11/2/2012 8:30 PM ET|
3 steps to simple, smart investing
You don't need degree in economics to reach your financial goals. And if you make it more complicated you could actually lose money.
Want to be the next Warren Buffett? You could begin by clearing your schedule, buying some highlighters, poring over annual reports and hitting the 800-page tome "Security Analysis." And that's just for starters.
Would you rather simply be a great investor? Then learn to invest simply.
The big secret to successful investing is that it's actually not all that complicated. Most of the mumbo jumbo doesn't matter. You don't need to know the difference between a credit-default swap and a credit card, or between a convertible bond and a convertible sofa, to manage your own money. Common sense will get you further than an MBA.
Investors often sabotage their results when they try to get fancy. "When investors tinker, they tend to buy things after they've gone up and sell things after they've gone down, which is a terrible way to manage a portfolio," says David Swensen, the manager of Yale University's $19.4 billion endowment and the author of "Unconventional Success: A Fundamental Approach to Personal Investment."
Over the past 10 years, for example, mutual fund investors have cost themselves an average of 2 percentage points per year by buying high and selling low, according to fund tracker Morningstar. Perhaps we would mend our ways if we could more easily see evidence of how much our follies cost. But complex investing often means cluttered accounts, and it's difficult to tell what your actual return is when your portfolio is a messy menagerie.
Among the few things that an investor can predict in advance are costs. "There's only one thing about investing that I am absolutely sure of: The lower the expense that I pay to the purveyor of an investment service, the more money there will be for me," says Burton Malkiel, a professor of economics at Princeton University.
Consider this example. Suppose you're preparing for retirement by saving $10,000 a year over the next three decades. Assuming your portfolio averages an 8% annual return before fees, you would retire with a nest egg of a bit more than $1 million if your costs totaled 1% a year. But if you paid 2% a year, you'd end up with $838,000. In other words, paying 1 percentage point less per year would translate into 21% more money at the end.
Never assume that a high-cost investment can justify its price tag with better returns. Morningstar's research has shown that returns from high-cost funds trail returns from low-cost funds, on average. And expenses are the single best predictor of whether a given fund will beat or lag similar funds over the long term. Moreover, new academic research suggests that hedge funds -- which typically charge 2% annually, claim 20% of any profits and are available only to affluent investors -- don't perform, on average, any better than the stock market.
Your mix is key
Beyond costs, what matters most is the variety of investments you hold and the proportions in which you own them. Holding both stocks and bonds and perhaps some other kinds of assets can reduce your risk and possibly even boost your returns. And if you own many stocks rather than just a handful, your fortunes aren't tied too closely to any one company, industry or region. Thankfully, you can achieve broad diversification with as few as two well-chosen low-cost funds. You can even get a well-diversified portfolio with a single target-date retirement fund.
Finding the right mix of investments may be your toughest challenge. Over the long run, stocks return more than bonds do, and riskier stocks, such as shares of small companies and of businesses that are based in emerging markets, tend to outpace stocks of safer, large U.S. companies. So generally you want to hold more money in stocks (and particularly in riskier kinds of stocks) when you're young and have a long time to invest, then shift gradually into bonds as you near retirement or the date when you'll start tapping your savings.
We say "generally" because you never want to hold more in stocks than you are comfortable with. Think back to 2008, when the stock market was crashing. If you sold shares abruptly that year, you may have gone into the debacle holding too much in stocks. The trick is to own enough risky assets to give yourself a shot at meeting your long-term goals, but not so much that you'll be tempted to jump ship in a crisis.
"Once you develop a plan, the most important thing is to stick with it," says Susan John, the chair of the National Association of Personal Financial Advisors.
If you think you'll bail out during the next market downturn, don't go online every hour to check the value of your portfolio. As long as you have a thoughtful mix before a crisis hits, ignorance can be bliss. It may take time for the stock market to recover, but it will.
In the following pages, we've laid out three steps to get your portfolio on track and keep it there. We bet you'll be surprised to see how smart simple investing can be.
More from Kiplinger's Personal Finance magazine:
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You only need two steps.
1. Buy (15% of your income invested into the stock market averages).
Suppose you're preparing for retirement by saving $10,000 a year over the next three decades. Assuming your portfolio averages an 8% annual return before fees, you would retire with a nest egg of a bit more than $1 million if your costs totaled 1% a year. This nothing but a wild dream unless up are lucky in the Stock Market. Try saving money in a money market account or CD and watch it go down a rat hole because of inflation. ♥♥
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