How should I invest in an AI-first economy?
As a Data Science Consultant, I get asked this question quite often. Surprisingly, my advice for investing in the era of AI is identical to my pre-AI investment advice. The only difference is that investing in our economy is now more important than ever as returns to labor continue to decrease and returns to capital continue to increase.
Please note that I am not a financial advisor and I do not offer any financial services. However, because I get asked this question so often, I decided to document my top 20 investment tips that I’ve learned over the past few decades. These tips come from various courses, books, articles, and the FIRE community.
My investment strategy is as follows:
First, you need to know how much money you actually need to live comfortably in retirement. A good practice is to take your average annual expenses and multiply by 25. This is how much money you would need in your investments to safely withdraw 4% each year in retirement. Ask yourself, how much is enough? Otherwise, the default answer will always be “more”.
Before you can begin investing, you need to have money to invest. One of the best ways to do this is to minimize your expenses. Most people spend a surprisingly large amount of their monthly income on unnecessary or wasteful expenses. So, analyze your monthly expenses and identify places you can reduce. Minimalism is the key!
Taxes eat up around 30% of the average American’s annual income. While we are required by law to pay our taxes, we are only required to pay what we legally owe. Don’t pay any more than you’re required to pay by claiming every deduction possible. Remember: Tax avoidance is good; tax evasion is bad.
Businesses are one of the most financially lucrative investments out there. They can provide you with an income stream that is not dependent on an employer. They also provide you with a wide assortment of tax deductions that are not available to the average employee. Even if it’s just something small (like a for-profit hobby) and only earns you a modest income, start a small business and leverage the tax advantages.
The best investment you can make is an investment in your education and career. Getting a college degree, an advanced degree, or professional training is one of the best ways to maximize your lifetime earning potential. However, it’s important that your skills are valued by the labor market so that you will be compensated accordingly.
Most people only make money 8 hours a day when they are working at their day job. However, the most financially successful people learn how to make money 24 hours a day — even when they sleep. Passive investments like index funds, real estate, appreciable assets, etc. allow you to do this.
The best passive investment vehicle is an index fund with a low expense ratio. Index funds track a market index, so they are not actively managed by human investors. If you only invest in one thing, invest in Vanguard’s Total Stock Index Fund (VTSAX). If you only invest in two things, then also invest in Vanguard’s Total World Index Fund (VTWAX).
Invest in your index funds on a monthly basis. Investing regularly allows you to leverage dollar-cost averaging. However, if you end up with a large sum of money that you want to invest or if you need to make a withdrawal, then be sure to buy low and sell high. Diversification helps by giving you a few options to choose from when maximizing an investment or a withdrawal.
Automate the transfer of funds directly from your paycheck into your investment account each month so that you never have a chance to spend it. This is the same technique the IRS uses when they deduct estimated income taxes from your paycheck each month, rather than collecting all of your taxes at the end of the year. Psychologically, it’s much more effective if you never actually see the money in your hands.
Don’t trade stocks. Just invest in your index funds on a regular basis and only pull money out if/when you need it (hopefully only in retirement). Stock trading is risky and can potentially be addictive. The average person can’t outsmart the market. In fact, even the best investors can’t outsmart the market. This is why it’s better to bet on the success of the entire stock market as a whole using index funds.
If your company offers an employee 401k, then max it out every year that you can. If you own your own business, create a Solo 401k, a SEP IRA, or a SIMPLE IRA and max it out every year. These investments allow you to avoid paying upfront income taxes and your taxable income will likely be much lower when you begin withdrawing the money in retirement.
Don’t put all of your eggs in one basket. Index funds automatically diversify your risk across the entire US stock market or global stock market. However, you should also have some of your investments in bonds or other assets that do not fluctuate with the stock market. Use the 120 Rule to determine how much you should have in these lower-risk asset classes.
There may be times when you need to withdraw money for an emergency, or for a large purchase (like a house) when the stock market is down. So, you should have some of your money in semi-liquid, low-risk investments available for withdrawal during a down market. Having 3, 6, or 12 months’ worth of your monthly expenses readily available in a safety net is a good practice.
Let the market do the work for you by putting your investments on autopilot with an index fund. Don’t check the stock market daily, don’t read the financial news, and don’t watch investment shows on TV. These news sources are designed to create persistent low-grade anxiety and fear in you, so that you will buy their sponsor’s products and seek out their financial advice.
Each year, take some time to analyze your investments and reallocate money based on the 120 Rule (mentioned above). Then don’t even look at your accounts for the rest of the year. Even during 2008 financial crisis and the global pandemic, I didn’t even bother to look at my investments. They are all on autopilot and the economy has always recovered given enough time – here’s all the proof you need.
The earlier you start investing the better off you’ll be at retirement. Exponential growth curves are one of the most powerful things in the universe. Investing $1,000 in an index fund (with a 10% rate of return) when you’re 20 years old, would be worth over $100,000 when you are 70. Investing $1,000 when you’re 50 years old would only be worth a little over $7,000. Compounding over time makes a huge difference!
When you finally get into retirement, the goal is to have enough money invested in your retirement accounts so that you can live off of the interest of those accounts. If you withdraw less than 4% each year you can live off of the interest indefinitely. If you withdraw more than 4% each year, your nest egg will progressively shrink each year until it’s gone.
High-net-worth parents teach their children good financial habits while they are young. However, low-net-worth parents discourage conversations about money. Instead of giving your children gifts of money, get them an index fund in an IRA and invest the gift money instead. Then encourage them to put a little money in each month once they start earning a paycheck. With compound interest, they will likely be able to live off the interest alone when they retire.
Stock brokers and investment advisors have an obligation to make money for their company – they do not have an obligation to make you money. So, if you do need to seek financial advice, seek out a fiduciary advisor rather than a financial advisor. A fiduciary is required by law to put your interests above their own.
The entire financial industry is set up to make you feel like investing is too complicated for the average person and that you’re not smart enough to do it on your own. This is done so that you will be dependent on them for advice – and then they can charge you for that advice.
The reality is that the financial strategies that actually work (in practice) are so ridiculously simple that no one could make a reasonable profit off of charging you for this advice. So, they manufacture complexity, confusion, anxiety, and fear. Then they try to sell you investment schemes, self-help books, and actively managed funds to keep the industry going. Much of it is a scam; please don’t fall for it.
However, everything beyond the basics of investing for retirement often does require a licensed professional for advice. So be sure to find a good accountant, lawyer, fiduciary, and others that have good reputations and do not have any conflicts of interest. They are your allies in the world of finance.
If you’d like to learn more about any of these topics, I recommend the following resources: