A Simple Secret to Retirement Investing
Reprinted courtesy of MarketWatch.com
To read the original article click here.
By Paul Merriman
Sometimes investing seems so complex that it turns many people away. But smart investors often learn to follow a single path that leads them exactly where they need to go. Can retirement investing be reduced to just one rule?
I recently had lunch with Hal, a good friend in San Miguel de Allende, Mexico. Hal has had three very distinct careers, first as an internist, then as a psychiatrist and finally as a software engineer. After he retired, he decided to take up painting and went back to college for five years to learn how.
Hal described a book he found very helpful which outlined a “simple secret” for becoming a better painter. This “one rule of composition” is more than I want to try to describe here, but the conversation reminded me of a simple rule that I once thought could be the core of an investing book.
Fortunately for you (and for me), I can describe this rule without writing a book. Here’s a three-word version: “It’s All Defense.”
Young investors and middle-aged ones alike who are saving money often invest aggressively. They’re naturally seeking growth, and as we know, many of them invest much too aggressively for their own good.
To use the metaphor of football, there’s offense, and there’s defense. The offensive team takes risks as it tries to move the ball down the field. The defense tries to keep that from happening.
For my purposes here, I’ll define an offensive investor as one who is trying to accumulate money and a defensive one as somebody who’s trying to hang onto his money and preventing others from taking it away.
Wall Street thrives on aggressive investing. Beat the market. Find the latest hot stock. Find the hottest mutual fund manager. Buy. Sell. Buy something else. Sell again. Try harder!
But when you reach retirement age, your mantra should be: “It’s All Defense.” Let me show you what I mean.
How many stocks do you own? Aggressive investors may spend a lot of time and care in choosing a relatively small number of companies to own. Almost all investors who play that game wind up with mediocre returns at best. Defensive investing means owning thousands of stocks through index funds. Your risk will be cut dramatically. But not your return.
How many industries do you invest in? Aggressive investors often are convinced that they know what industries will prosper. We saw this with airline stocks in the 1960s and software stocks in the 1980s. We saw it with dot-com stocks in the late ’90s and financial companies in the past decade. YOU: Skip the sector funds and invest in entire broad economies. This will cut your risk a lot. But not your return.
What asset classes do you own? Aggressive investors may concentrate on high-performing asset classes like small-cap value stocks and emerging markets stocks. That is more appropriate when you have the luxury of decades in the future in which to recover from mistakes. But when you’re retired, it’s time to spread your wealth and take your gains from wherever you can get them.
I recommend 10 equity asset classes in addition to the large-cap stocks that make up the S&P 500 Index. These are large-cap value stocks, small-cap stocks, small-cap value stocks, real estate stocks (REITs), international large-cap stocks, international large-cap value stocks, international small-cap stocks, international small-cap value stocks, emerging markets stocks and international real estate stocks. These are all available in low-cost mutual funds and exchange-traded funds (ETFs).
The world is full of opportunities, and when you diversify that widely, you won’t miss out. The world is also filled with surprises, not all of them pleasant; widespread geographic diversification helps you make sure that no single surprise will derail your plans. That’s good defense.
When you’re accumulating assets, you may think you are smart enough and/or lucky enough to manage your assets and know what’s best. (I don’t recommend that approach, but it’s very common among investors.) But when you reach retirement, if you haven’t done so already, it’s high time to put your future in the hands of the professionals. You can (and should) do this by investing in mutual funds or ETFs instead of picking stocks on your own. And you may want to take this a step farther by using a personal financial advisor to make sure you minimize your chances of losses. That’s good defense.
Many people who are accumulating assets like to “take a flier” on a few stocks or fund managers. But retirement is not the time for speculation, even with a small part of your money. Leave the lure of big potential gains to other investors. Instead, take the moderate road to a safe financial future.
If you follow these common-sense principles, you’ll enhance your chances for a reasonable piece of the action along with greater peace of mind. For savvy retirement investing, It’s All Defense.
Richard Buck contributed to this report.