Investments Include More than Just Stocks
Keeping a Mix of Asset Classes is the Key to Diversification
Although you may have a diversified portfolio of stocks, this first step of Level Four advocates that you diversify across many different asset classes, not simply stocks.
So, what is an asset class? There are varying definitions in the investment world, but we define an asset class as a group of investments that have similar characteristics and behave similarly in the marketplace.
Some of the common asset classes include:
- Real Estate
- Stocks
- Bonds
- Commodities
- Cryptocurrencies
- Business Interests
- And many others…
The goal in Level Four is to stay diversified across many different asset classes. You cannot consider yourself diversified if all of your investments are in one asset class. For example, if you own a portfolio of excellent stocks for the long-term, that is wonderful. But you would certainly not be diversified across asset classes. Stocks are paper assets. You want to have hard assets as well, like real estate, precious metals. And how about some digital assets, like Bitcoin.
Even owning your own business is a great way to get diversified.
It’s Time To Redirect Your Systematic Savings Plan Towards Investments
Recall from Level One that you began building a systematic savings plan. By now, you are undoubtedly saving at least 15% of your gross income every single month. Prior to embarking on Level Four, you were directing this 15% into your savings, building a total savings reserve worth six months of your income. Now that you have established your savings reserve, this does not mean it is time to stop your systematic savings plan! Instead, you are going to continue this habit of saving 15% (or more) of your income from now on. This is a powerful new habit that empowers your future self — with your current paycheck. However, instead of keeping this money in a simple savings account, it is now time to embark on the exciting journey of investing.
In essence, your 15% savings from each paycheck will now be re-directed into investments from a variety of asset classes.
(Note: If an emergency/opportunity arises and you need to tap your six-month cash savings reserve, no problem! It could be a flat tire, a new roof on the house, or even a great investment opportunity. The strategy here is to simply redirect your 15% savings back towards your savings reserve until it’s worth six months of your income again. Once your savings reserve.)
This is also a good time to examine your retirement savings plan (if you haven’t already). If you have a 401(k) plan at work, you may want to begin or continue to put a portion of your income into the 401(k) plan, especially since it allows immediate tax savings and tax-deferred growth on your investment within the account. Many financial advisors recommend maxing out your 401(k), but we have a different opinion.
How Does Your 401(k) or IRA Fit into Your Investments?
A 401(k) itself is not an investment; it is essentially just an account that is regulated by the 401(k) section of the IRS tax code. If you have a 401(k) at work, you are able to contribute pre-tax dollars up to a certain limit ($17,500 for the year 2014). Furthermore, employers are allowed to match some or all of the contributions you make. For example, your employer may have a matching program in which they match your contributions dollar-for-dollar up to 3% of your gross income. Here’s an example of what that would look like if you earned $4,000 per month.
401(k) Contribution Example
- Your monthly gross income = $4,000
- You contribute $200 per month, or 5% of your income, to the 401(k)
- Your employer matches and contributes the max of 3% of your income, or $120
- Total employee and employer contributions for the month = $320
- Instant return on your money due to the match = 60% (a.k.a. ‘Free Money’)
Earlier we mentioned that most financial advisors recommend maxing out your 401(k). We suggest contributing enough to get the full employer match, but seriously consider other financial products for the rest of your retirement savings. Here’s why.
Remember that when you contribute to a 401(k), you do not have to pay income taxes on your contributions. The taxes are deferred until you reach retirement and begin taking distributions from the 401(k). This is great when it comes to tax savings, but not so great when it comes to control over your money. You see, a 401(k) is completely government-controlled. Try to collateralize your 401(k), and you will get laughed out of the bank. You may have $150,000 in your 401(k) now, but since you have not paid the taxes on this amount yet, you can not use it as collateral (unlike most other assets you own). And since the U.S. federal government is on a collision course with bankruptcy our country, it may be wise to think twice about placing most or all of your retirement savings into a government-controlled asset like a 401(k).
The Checklist
Before proceeding to the next step, be sure that you:
When you have examined this step, you are now ready to advance to the next step of Level Four which is to Remember P.A.C.E. for Inflation Protection.
