Here are the phases to investing that I’ve developed over the years.

Many authors have covered personal finance. Many more will follow. My approach may be more holistic than some. My goal is to find the best way to spend my time, money, and other resources. Note that I’m not licensed anywhere to give this kind of advice, so take this for what it is: rambling thoughts.

As a baseline, let’s consider: If you make $10k/year and put 10% into the general stock market, you would have $120k after 30 years. That’s enough to reliably draw $400/mo for decades. Double that if you made $20k/year. Double it again if you did that for 40 years. That’s the power of investing and interest over time. (Quick aside: Social Security takes more and doesn’t yield as much)

Returns on investment can take many forms:

• Learning
• Contacts and relationships
• Money

Ideally you should arrange your life so that you’re always developing all three. Primarily you do this through work. However, there will be times that you will have to venture out on your own.

General Guide to Income Allocation

• At least 10% to debt payments and investments (more if 10% isn’t enough to reduce your debt).
• At least 10% to tithe. You may believe this to be an irrelevant religious tradition, but it’s important that you actively seek out projects that you think are worth developing or investing in — even with little or no expectation of return. The returns could be measured in knowledge, connections, good will, karma. Paying taxes isn’t the same. It is important to do this intentionally. It is important to do this willingly. It prepares you for the later phases.
• At most 10% on entertainment. Some costs are required: housing, food, clothing, etc. Some costs save you time and are ultimately worthwhile. Some costs are extravagances. Identify and limit the extravagances. However, it’s important that this not be zero. A life without any entertainment is hard to live. Some people can do it. I can’t.

That leaves roughly 70% for the daily necessities. If your expenses
are less than that, you can increase the other buckets, but keep
entertainment at or below investments.

Investing Phases

1. Falling into the abyss – live within your means

If your debt is growing you need to get a handle on this fast, especially if you’re accumulating high-interest credit card or other unbacked debt.

If you have cable, drop it. If you’re eating out a lot, it’s time for ramen and PB&J. If you have toys you don’t need, sell them. In this financial state, you can’t afford ego or luxury. Get a better job. Get a second job. Reaching cash-flow neutral is absolutely paramount.

In this phase I would limit tithing and charity. You may be the biggest charity case that you know of. One wrong move, and you could be on the street. A great way to help others is to make sure they won’t need to help you.

You’ll be in this phase until your debt is no longer growing. In other words, your income is bigger than your expenses — preferably 10% bigger, but we’ll take what we can get.

2. Living on the edge – build the emergency fund

Your finances have stabilized, but there’s not much room for
error. Job loss, injury, or illness could put you in a very rough
spot. It’s time to build a buffer.

Open a bank account or some other stable fund and start saving.

You’ll be in this phase until you have enough in your low-risk account to cover 3 months of expenses. Make sure that you keep up with this as your expenses change in the future.

3. Drowning in debt – purge the leeches

Now that you have some breathing room we can focus more on long term finances.

In this phase, you have a large amount of unbacked debt. Credit card debt is some of the worst, but any debt above 7% interest is really bad.

Pay down the highest interest rates first and work your way down.

You will be in this phase at least until you have no interest rates greater than 7%. There is little point to investing anywhere else until this is accomplished. Your debts would eat your gains faster than any accrual aside from blind luck.

4. Work – develop your skills

Now that you’re out of serious debt your investments will have some punch. Now we can start building long-term investments. Open a brokerage account (Schwab has the lowest fees today), IRA, 401k or some combination thereof. Invest broadly in the stock market via ETFs or other funds — and then promptly forget about them. Your time spent working is worth far more than any effort to manage your meager investments.

Now is the perfect time to learn things. Learn how to do the job you’re doing. Learn how to do the job you want. Learn about finance, learn about business, learn about science. All of these things are worthy of your time.

If you’re in this phase and you’re young enough, you’re in really good shape. Time favors those who invest. If you’re not young, you may just expect to work longer. It obviously gets more difficult as you get older, but it’s usually something you can do. At the least you can be proud that you’ve significantly reduced the burden you would be placing on others if your life takes a wrong turn.

If you want to progress further, you’ll be in this phase until your total portfolio value is roughly 2x your annual expenses.

5. Long-bets – learn to manage wealth, carefully

You’ve been working and investing for a while and now you’ve built up a little wealth. Now we should learn to manage it. The experts may disagree at this point. The buy-and-hold strategy is definitely a strong one, but the world doesn’t run on people who sit around waiting for good things to happen. Just as in the last phase we developed our work skills and discipline and did something, now we will do the same with our wealth.

Pick one to five specific things to invest in and put no more than 7% of your total portfolio value into those. Then choose a target return of 2x-10x and hold on. Expect that you’ll be with these for at least 5-10 years. If they go under, try to understand what went wrong. If they hit your return target, sell them down to no more than 7% of total portfolio value and keep going… or choose something else.

I recommend choosing projects that not only look like they could eventually yield a return but that you also agree with in philosophy and principle. That way a complete loss could still be a justifiable attempt to make something worthwhile. Preferably, You would have domain knowledge around your investment. That way you have some way to expertly evaluate what you’re getting involved in. This is a great time to start a business, or support a friend in his.

You will be in this phase until your total portfolio value is around 25x your annual expenses. With any luck, good choices and due diligence will hasten your trip to the next phase.

6. Director – move mountains

Congratulations, your expenses are covered by 4% of your portfolio. You are financially free. This is effectively a retirement point. Many retirement advisors would recommend having a larger portfolio, but you’re in good shape regardless. Keep your expenses in check, manage your projects well, and you can take on enormous challenges.

At some point, subtracting long-bets portion of your portfolio still leaves you with 25x your expenses. Everything beyond 25x can be used for whatever you want. Open a restaurant, a comedy club, or a SpaceX.

Notes

The lines between these phases are fuzzy, but that’s roughly the outline. The limits to the phases are suggestions that can be moved one way or another depending on your willingness to take the risk.

Note that these phases are entirely dependent on your expenses.  The key to moving through the phases is to control those expenses. There will be points in life where your expenses will increase for good reasons. Children are a good example. Roll with it. There may be other times that your income will drop. In those times, you will be incredibly grateful that you only depend day-to-day on at most 70%. Do your best to bring it back down.

Why the numbers?

7% – This shows up a lot, and that’s because it’s roughly the long-term whole-market return rate once you’ve accounted for inflation. Historical inflation is ~3.3% and historical whole-market returns are ~10.5%. This means that the numbers in your account will appear to go up by roughly 10.5% every year (the swings can be large, so keep your hat on), while the buying power of each dollar will fall by about 3.3%. So if you’re withdrawing and spending more than 7% of your portfolio, even if the numbers appear to be getting larger, your ability to do things with your portfolio is shrinking.

This means that debt charging over 7% interest is worse than
neutral. You’re always going to be better paying off the debt
than investing those dollars.

2x-10x (long bets) – The point of these long bets is to let them amplify your portfolio growth. One of the worst things you can do is drop out of an investment early because it made you a few dollars. It makes the management of those investments expensive, and you’ll probably miss out on the biggest gains. You already have your base portfolio.

Keep in mind that at 10.5% per year, your cash amount will double roughly every 7 years. If your big bet takes longer to double, it’s under-performing.

25x expenses (long bets) – This is essentially a retirement threshold. Your expenses would be 4% of your portfolio. A general market portfolio will return ~7%, roughly 20% of that will go to taxes on withdrawal. That gives you 5.5% to live off of. If 4% covers your expenses, then you need to draw about 5% of your portfolio to cover it. Obviously the more you have, the better, but you’re in good shape either way.

Other Thoughts

Get married. Find a good partner and settle down. Yes, your night life will slow down — that’s the point. How to do this well is a topic for another day (and probably another author). Just like you can do more when you don’t have to hunt for food all day, you’re more effective when you aren’t frequently looking for companionship.

Casinos are a no go. Everything about them is designed to draw you in and take your money. Markets exist to turn wealth, ideas, and work into more wealth.

Control your expenses. Sometimes you can spend money to save time. Those are beneficial. There are many others that are just expenses. Drawing the line isn’t always easy, but think about it. Establish a rule for separating them and stick to it.

Never stop learning. Learn via your workplace, take classes on the side, or do a side-project that teaches you something. Outsource the things you know how to do. Do the things you don’t until you’re comfortable with them. Of course, you can’t do everything, so choose judiciously.

Start a business. It’s cheap and easy to fill out the paperwork. You don’t necessarily need an accountant or lawyer, but they can help you through the basics. Try to get revenue for your hobbies or try out ideas. When you have a real business idea, you’ll be more familiar with the nuts and bolts.

Government-supported accounts, like IRAs and 401k, have some tax benefits, but they make your money unavailable for the bigger projects you might want to tackle: entrepreneurship and large investments. Sometimes they’re worth it, like when employers offer matching cash. Keep in mind that government programs are subject to change without much warning and in ways that might not be legal if done by a business. For example, the Social Security program (not an investment account) publishes future payout numbers that aren’t going to be possible given impending solvency problems. It’s Bernie Madoff-level reporting that would mean a class-action lawsuit for a corporation.

While average returns from general stock investments are around 10%, their value can fluctuate wildly from year to year. If you can’t be invested in the general stock market for a period of 10-20 years, you may want to plan for a smaller return and hope for the best.

Extreme risk management. In really outside circumstances, you may want to hedge against your currency value crashing. It doesn’t happen often, but when it does, you may be in a world of hurt. Cash alternatives like other currencies, gold, or bitcoin could be useful in such a situation. In addition, if they end up performing well as assets, you can sell them down and put the proceeds in your portfolio (enormous gains for cryptocurrencies lately). There are a lot more considerations for holding and, more importantly, using backup cash-equivalents in emergencies which I won’t go over. See a survivalist channel for more details. Because of the extreme outside risk of this, I would keep these alternatives at less than 1% of portfolio value. They shouldn’t be expected to perform well.

It is cheaper to live now than at any point in the past. Doubt that? Check out humanprogress.org. People tend to balloon their lifestyles as their income grows, sometimes to the complete exclusion of their future. The rest of the world is more than happy to come up with ways to talk them out of their money, but that doesn’t need to be the case.