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.
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?
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
Glen @ Monster Piggy Bank says
I would probably manage 1 million the same as I manage my current portfolio. I would distribute it across property, shares, commodities, bonds and general savings accounts.
I don’ believe the sum of money really matters, but rather the percentage you allocate to each asset class.
[email protected] says
I certainly hope and expect to have to invest $1million. If you don’t then you are thinking too low. If you gave me $1million right now, I’d split it between real estate, US stocks, Foreign stocks, Bonds, Cash, and maybe I bit is something more out there like P2P?
I agree! A million dollars is probably a low target by a lot of standards (considering inflation). Good mix of investments.
John S @ Frugal Rules says
I hope that I’d be able to manage $1 million if and when we have it. You bring up a great point MMD about needing to look at those expenses and being mindful of the return…. .5% seems like a small amount, but it can be thousands of dollars which is not chump change (at least in my opinion.)
I don’t think you’ll have any problem hitting one million (or more)!
Jennifer Lynn @ Broke-Ass Mommy says
Yikes. With such an unpredictable economy unfolding, one really has to be on their toes and diversified in these turbulent markets.
I probably would spread my cool million around and invest: in a personal business, to further my education, a percentage plunked into strong dividend-yielding stocks, a chunk into practical real estate options, and then a healthy percentage into commodities, emerging currencies and meaningful community bonds.
The personal business idea is interesting: What would you start?
I think I would invest the whole thing in real estate. Stocks overwhelm me too much. 20 small condos that get $500 each after a little renovation, and an intern to oversee all that.
Another real estate mogul is born! Chances are you’d probably double your return a lot faster than my strategy would.
STEVEN J. FROMM, ATTORNEY, LL.M. (TAXATION) says
Great post. You have simplified a complex topic for those getting started. The keys are diversification, discipline, and consistently adding to your portfolio. Set up a tic tac toe board with nine categories of growth, blend, income and large medium and small cap funds and fill them in based on your risk tolerance. Add in some international funds and there you have the beginnings of a working cruise control investment plan. Also, Fidelity investments and other mutual fund groups have a question and answer set up to judge your risk tolerance to help build a portfolio. Learn, learn, learn and keep up in this area. It will all work out.
Thanks Steven, and welcome to the site! I think that your last part … learn, learn, learn … is really the key. The more you know, the less scared you are to make that leap of faith to properly manage your funds.
Jason @ WSL says
Ah…the positive and negative correlating asset classes. It’s something a lot of people don’t grasp but it’s important that you try to understand it so that you can know why you must really diversify across a spectrum of asset classes. Most people definitely aren’t diversified; fortunately the mutual funds that I’m in have been “scientifically”/mathematically engineered to help with the negative correlating assets and make sure you’re spread out across a myriad of things.
Those mutual funds sound pretty incredible. What are the names of those funds?
I think it depends when I get that million dollars. If I am still a ways off from retirement, I would probably keep a similar allocation to what I have now, and maybe add another asset class or two. If I was closer to relying on that money, I would definitely need to learn more about protecting the downside utilizing more advanced techniques.
It’s never too early to setup the fortress around you money. Who knows when that next down-turn will be and how far it will cause us to drop.
[email protected] says
Great post. It really scares me that the average person will have to manage their own money. The sad thing is though that there will be many without any money to manage at all.
My plan is to invest in equities, real estate, and my own business. With three different streams of income I’m hoping that I’ll be able to retire financially independent.
Good point, and a little sad. I’d love to think that a few of these posts will encourage people to at least save up enough to have this problem eventually.
You’ve got a good and straight-forward plan. I actually think the “my own business” may be the capstone.
Justin @ The Family Finances says
And to think that there are a ton of people that set up their 401k when they start their job and then never look at it again until retirement.
We just received our annual company match, which got people talking about their 401ks. I work at a bank with a lot of (you’d think) financial-minded people. But a lot of them had no idea what funds they were invested in, let alone what the expense ratios of those funds were. It’s sad really.
I don’t know what’s more sad – to hear about people working in the banking industry who don’t understand investments, or the general status quo of never paying attention to the details that contribute to a life’s fortune. The thing I always try to remind myself about these things is that despite all the buzz words and fancy terminology, its really not as complicated as the institutions would like us to believe.
I’d have it all invested in dividend paying stocks. A combination of international and US. That lump sum would allow me to hit my target goal of $50k/yr in dividends in one go!
Not even just a little bit in some cash or real estate?
Well written article, MMD! Your last 4 points succinctly summarize your wisdom.
Thanks Shilpan! I really do appreciate the compliment and encouragement!