Tom’s Thoughts: Sandboxes and Steam Valves
Everyone has something they enjoy doing with their money. In fact, the purpose of having a financial plan is so that there is money available to be spend of something that you get enjoyment out of. But structuring your accounts and decision-making process is essential to enjoying yourself while not impacting your larger financial life.
Structure on a day-to-day level is the difference between paying for each drink at the bar with cash versus having an open tab that you might run up too fast. Structure on a longer-term level is having your 401(k) contributions taken out of your paycheck before the money even comes to your bank account.
So find where you want to play, and then build what I like to refer to as a sandbox. I like this analogy because it’s where you can let your inhibitions go and truly enjoy yourself. But most importantly, as long as the sandbox is built correctly, whatever you do inside the sandbox doesn’t matter – the sand can be re-leveled and you’ve done no lasting damage to your financial future.
A specific example of this sandbox idea involves those who like to play in the stock market. This is a conversation I’ve had with quite a number of people so far this year, and it’s very timely with the recent focus on day-trading in general, and Robinhood in particular, in financial media. While playing around in the stock market certainly doesn’t appeal to everyone, the concept of structuring things so you can play without doing damage applies to all of us in one way or another.
Similar to going out for a nice dinner, or playing in a fantasy football league with a buy-in, those that enjoy making moves in the market get enjoyment from more than one source. There is enjoyment in researching all of the restaurant options, or players available, or stocks that might perform well. There is the enjoyment of the food itself, watching your fantasy players perform well after you put them in your line-up, and watching the stocks you picked go up and up. And then there are the bragging rights, which we all love: posting a picture of your meal on social media, talking trash to the team you played against in the fantasy league, and bragging at parties about the awesome stocks you picked.
In all of these cases, the money spent, or deposited up front, is the cost of enjoying the process; on a budget, these expenses would all be best categorized under “Entertainment”. None of these is a question of “or”, but rather of “and”. You don’t choose between nice dinners out or a nice retirement; you want to figure out how to do both. It usually makes sense to avoid eating at a Michelin-starred restaurants every night of the week. And I don’t put up a house as my fantasy league buy-in. If someone gets enjoyment from taking chances in the market, we want to set up a way to do that and to maintain a long-term investment plan.
My approach to building an investing sandbox is to create what I call a “steam valve” account. It is a small amount of money (in percentage terms), usually in a separate account, that can be invested however you see fit. The advantage of the steam valve account it that it provides an outlet to make moves and feel like you’re doing something when the market is making big moves up or down, so that you leave the vast majority of your portfolio on autopilot.
The steam valve sits alongside a large, well-diversified, long-term investment portfolio that properly takes your risk tolerance and risk capacity into account. How small is the account? Optimally it’s no more than 5% of your portfolio; small enough that if it goes to zero it won’t hurt your long-term financial situation.
To be clear, I don’t want your steam valve account to go to zero. In fact, I’d love to hear about how well it’s doing and what smart stock picks you made. But the key is to never depend on the steam valve account to provide the funding for any of your goals. Given that the investment approach is likely to be on the much riskier side of things, you wouldn’t want to put your financial plan at risk of a sudden market drop or bad decision. But if the account grows immensely, and some funds can be pulled out to spend more that you planned, then that’s just the cherry on top.
Given that the steam valve is often an entirely separate account – to reduce the temptation to mix up funds that have different purposes – you can put that wherever you’d like. And a cheap way to set up a small trading account these days is Robinhood. To be clear, I’m not specifically in favor of using the app; it’s designed to get your adrenaline going and increase your trading speed, which leaves less time for considered investment decisions. But many of the macro concerns about Robinhood – that it has been manipulating the market, that trading costs are exorbitant, that they are selling order flow, etc – are probably overblown (the story does a good job of looking at some Robinhood myths and concrete examples of the costs of trading with them). But, if you’re going to use Robinhood, then you certainly should understand exactly how Robinhood makes money, And more importantly understand the stocks that you’re buying and selling – particularly if you get into options trading. Understanding what you own makes it more likely you’ll stick with the position through a temporary rough patch, and it can help avoid shockingly sad stories.
But no matter what platform you use to trade, the idea is the same: put a structure in place so that you don’t impair your long-term finances.
No matter what you like to do with your money, build a sandbox so you can play in the way that’s most enjoyable for you.