How to Invest a Million Dollars and Why You’ll Need to Know How Someday

If you had a really large sum of money, would you know what to do with it? Would you really?? This might seem like one of those “pass the time” type of discussion topics, but I’m afraid that sooner rather than later a great deal of us are going to need to know how to invest a million dollars or so. It will be kind of like handling a bazooka and not really being sure what to do with is. Why do I think this will be happening?

… Because it already is. Do you have an employer retirement plan like a 401k, or do you still have a pension? If you said 401k, you’re probably in the vast majority. Like it or not, pensions are a thing of the past for most people, and with it deferment of letting someone else try to figure out how to manage our life savings in a way that will make it last forever. Even though some people criticize the 401k system as a ridiculous approach to retirement, that’s the hand we’ve been dealt and now it’s up to us to make sure we’re doing everything to the best of our abilities. That doesn’t just mean simply the act of saving, but also HOW we invest what we save.

Having almost achieved a net worth of $500K myself, I can’t say that it doesn’t at least bother me just a little bit to know that I’m the one driving this train of money. I have a lot of confidence when it comes to money. I handle it well. Heck – I even run a money blog about it!

But at the end of the day, do I REALLY know if I’m doing everything the way I should? Not to mention that as I continue to save and invest, the stakes are only going to get higher with every move.

Sure I could hire this out to a financial advisor (which I have full respect for), but then I’d have to surrender something like 2% of my assets each year in fees. For $20,000 (2% of one million), I think I could put forth some effort to try to figure this out for myself. Nobody cares about my money quite like I do.

And since I believe that you – my loyal My Money Design reader – are interested enough in personal finance to read about, then chances are that you’re probably going to have this same problem soon as well.

So as the masters of our own universe and ready to take on the challenge, what are we going to invest our million dollars in way that works for us? In a way that protects our fortunes and has sustainability?

The Details Will Matter:

The first thing to know is that you’ll have to mind the details. All those itty-bitty differences in percentages that people always talk about will matter.

For example, when someone gives you the option to choose between two mutual funds with expense ratios of 0.5% or 1.0%, how much will it matter?

When you’re just starting out and your retirement balance is only $10,000, that’s only a difference of only $50 or $100 bucks per year. Big deal…

But now what happens when you’ve built your fortune up to one million dollars? Now we’re talking about a difference of $5,000 or $10,000 per year. Given a $5,000 annual difference, I’d say it would be worth it to take a little extra time to consider if that 1.0% expense fee is really worth the return you’re getting.

The same thing goes for your investment returns. How badly can a few percentage points amplify your account balance? Well, let’s say the stock market has a good year and returns an average of 10%:

• In the beginning when you’ve only got $10,000, that’s an increase of $1,000. That’s cool, but nothing to get too excited over.

• Fast forward a few decades from now when your modest $10,000 has grown into one million dollars. Now that 10% growth is a swing of $100,000!! WHOA!!

• Alternatively, if you pick the wrong investment choices, that could be a DECREASE of $100,000! OUCH!!

My Point: We need to be VERY CAREFUL about what KINDS of investment choices we make. Otherwise, we could inadvertently leave ourselves open for huge losses or missed opportunities for massive gains!

So what can we do to protect the money we’ve worked so hard for and make it last as long as possible?

Your Asset Selection Will Determine How to Invest a Million Dollars:

One of the great things about being a student of financial education is that from time to time you get to read something that shows you how everything you’ve thought you were doing right up to this point was probably all wrong. Here’s what I mean by that …

A few months back I challenged myself to write a post about how to retire on $500K. It wasn’t the prettiest retirement, but I think it could be done. In a nutshell, my advice went like this:

1. If possible, put the money into tax-sheltered accounts (like IRA’s or annuities) to reduce the expenses from taxes.

2. Pick stable investments with low expense ratios that return close to the 8% market average (such as Vanguard mutual funds that invest in stocks and bonds). Don’t try to get cute and beat the Market Index Funds – you won’t be able to over the long haul.

3. Withdraw no more than 4% from your investments each year to cover your living expenses.

Sounds pretty straight-forward, right? So fast forward to now when I posed the same question to myself of how to invest a million dollars. I figured my answer would be pretty much the same.

But that was until I started reading something that got me thinking that I may have been overlooking a whole other aspect to this whole question. In fact, I realized that if you’re only investing in stocks and bonds, you may be doing yourself a GREAT disservice.

Recently I started reading the book The Little Book that Still Saves Your Assets by David Darst, and it really opened my eyes as to how UN-diversified we really are when it comes to traditional investing. His argument throughout the book is that in order to really protect your fortune, you need to consider investing in different asset classes that move in cycles that may be out of phase with one another, or not dependent on the other ones at all.

For example: Even though you may invest in US stocks and the markets turn downward, it’s possible that some of your foreign investments may be going up (and so on). So now rather than having a portfolio that’s completely in the red, you’ve got a “hedge” against the market downturns. That might not sound all that important, but think about when you retire and you’re living off that nest egg of yours. You’re going to feel a whole lot better about it when it’s showing overall positive gains rather than negative ones!

Darst does a great job of summarizes the various advantages and disadvantages of each of the asset classes so that you can craft together a portfolio that leverages them (see the tables presented in pages 63-67). Here’s a recap of the main asset classes he discusses:

• US / Canadian equity

• Europe equity

• Developed Asia equity

• Emerging Market equity

• US fixed income

• US short-term debt

• High yield debt

• Developed non-US debt

• Emerging market debt

• Real estate and REIT’s

• Real assets

• Private equity

• Managed futures funds

• Hedge funds

• Inflation-linked securities

• Cash / cash equivalents

Going through each and every one of the characteristics of these assets classes is WAY out of the scope of this post (hence why Darst was able to write a whole book about it). But I did give some thought about how I could apply this to my own unique situation and diversify my assets.

To create that proverbial “moat around our castle” (if you will), we’ll need to find the right mix of ingredients to use for our investments: Some for growth, some for stability. Some to protect against inflation, some against deflation.

Therefore, I can modify my previous advice above for $500K and mature it for this scenario.  Here’s how I would invest a million dollars:

• US / Canadian equity – Inflation hedge and growth exposure

• Europe equity – Inflation hedge and growth exposure

• US fixed income – Produces stable returns

• US short-term debt – Products stable returns

• Real assets – Doesn’t track US markets

• Managed futures funds – Volatility and currency hedge

Of course these are just my picks based on my preferences. Your breakdown may be completely different. And as always, before I made any moves whatsoever, I’d want to really look at the specific financial performance of the funds that I was going to go with.

Summary: 

In summary, I do believe that many of us will be challenged with task of handling some large of sum of money someday. It might be a million dollars; it might be more! But what I’d hate to see is that you get this far and then make a few wrong moves that sabotage your whole financial future. Therefore:

1. Use tax advantaged accounts where you can

2. Mind the fees

3. Pay attention to the potential returns

4. Diversify your assets keeping in mind that each one will have a specific purpose for improving the longevity of your portfolio.

Readers – Would you know what to do if someone asked you how to invest a million dollars? How would you break up the money across the different assets to make sure you stay protected?

Related Posts:

1)      Retirement Income Strategies for My Money Design – November 2012 Update

2)      Rethinking My Strategy for What Stocks to Buy This Year

3)      My Picks for Vanguard Mutual Funds for Our Roth IRA

Image courtesy of David Castillo / FreeDigitalPhotos.net