While a million dollars might not have the purchasing power that it once had, it is still a large sum of money. If you watch professional sports on ESPN, follow entertainment gossip on TMZ, or read Forbes, you are sure to come across stories about the huge salaries that some high-profile people earn. NFL quarterbacks earn over $25M per year. Hollywood actors earn over $22M per movie. The CEO’s of the Fortune 500 earn 600 times more than the average employee. The late Dr. Thomas J. Stanley would refer to those people as the “glittering rich”. Compared to the salary that the average person earns, those people are more along the lines of a rare commodity. While it is interesting to pay attention to what those people earn, it is not something that the average person should use as a benchmark of their financial success.
Today, the average household salary in the U.S. is about $58,000. With that being the current financial situation, having one million dollars would be a game changer for most people. It would not be enough to live as the rich and famous do. It is enough, however, to give the average person some financial freedom and peace of mind.
One million dollars is seventeen times the annual earnings of the average household salary. Many financial experts consider having 25 times your annual expenses in savings to qualify as being financially independent. If you had one million dollars, you would be well on your way as long as you do not drastically upgrade your lifestyle.
How would I suggest that someone invests a million dollars? For me, I like to follow a keep it simple approach. The core of the portfolio should be largely invested in stocks. Stocks are important for growth and keeping ahead of inflation, I also believe that there should be some fixed assets in a portfolio. Bonds are useful to reduce the market volatility that comes with investing in stocks.
How should you construct this portfolio? You should consider your age and your risk tolerance. A young person has more time to recover from a major market correction than a person who is retired and is drawing down money from the portfolio to pay for living expenses. The second factor to consider is how much of a loss can you can tolerate before you sell off your equities at the wrong time. If you can stomach a 50% loss in value, consider investing 100% the money in stocks. If you are more risk adverse and think that you could handle a 20% loss in value, consider a balanced portfolio of 60 invested in stocks and 40 percent invested in bonds.
Jack Bogle suggested that an investor should subtract their age from 100 and that would equal how much they should invest in equities. For example, if you are 25 years old, you should have 75% of your portfolio in equities. If you are more aggressive or not a fan of the current bond yields, subtract your age from 110 instead of 100.
While bonds might not be an attractive option for growth, they do serve a role in almost every diversified portfolio. They allow investors to buy low and sell high in the form of rebalancing. If the stock portion of a portfolio has a negative return for the year, an investor can exchange money from the bond portion of their portfolio and take advantage of buying stocks low while selling bonds high.
I am not a financial planner or a professional investor. I can only share my experience, what I have learned, and what I hope to achieve as an investor. When I was a new investor, I held 100% of my portfolio in stocks for over ten years. That period included three years of negative returns from 2000 until 2003. I have also followed the rule of 110 minus your age in equities. By adding bonds to my asset allocation, it helped to smooth out the market volatility of the great recession.
Since the purpose of this post is to give advice on how to invest a million dollars, I would suggest the Sweet Dreams Portfolio. The Sweet Dreams Portfolio is my current asset allocation. It is a balanced-growth asset allocation of 65% in stocks and 35% in bonds. This portfolio allows you to own every U.S. and international stock including emerging markets. It is based on 110 minus the average age of my wife and myself in equities. Let’s examine the growth and performance of one million dollars over the course of the past 20 years.
The Sweet Dreams Portfolio
Vanguard S&P 500 or Large Cap Index Fund = $380,000
Vanguard Extended Market or Small Cap Index Fund = $110,000
Vanguard Total International Stock Market Index Fund = $160,000
Vanguard Total Bond Market or Inter-Term Tax-Free Bond Fund for a taxable account = $350,000
20 Year Performance
5-years = 8.16%
10-years = 6.82%
15-years = 6.88%
20-years = 7.18%
Best Year = 23.93%
Worst Year = (23.32)
$1,000,000 grew to = $4,188,631 (Rebalanced Annually)
Average Expense Ratio = 0.06% (Admiral Shares)
Dr. William Bernstein wrote “that if you won the game, quit playing”. While a million dollars might not be enough to declare victory for everyone, it is a nice lead to have. For me, I recommend holding on to that lead by running the ball and playing great defense. To translate that football analogy into financial advice would mean to shoot for a nice conservative return of 6.8%. That would enable you to double your money about every decade.
This post was entered into the “How to invest a million dollars” contest.
Please visit www.howtoinvestamillion.com to check out all of the sample portfolios.
Please remember to check with a financial professional before you ever buy an investment and to read the Disclaimer Page.