By Myra O’Dell
Successful investing involves taking calculated risks. I believe that in order to give yourself the best opportunity to reach your investment goals, you need to focus on the aspects of investing that you can control. Here is my list of things that you can count on when investing:
- There will always be uncertainty in short-term investing. Making a long-term plan and sticking to it is the best strategy. The random walk theory, a concept introduced by Burton Malkeil’s book in 1973, “A Random Walk Down Wall Street,” suggests that stock price fluctuations are independent of each other and have the same probability of going up as they do going down, but that over a period of time, prices maintain an upward trend. If this is true (I believe it is true), you should ignore short-term fluctuations in the market and stick to your long-term plan.
- The less you pay in expenses (i.e. commissions and annual expense ratios), the more money you keep to invest and work for you to reach your goals. This is a no brainer. Keeping your expenses down makes a significant difference in your long-term results. While you can’t eliminate all expenses, be careful to keep them as low as possible.
- Taxes can eat up your returns. This one is similar to #2 above…the less you keep, the less you have working for you. Remember to be aware of the tax consequences of your investment decisions. Make use of tax deferred vehicles such as IRAs, Roth IRAs, and 401(k)s. In taxable accounts, consider using municipal bonds and tax-efficient investments such as mutual funds with low turnover ratios. Also, take advantage of long-term capital gain tax rates when possible.
- In the long run, stocks will outperform bonds. If you have a long time horizon for your investments, it is likely that including a portion of stocks in your portfolio will give you more bang for your buck.
- Including a portion of good quality bonds reduces risk. While stocks will outperform bonds in the long-run, there is still good reason to include good quality bonds in your portfolio. Bonds reduce the overall volatility of your portfolio. This becomes more important as you reach the date in which you will be withdrawing from your portfolio. You should meet with an investment advisor to help you create an allocation that suits your time horizon and risk tolerance.
- Diversification reduces risk. No matter how good you think you are at picking the winning stock or asset class, over the long term, diversification will win. By investing in all types of stocks- large, small, value, growth, US and international- you won’t be dependent on any one asset class and no matter which ones are doing well, you will own them and reap the benefits.
- There will always be an asset class that is underperforming the rest of the market. Hindsight is always great when it comes to investing! But, consistently determining which asset class will perform best in the future is impossible! Refer to my blog post Investor Behavior and the Hot-Hand Fallacy for more information on this topic.
- When it comes time to rebalance, it will feel like the wrong thing to do. Selling the investments that have done well to buy the investments that have lagged may seem like a dumb thing to do. However, it forces you to buy low and sell high and also keeps your portfolio’s risk in check. I recommend picking one day of the year to rebalance and continue rebalancing on that same day each year. By automating this process, you avoid the urge to time the market and also take the destructive emotions out of investment decisions.
- The more you can save now, the better chance you have of reaching your financial goals. This is the result of a principle called the time value of money. When you have time on your side, you open up the door to compounded returns. I’ve never heard anyone chastising themselves for starting their savings plans too early in life. So, no matter what your age is, begin a savings plan now and you will thank yourself later.