Anyone that invests wants to do so successfully. There are many books written on the subject, and hundreds of millions of dollars are spent each year on services that promise the best stocks for one’s portfolio. Wherever one looks, there’s no shortage of hot stock tips or trading strategies that promise to get rich. But, the process of successful investing isn’t hard if keeping these five key concepts in mind.
The longer the investment period, the greater the effect that compounding returns will have on overall wealth creation. To illustrate the difference a few years can make, consider the results of two hypothetical investors: Sarah (25) and John (35) both wanting to retire at age 65. If each invests $10,000 a year until retirement and earns an average of 7% per year on investments, Sarah will amass almost $2,000,000 while John’s portfolio will reach approximately $945,000. The extra ten years and $100,000 that Sarah saved and invested turned into over $1,055,000 more in portfolio value than John’s ending value. It pays to start investing early.
Selecting the right mix of investments is one of the most important decisions an investor must make. It is the primary determinant of the amount of risk in an individual portfolio and, consequently, the level of expected return. As investors get older, investment objectives and risk appetite may change. As a result, it may become necessary to adjust the mix of assets to achieve the desired results. Younger investors, or those with a greater ability to withstand risk, can afford to invest primarily in higher risk securities, such as equities. Older investors, or those with a lower capacity for risk, should allocate a higher percentage of their assets to fixed income securities, such as bonds and certificates of deposit. The appropriate mix of stocks and bonds will be dependent upon the particular investor’s situation.
There is no reason to pay high fees and commissions when there are plenty of excellent no-load, low-cost mutual funds and exchange-traded funds (ETFs) available that track all the major indices around the world. With expense ratios as low as 0.04%, passive funds, such as the Vanguard S&P 500 ETF, give investors access to the most widely followed benchmarks at a fraction of the cost of comparable actively managed funds. For every dollar of commission or excess expense saved, that amount will stay invested and continue to compound over time.
Asset location refers to the thoughtful distribution of investments among accounts with different tax attributes, such as taxable accounts, tax-deferred accounts (IRA, 401(k), and other retirement accounts), and tax-exempt accounts (Roth accounts). As a rule of thumb, keep less tax-efficient assets, such as taxable bonds and real estate securities which generate ordinary income taxed at higher rates, in tax-deferred accounts. On the other hand, place more tax-efficient growth assets, which generate capital gains and qualified dividends in taxable accounts. Assets that have the greatest potential for return, regardless of tax characteristics, should be held in Roth accounts for the maximum benefit. Being disciplined with asset location can improve the after-tax return on the overall portfolio and leave more money to grow.
It can be tempting to try to time the market and get out before bear markets take effect. However, there is ample research that suggests it’s much better for investors to stay invested and weather the storm. The chart below shows how reacting to short-term stock market changes can hurt performance over a long period of time. Missing the five best single days of performance from October 1989 – December 2016 in the S&P 500 would have reduced annualized compound returns from 9.38% to 7.75%. In other words, the growth of $1,000 over this period would be reduced from $11,510 to $7,636, a reduction of over 33%.
While these concepts may be easy to understand, it can be hard to implement without proper assistance. To ensure you have the right allocation and plan in place, work with a Registered Investment Advisor (RIA) or a fee-only planner that understands your situation and who will always put your interests first. For a free consultation with one of our investment advisers, please call (858) 509-9500.