Investing success does not require expertise in markets, the direction of interest rates or the global economic outlook. As much as the pundits may want you to think you need to be on top of all the news and react accordingly, the reality is that following a few simple and timeless investing rules will help you reach your goals.
Get out of your own way. You’ve no doubt heard the advice to buy low and sell high. It makes perfect sense, but unless you’re Warren Buffet it can be insanely hard to buy more stocks in the middle of a bear market when stocks are losing value. This is where automation is an investor’s best friend. One of the sneaky-smart upsides of a 401(k) plan is that you will keep having your contributions pulled from every paycheck regardless of what the markets are doing. You can also easily set up periodic automatic investments into an IRA or regular taxable account. Discount brokerages provide this service for free.
Diversify. There are two levels of diversification that are essential for investing success. The first is to have a mix of stocks and bonds. Stocks offer the best shot at inflation-beating gains over the long-term. Bonds help you sleep better when stocks are going through one of their intermittent down periods. What’s the right mix? That depends on your goals, your age and your stomach for risk. You can get a sense of what the pros think makes sense by checking out a target-date retirement fund (TDF) with a retirement date that dovetails with your age. Your 401(k) likely has a suite of TDFs; online there will be information about the portfolio’s asset allocation. You can also check out TDF portfolios at Morningstar.com.
The other important diversification is to own a lot of different stocks and bonds. Having your money riding on just a few single stocks or bonds is asking for trouble.
The bulk of your money should be invested in mutual funds or exchange-traded funds (ETFs). A single fund or ETF will typically hold dozens, if not hundreds of stocks and bonds.
Embrace being passive. There are two camps to investing: active mutual funds and ETFs are run by a manager(s) who makes the buy/sell/hold decisions for the portfolio. Index funds and ETFs take the human element out of the equation and aim to track a benchmark index. Indexing is considered “passive” investing. Study after study shows that over the long-term active managers don’t outperform indexes. A big reason is that active funds charge a higher investment fee. That’s an argument for building a core portfolio from low-cost index mutual funds and ETFs.
Be a Fee Fiend. Mutual funds and exchange-traded funds charge an annual fee, called the expense ratio. Expense ratios on index mutual funds and ETFs can be less than 0.10%, while active funds often charge more than 1%. Over a 40-year investment horizon, $10,000 invested in a low-cost index fund or ETF that charges 0.10% will grow to around $100,000, assuming a 6% gross annualized return. If you’re invested in a fund that charges a 1% expense ratio you will have about $70,000.
Take Advantage of Time. The earlier you start investing the longer your money can compound. Framed as an incentive: Getting serious about retirement investing in your 20s will require you save less of your current salary than if you wait to your 30s or 40s to get serious. One academic study estimates that if you start saving 11% of your annual salary by age 25 you should be in solid shape at age 65. Start saving at age 35 and you will need to save 17% of your salary. Wait until age 45 and you would need to save 30% of your annual salary to be able to retire at age 65 and cover your basic expenses.
Be Patient. For a long-term goal such as retirement, the biggest risk you face is getting out of the market when stocks are falling.
The data research firm Morningstar took a look at the period 1997-2017, which includes a couple of ugly bear markets. If you stayed calm and didn’t bail out of stocks throughout that entire 20-year stretch you earned a 7.2% annualized return. But if you had missed just the 10 best days for stocks in that 20 year period your return was cut to 3.5%. If you missed the 30 best days among the 5,217 trading days you would have a negative return on your stock portfolio.
Keep that in mind the next time stocks start to crater. And if it helps, keep reminding yourself, it’s the time in the market, not market timing that will help you meet your goals.
Disclaimer: the content presented in this article are for informational purposes only, and is not, and must not be considered tax, investment, legal, accounting or financial planning advice, nor a recommendation as to a specific course of action. Investors should consult all available information, including fund prospectuses, and consult with appropriate tax, investment, accounting, legal, and accounting professionals, as appropriate, before making any investment or utilizing any financial planning strategy.