The 5 Things That Really Matter When It Comes to Investing
January 23, 2014One of the most common questions I get asked is how to divide your money between different types of investments. You’ve probably heard that 90% of investment returns can be explained by your asset allocation or how you divide your money between stocks, bonds, and cash. The problem is that asset allocation guidelines can vary dramatically based on where you look. So how do you decide?
I recently saw this site that took 9 different asset allocation strategies recommended by various investment experts and compares the results of following them since the 1970s. What was the outcome? William Bernstein’s portfolio from “The Intelligent Asset Allocator” had the highest compound average return at 10.49%. But the lowest performing portfolio (Harry Browne’s permanent portfolio) earned 8.88%. So the difference between picking the best and worst performing portfolio was less than 2 percentage points. Of course, past performance may not repeat and the best strategy for the next few decades could be very different.
So what are the real keys to investment success?
1) Start early. The earlier you can start investing, the longer your money will compound. Earning just 6% over 20 years beats earning 12% over 5 years.
2) Save. It doesn’t matter how well your investments do if you don’t have much invested in them. If you can only start with a small amount, just gradually increase your savings amount over time and pretty soon you’ll be saving more than you ever thought you could.
3) Diversify. One thing all the portfolios have in common is a mix of different types of investments. Keep in mind that individual stocks can go to zero and never come back and the stock market as a whole can go down and stay down for a long time.
4) Have a plan and stick with it. Regardless of which asset allocation strategy you choose, the most important thing is to stick with it through thick and thin. Every strategy is going to have periods of underperformance. You don’t want to abandon yours before the tables eventually turn so pick one that matches your risk tolerance.
5) Keep costs down. That 2 percentage point difference can be easily swallowed up by 1-2% in trading costs, 1-2% in mutual fund fees, and another 1% in investment advisory fees. Then there’s taxes. Consider implementing your asset allocation strategy through a discount broker using low cost index funds and try to take full advantage of tax-sheltered accounts and strategies like tax-loss harvesting.
The best part? You don’t need to do a lot of research or hire an investment advisor. By following these 5 simple steps, you’ll end up making a bigger difference in your net worth than trying to pick between David Swenson’s and Andrew Tobias’s recommended portfolios.