6 decisions every investor must make
Reprinted courtesy of MarketWatch.com.
To read the original article click here
This is the 100th article I’ve written for MarketWatch readers, and I want to use that milestone to go briefly back to the basics.
Here are six of the most impactful decisions every investor makes, either by design or default. For each one, you’ll find a link to one of my 99 previous articles.
One: Start saving money, and make a plan for it
It’s pretty obvious that you can’t be a good investor if you don’t have money to invest. That means you’ve got to save, and the earlier you start, the better. Time really is the crucial factor. If your investments earn 9% over the long run, every dollar you saved at age 25 will be worth more than twice as much as a dollar you saved when you were 35.
Without a plan, you will be at the mercy of all the carefully calculated hype and noise from Wall Street and much of the financial media. If you invest a few hours in making a good long-term plan, I think those hours will be among the most valuable hours you ever spend.
Where do you start? I can’t think of a better place than identifying 10 numbers that can change your life.
Two: Figure out where you will place your trust
This isn’t a topic you see a lot about, but I could argue that it’s more important than anything else you do (once you have actually started saving money, of course). You have three basic choices.
First you can trust Wall Street, which always has a better way for you to invest, no matter what you’ve already done. Wall Street’s solutions often sound wonderful even when they are loaded with high costs and conflicts of interest.
Second, you can trust what I call Main Street. This is made up of your relatives, your friends, your neighbors, your colleagues or even that guy you wound up sitting next to on a plane. They’ll tell you their own wonderful investment results and urge you to follow their footsteps. Trouble is, they’ll never tell you about the foolish mistakes they made, never show you their investment account statements to verify what they are saying.
Third, you can trust what I call University Street, the academics who spend their lives trying to determine what really works and what doesn’t work. University professors aren’t trying to make a profit from what you do. If anything, they are trying to impress their own colleagues with how good their research is. This, of course, is to our benefit.
I wrote about this topic last winter.
Three: Choose the asset classes in which you will invest
Tons of academic research has concluded that more than 90% of your investment return will come from the types of assets in which you invest your money. You will most likely have a significant part of your portfolio in stocks, and the kinds of stocks you choose will make a huge difference in your results. This choice is called asset class selection.
I’ve written about this topic extensively and repeatedly for nearly 20 years. What I know and what I recommend are nicely summed up in “Six Steps to the Ultimate Retirement Portfolio.”
Four: Control your level of risk
More investors get tripped up by inappropriate risk management than by any other factor. Some get in over their heads by taking too much risk, only to bail out altogether when the going gets rough; as a result they forfeit a lot of potential gains. Others are too timid, trying to avoid almost all risks; they pay a heavy price by earning lower returns. Ironically, their aversion to risk actually increases the risk that they won’t have enough to retire.
In the broadest sense, you control risk by choosing how much of your portfolio is in stock funds and how much in bond funds. When I was an investment adviser, the best tool I found to help people with this was a table comparing the long-term results of 11 combinations of stocks and bonds.
You’ll find that table, along with suggestions for applying it, in another article from earlier this year.
Five: Choose the funds in which to invest
Naturally you should want to choose the best funds to carry out your plan for allocating your assets and controlling your level of risk. Wall Street has an endless array of funds to offer, many of them run by all-star managers who supposedly can help you beat the market.
Don’t fall prey to these temptations. Instead, use index funds. You will benefit many times over by harnessing the power of their low costs, their broad diversification and their predictable asset class structures.
Earlier this year I identified 30 reasons that index funds are likely to make your life and your portfolio better.
Six: Make a plan for taking money out when you retire
Young people think it’s strange to hear me say that planning how they will access their money in retirement is just as important as setting up a 401(k) plan.
The fact is that even small changes in how you access your money in retirement can determine whether you’re likely to run out of money at an early age or you’re likely to be able to live a comfortable retirement and potentially leave millions of dollars in your will.
You don’t have to actually make these choices until you retire, but even if that day is decades in the future, this exercise will drive home the importance of how — and how much — you invest while you’re working.
If you’re closer to retirement age, this article will help you determine when you can afford to take the big step.
You can think of these six decisions as the forward gears in a car. If you do the first one very well, you’ll be in first gear. Do any additional one very well and you’re in second. And so on. If you do all of them well, you’re cruising in sixth gear, and Warren Buffett should be looking over his shoulder.
Want more? I suggest you get a copy of my book “101 investment decisions guaranteed to change your financial future.” It’s available in paperback at Amazon.com or as a free e-book.
Richard Buck contributed to this article.