Thread by @bdc

💸 Thread: Step-by-step guide to successful low-cost investing in the US with Vanguard.

Establish an emergency fund. Before you start investing, the priority is to pay off any debts and save about 6 months worth of expenses in case shit happens. Keep this cash in a high-yield savings account or a treasury money market fund such as VUSXX (investor.vanguard.com/mutual-funds/p…).

(Treasuries are exempt from state taxes, so they might yield a bit more after taxes than a regular savings account depending on your state and tax bracket.)

Start early. The earlier you start investing, the more you'll benefit from the magic of compounding, aka "the eighth wonder of the world" (e.g. it's better to invest $100 every month than a lump sum of $1,200 at the end of the year). Try investing at least 10% of your income.

Define your asset allocation. Your portfolio will essentially have two core asset classes: stocks and bonds. Stocks are the high-risk, high-reward component of your portfolio while bonds give it some stability. Over time, stocks tend to outperform bonds, but it's a rocky path.

You should be prepared to see the value of your stock allocation drop significantly at any point in time. If you can't stomach the stock market's inevitable volatility, you shouldn't be invested in the stock market at all.

Now, if you *do* accept this volatility and stay the course when the markets go south, you'll likely be greatly rewarded. The total stock market averaged a whopping 14% annual growth rate over the last 10 years. That's a pretty satisfying return for doing nothing.

Assessing your risk tolerance is hard but critically important. Most people overestimate their risk tolerance, especially given this 10-year bull market. It's much better to have a conservative stock allocation if it prevents you from panicking and selling when markets crash.

Add 10 to your age. That's roughly the percentage you should allocate to bonds in your portfolio. The rest should be in stocks. So if you're 30 years old, I recommend you invest 60% in stocks, 40% in bonds. That's fairly conservative, but it'll help you stay the course.

(Staying the course is the most important thing you'll have to do to be successful with your investments. Virtually everything else is secondary. Buy stocks frequently and hold them ~forever. Don't look at the value of your portfolio too often. Ignore financial news.)

After you determine your asset allocation, you have to determine what those assets actually are. We'll start with stocks. This is quite simple: VTWAX is the only fund you need (investor.vanguard.com/mutual-funds/p…). It's extremely diversified and cheap, and it's simple. Simplicity is key.

Alternatively, if you're in the highest tax bracket, you could replace VTWAX with 55% VTCLX, 40% VTIAX, and 5% VTMSX. It'll be slightly more tax-efficient but it adds complexity. You should avoid complexity. As Bogle said: “Simplicity is the master key to financial success."

Now, bonds are a bit more tricky. There are different types of bonds and different types of risks. There are also different tax considerations depending on the bond placement (taxable vs tax-deferred) and the tax bracket. I'll focus here on taxable accounts as they're trickier.

It's important to understand a little bit what bonds are and how they work. Bonds are essentially loans that *you* make to a company, the government, etc. in exchange for an interest rate that's typically higher than what you can get from a traditional savings account.

Now, just like with stocks, the riskier the bond, the greater the potential return. The risk of a bond is measured by its credit quality and maturity. A long-term bond issued by a sketchy company will likely have a high yield, but that shouldn't make it attractive to you.

Remember that bonds are for safety, so you should generally be very conservative with them. For instance, if you loan money to the US government, you're pretty much guaranteed to be paid back (and if the US government can't pay anymore, we have bigger problems).

The other risk is duration. Longer bonds usually pay more, but they're more sensitive to interest rates. If interest rates go up, the price of longer bonds will fall significantly more than shorter bonds. Overall, an intermediate duration (~5 years) is usually the sweet spot.

So, you now know that you want high-quality bonds (called "investment grade") with an intermediate duration, but you still don't know what type of bond you want. The answer to that will depend on your taxes.

If you don't pay a lot of taxes (i.e. tax bracket under 32%), you can either go with VBTLX (investor.vanguard.com/mutual-funds/p…) or CDs (certificates of deposit). CDs are a bit safer (they're usually FDIC insured) but they're less liquid and convenient. I'd personally favor VBTLX.

If you're in a high tax bracket, municipal bonds will likely yield more after taxes. State-specific bonds are the most tax efficient as they're exempt from both federal and state taxes. For example, if you live in CA, VCAIX would be a great choice (investor.vanguard.com/mutual-funds/p…).

(By the way, Vanguard often offer "Admiral Shares" of their funds, which are the same funds at lower costs but higher minimums. So, for example, if you have $50k, you can use VCADX (investor.vanguard.com/mutual-funds/p…) instead of VCAIX mentioned above.)

National munis such as VWITX (investor.vanguard.com/mutual-funds/p…) are another great option. They're only exempt from federal taxes but they provide additional diversification. Some people (like Dr Bernstein) suggest to split the muni allocation between national and state-specific bonds.

If further diversification and safety is desired, you should consider treasuries such as VSIGX (investor.vanguard.com/mutual-funds/p…). They're exempt from state taxes and the default risk is basically null. As usual, since the risk is lower, you should expect a lower return as well.

The last type of bonds I'd like to cover are TIPS. They're like treasuries, but they protect you against unexpected inflation. If your stock allocation is relatively low (< 50%), about half of your bonds should be in TIPS. VTAPX would be a great option (investor.vanguard.com/mutual-funds/p…).

Now, keep in mind that all these bond considerations are relatively minor optimizations (I heard engineers like those). If you don't want to think about it, just use VSIGX and you'll be fine. The real growth of your portfolio will come from your stocks, not your bonds.

Example:
- Age: 30
- State: NY
- Tax bracket: High
- Risk tolerance: Moderate

Recommended portfolio:
- 60% VTWAX
- 30% VNYTX
- 10% VSIGX

10-year annual growth rate:
7.1%

Example:
- Age: 20
- State: TX
- Tax bracket: Low
- Risk tolerance: High

Recommended portfolio:
- 80% VTWAX
- 20% VBTLX

10-year annual growth rate:
8.3%

Example:
- Age: 45
- State: CA
- Tax bracket: Highest
- Risk tolerance: Low

Recommended portfolio:
- 20% VTCLX
- 15% VTIAX
- 5% VTMSX
- 30% VTAPX
- 15% VWITX
- 15% VCAIX

10-year annual growth rate:
6%