Wednesday, September 03, 2014 |
Joe Alfonso, Personal Finance Expert,
You’ve got money to invest but you’re worried about wading into the morass of financial decisions that might entail.
Don’t. In spite of what financial pundits and many investment advisors may claim, successful investing is not rocket science.
However, admitting this simple truth does not help sell ads or justify high asset-management fees, which is why you rarely hear it mentioned.
The fact of the matter is that keeping investing simple by focusing on core principles will increase your chance of achieving long-term success. Adhering to the following four simple truths will help you increase your chance of achieving investment success and avoid falling victim to misinformation and emotion-driven behavior.
1. Control what you can (don’t worry about the rest)
There are things that you can do to maximize your investment, and other things that you really have no control over. But you can ensure that the things you can control protect you at least to some extent from the things you can’t.
One tip would be to diversify across different markets, international and domestic, developed and emerging. This will allow parts of your portfolio to zig while other parts zag given how different markets perform relative to others and create a smoother overall investment ride for you. Mutual funds invest in hundreds of different stocks, helping you achieve instant diversification.
Something else you can control is cost, and one way to keep costs low is by investing in low-cost mutual funds. Various empirical studies have shown that cost is a key predictor of the future relative performance of a mutual fund; low-cost funds tend to outperform their higher-cost peers.
It’s also advisable to take on only as much risk as you need to achieve your goals while still being able to sleep well at night. The purpose of investing is not to help you win bragging rights at cocktail parties but to finance your key life goals and ambitions.
2. Do not use bonds to chase higher yields
The proper role of bonds is to dampen the overall volatility of a portfolio to a level that is appropriate for you. Many investors fail to realize this and instead use bonds as a way to achieve higher income. In the process they buy riskier bond investments, making their entire portfolio overly volatile.
3. Rebalance periodically to maintain your desired overall risk exposure
Market values fluctuate over time. What began as an equally weighted stock-and-bond portfolio can over time become over weighted to one asset class or the other. As a result, a portfolio can become more or less risky than is appropriate for you and needs to be brought back into proper balance.
4. Maintain a long-term discipline
Buy and hold and don’t try to guess where the market is headed next. As Peter Lynch once said, “Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves.
Adhering to a sound strategy through thick or thin is key to avoiding ill-timed investment decisions driven by fear and emotion. Resist the temptation to follow the herd at all costs.
Adhering to a “passive” investment approach, such as that followed by index funds, that avoids making individual stock bets or trying to time the next move of the market is a great way to incorporate the above principles. Most investment managers who employ stock-picking or market-timing strategies, known as “active managers,” fail to outperform passive managers over time. While there may exist at any given time some active managers who do outperform, whether through luck or true skill, this is of no help to an investor because it is impossible to identify these managers in advance. Owning passively managed mutual funds, such as those from Vanguard or DFA, is the most practical way for individuals to implement a passive investment strategy.
Markets work and are highly efficient in reflecting all known information in the current price of securities. Future price changes are the result of new information that is by definition unknowable in the present. Trying to predict future market prices is therefore nothing more than gambling, the antithesis of investing. Remember, too, that higher risk is rewarded by higher expected return. Market efficiency and the relationship of risk to reward are fundamental truths and inherent characteristics of capital markets. Reflect on this the next time you hear that “this time is different.”
Your financial success depends on sticking to the above core principles. If you feel you can’t do this on your own, seek out the help of a fee-only financial adviser who places your interests first. Good advice is never cheap, but its value is priceless because it will help you achieve your long-term goals while avoiding the madness of the crowds.
This Article Originally appeared in the Business Section of GoLocalPDX