A few months ago I was helping a friend set up her investment account. As I was walking her through her options, I realized that the words coming out of my mouth sounded…obnoxious.
“You’ll want to make sure you have proper diversification. What’s your risk tolerance? These funds have good historical performance and the expense ratio is lower.”
She, rightfully, looked at me like she hated me. I hated myself. We had casually moved from an easy conversation over coffee to a jargon-filled diatribe on her best investing options. And I couldn’t get away from it. No matter how hard I tried to back up and start the conversation over, I had no words to appropriately describe where she was about to put her money. And since one of my biggest rules is to not buy things you don’t understand, I was failing her.
If you’re a seasoned investor and you have it all figured out, this isn’t for you.
But for the rest of us, this should clear things up.
I spent a long time trying to figure out how to explain investing in a way that didn’t sound like such a snooze. One morning as I was blending my smoothie, it dawned on me that this might be the perfect, simple analogy.
The Juice Bar
This is where the whole investing process begins. You walk into a juice bar and you’re ready to buy some juice. In investing terms, your brokerage is the juice bar (the big name companies like Vanguard, Fidelity, or Schwab and the newer arrivals like Betterment or Wealthfront). These juice bar brokerages don’t grow the fruit – they’re literally a place to buy the juice. They may also blend the juice in-house (ex: Vanguard) or buy juice from someone else (both Betterment and Wealthfront buy juice from Vanguard and sell it to you, adding on their own little twist).
Once you get into the juice bar, it’s time to pick your glass. The glass is just a vessel to hold your juice. An account is just a glass, nothing more. But you have a lot of different choices in the glass you choose. A few types of glasses you’ll see on the menu are:
- “Get 25% more free!”: This is what the sign for your 401k glass would say. If it’s being offered, this glass is usually your first choice because of an employer match. If you buy 12 oz of juice and put it in the 401k glass, your employer will throw in another 3 oz. Employers have different match amounts, so the % free would vary, but the basic idea is this: you get free juice. Who doesn’t like free juice?
- “Get a break on taxes”: This is what the sign for your IRA (both traditional and Roth) glasses would say. Amazing. If I can’t get free juice, I might as well get tax-free juice. There are some stipulations though, and two main ones are:
- 1: there is an income limit. If you make over a certain amount of income, you can’t pick this glass
- 2: there’s a limit to how much you can fill up this glass each year. You can only buy $5,500 worth of juice to go in this glass each year if you’re younger than 50. Even if you can afford $7,000 of delicious juice.
- “Super healthy, but regularly priced juice”: This is what a sign for your brokerage account glass would say. There are no special deals going on, but it’s better for you than buying a coffee or a glass of water (ie: it’s better for you than not buying a juice/not investing). Depending on your options, it might not be your first choice of glass, but it’s a great glass to have.
When you go to a juice bar they have a menu of different options for you to choose. You don’t walk into a juice bar and order straight apple juice. That’s weird. They have blends of different types of fruit or vegetables that when blended together are supposed to give you better results.
These blends of juice represent the funds that you pick. In this example, we’ll specifically use Index Funds (see this article for a more detailed description of Index Funds). For the rest of this article on juice, we’re going to talk about investing in the stock market, specifically.
Let’s say you pick the “Basket of America” juice from the menu. This juice tries to give you a flavor of every single fruit and vegetable that is grown in the US. That would be like a total stock market index fund. You get a tiny little taste of every single type of fruit and vegetable out there (or a taste of every single companies’ stock in America). Some might be good, some might be bad, but when blended together it tastes balanced yet refreshing.
You might also pick the “Small Fruit Smoothie” which would be a mix of only small fruit. No bananas or pineapples in here. That would be picking something like a small-cap (code for small company) index fund.
There’s the “International Cooler” which only blends fruit and vegetables not grow in the US. Or the “Tech” which only blends fruit and vegetables grown GMO or by tech companies.
The point is, there are a lot of different juice blends that you can pick from and each has different benefits.
Some blends have performed really well in the past. These blends might include traditional fruit and vegetables like apples & bananas. Some blends are rising stars (like blends with the “superfood” acai) – they don’t have a long history but could have a strong performance in the future.
Just like juice blends, there are so many different funds. Understanding how well each blend has performed and how likely it will be to continue performing well in the future is one part of your decision to buy.
And – good news for those of us who are indecisive – you don’t have to pick just one juice blend. In fact, you should pick more than one juice blend and have some diversity (investing word: diversification) in your account.
You may have guessed by now that the fruit or vegetable that goes into the blend is the individual company stock. One type of fruit or vegetable represents one company.
A question you might ask yourself here is “why are we blending the juice together? Why can’t I just have apple juice?” You can just have apple juice. Or kiwi juice. Or whatever single flavor of juice that you want. But what if the apple crop is horrible that year and the juice is disgusting?
You just wasted your money on it. If you had just a bit of apple juice in a blend, the apple might be horrible the but strawberry might be a stellar crop this year and it will even out the bad apple. Pick the blend. In the long run, it’s the safer bet. You can read about my mistake of picking the fruit, rather than a juice, and how it cost me $16k.
A barista or a bottle
One of my favorite juice spots in London has two options for your juice: you can buy pre-bottled juice that you can grab from the fridge or you can stand in line and wait for a custom blended juice for the barista. I always grab the bottled juice because it’s cheaper and it does the same thing as the barista blended juice.
You may have heard of the terms “active” or “passive” investments. When you’re picking a fund (your juice) you can either go with an actively managed mutual fund or a passive index fund.
The index fund is like picking up a pre-packaged bottle of juice. There’s nothing wrong with this juice. A lot of people drink this juice. But because it’s been pre-packed and doesn’t have someone concocting it each day, it’s cheaper.
The actively managed mutual fund is like ordering from a barista. He or she makes custom blends, hoping to get better results than what you’d get from a bottle. But to have the barista make the blend, they’re going to charge you a little more. Anywhere from 1% to 3% more. That doesn’t sound like a lot but add it up over the years and it’s a ton of money.
What’s even more interesting is that studies show the juice you order from the barista (the actively managed mutual fund) doesn’t perform any better than the juice you pick up off the shelf (the passive index fund). You can read a summary of one of the studies from Morningstar here.
Getting some help:
Figuring out what juice you want to order can sometimes be confusing. You might want a little help deciphering the menu and deciding what your juice priorities are.
There might be someone at the juice bar who can help you figure out your goals and decide what exactly you want to order. They can suggest juices to buy and other add-on items like protein bars or moon dust, to round out your whole purchase. When it comes to investing, this is what a financial advisor would do for you. They’d listen to your goals, and then suggest what juice blends (funds) you want to buy as well as what other products you should add to your basket (like CD’s).
To get that in-person, individual help they’re going to charge you a little more. They might charge you a flat fee or a percentage of your entire order. This is on top of the price of the juice you’re already buying.
If instead of a person to dole out advice, you were to go up to a computer, fill out a questionnaire about your goals and preferences, and get a list of things to buy, that would be like using a robo-advisor. The fee for filling out that questionnaire and getting a list of things to buy is cheaper than getting in-person help, with fees that usually range from 0.25% – 0.5% of your entire order. Again, this is on top of the price of the juice you’re already buying.
If you don’t take a survey and prefer to read up on the different benefits of different products yourself, you can buy them directly from the source: either the barista or the pre-bottled juice. If you’re buying pre-bottled juice and you know what you want to buy, you can go directly to a brokerage like Vanguard or Fidelity and purchase the juice (the index fund) out of the fridge.
The Long Game:
If you drink a green juice once, do you really get the health benefits? No.
The same goes for investing. The best benefits come over the long term. There will be ups, there will be down, but this isn’t a Wall Street movie. The majority of us aren’t in it for the (sometimes daily) ups and downs that come with investing. While there is no way to know that your investment will definitely make money, most financial experts feel relatively comfortable estimating long-term stock market gains at 7%. (Here’s the data to show that the historical returns have been 7%. Historical performance doesn’t predict future performance, but this is a decent indication that investing over the long term isn’t a bad idea.)
Since the financial crash, the market has gone up – a lot. But it’s good to remember that there will always be ups and downs even when you’re buying a blended juice (fund). That doesn’t necessarily mean that your long-term investing plans should change based on your short-term concerns.
Have I taken this too far? Do you hate me at this point? Here’s the TLDR version:
- Pick the juice bar: your brokerage
- Pick the glass: 401k, IRA (Roth or traditional), Taxable
- Pick whether you want a bottled juice or a barista blending: passive or actively managed
- Pick the juice: the funds or other products you think will be best for your health. You can pick it on your own, fill out a survey and have a computer pick it for you, or talk to someone about your goals and have them pick it all for you.
- Don’t pick the fruit: don’t pick individual stocks. There’s too much to lose.
- Things go up and down: don’t lose sight of your long-term strategy because the market will go up…and it will go down.
As with anything, there are nuances. People will pick apart details of decision making until you’re ready to completely give up and keep your money under your mattress. But if you start with really understanding the basics, and strip everything else out, talking about risk in your juice blend or fees from a barista make a lot more sense.
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