcomes, dollar cost averaging
worked out in your favor, and the upside of the top 10% of outcomes was a lot higher with lump sum investing. When we look at the median return, which removes the extremes, it shows that the annualized returns are still in favor of lump sum investing. What about doing lump sum
or dollar cost averaging when there's a bear market
or when the stock market is considered to be historically high? They found that in bear
markets lump sum investing produced better outcomes most of the time. When stocks are considered to
be at historic all time highs, lump sum investing also produced better
outcomes most of the time. Even though lump sum investing seems to be the no-brainer
choice, here's the thing. As I always like to say on this channel, we are not some numbers in a spreadsheet. We are humans who live in the real world with feelings and emotions. Yeah, if your house burns down tomorrow, then sure, you'll be able to
get it replaced with insurance, but that's still gonna mess with you on a pure emotional level. It's the same thing if you lump
some invest a large amount, then see it get cut by 35% shortly after because the market went
down for whatever reason. You're going to want to take your personal psychology into account before choosing one way or the other. Even though historically and based on math lump sum investing seems
to be the better option, it might be worth missing out
on that slight outperformance to help you sleep better at night. I used to be one of those
dollar cost average people in the past because I wasn't sure how I would react emotionally to a sudden drop shortly after investing. Now that I'm more experienced and understand my personal emotions and psychology a lot
better, I have no problem lump sum investing
larger amounts of money. But if this isn't you or you are not sure, then there's no shame in
just dollar cost averaging or doing a hybrid approach
where you lump sum half of it, then dollar cost average
with the other half. Trust me, there's a lot worse things that you could be doing, like heavily investing for
dividends before you're retired. One thing I would beg you
to do is continue investing even when the stock market is down. This is the time we see
a lot of people slow down how much they're investing, when in reality, it is the best time to continue putting money into the market since prices are low. Sometimes we get so caught up in saving and investing for the future that we forget to live for today. So before you invest that money, I want you to think about
if it could be spent in other areas to either
improve your lifestyle or save you time. For example, I've done
this over the past year by getting five gallon jugs
of Mountain Valley Water delivered to my house
a few times per month, which saves me time and
improves my lifestyle. I pretty much only drink water, so I consume an insane amount
of it every single month. I could be investing that
$300 per month for the future, but I've already run the numbers and I am ahead on saving for retirement. If you wanna run the numbers for yourself to see where you're at
with saving for retirement so that you know if it makes sense to spend the money to
improve your lifestyle, then there are two tools that
I like to help you with this. The first is Empower, which is free. They let you link your
investment accounts, then run some future projections to see if you'll have enough money and when you'll run out of money. If you wanna get a more accurate picture with a lot more detail
compared to Empower, then the second retirement
planning tool I personally use is called NewRetirement. This is my go-to,
trusted tool to make sure that I'm going to have
enough money when I retire. There is a yearly fee for this one, but it's the best
retirement tool I've found for do-it-yourself investors. I'll see you in the
next one, friends. Done.
