John Bogle, former Chairman of the Vanguard Group investment company, once said, "The secret to investing is that there is no secret to investing." That's right. There is no magic formula or foolproof strategy. Despite media hype to the contrary (the word "secrets," along with "new" and "hot," is a favorite of the financial press), there is no overnight path to investment success and riches.
What does exist, however, are basic financial planning principles and investment strategies that have stood the test of time. Below is a description of ten such strategies. While none of them are new, nor are they a secret, they can help investors navigate today's uncertain investment environment.
Save 10% of What You Earn--Research on millionaires indicates that most grew their portfolios over time through regular investment deposits. The process of saving a fixed amount of money at a fixed time interval (e.g., $50 per month) is called dollar cost averaging. If saving 10% of earnings is impossible, start with less (e.g., 4%) and give your savings a raise when your income increases or when household expenses, like child care or a car loan, end.
Set Goals and Match Your Time Horizon--Match your investments with the time horizon for your financial goals. Place money that you will need within five years in short-term vehicles such as certificates of deposit (CDs), money market mutual funds, and Treasury securities.
Have Reasonable Expectations--A recent survey by Merrill Lynch found that 10% of respondents expected a 15% to 49% a year investment return and 15% expected a 50% return or more. Stocks have returned a little over 10%, on average, since 1926. Investors who expect returns greater than long-term averages are likely to fall short of their goals.
Diversify, Diversify, Diversify--This means building and maintaining a portfolio that includes different types of asset classes (e.g., stocks, bonds, real estate, and cash equivalents) and different types of investments within each asset class (e.g., large, medium, and small sized companies and bonds issued by both government and corporations). Periodically rebalance your portfolio to maintain your original asset weightings (e.g., 50% stock, 30% bonds, 20% cash).
Don't Panic...Take A Long-Term Perspective--Large market gains often follow large market losses. If you panic and sell stock during a prolonged market downturn, you may miss the rebound that happens afterwards. Consider this example from recent history. In 1973-74, the stock market was in a deep slump and many investors abandoned stocks altogether. After reaching a low point in October 1974, the Standard & Poor's 500 stock market index rebounded in 1975 and returned 37.1%. Between 1975 and 1999, it returned an average annual return of 17.2%.
Don't Be a Market Timer--To succeed, market-timers must be right twice: about when to get out of the stock market and when to get back in. And they must be right often enough to offset transaction costs (e.g., income taxes and brokerage fees). Market timing is virtually impossible to do on a consistent basis, as evidenced by the poor results of mutual funds that employ this strategy.
Reduce Investment Costs--Costs matter. Every dollar spent on fees, commissions, transaction expenses, and income taxes is a dollar that is not in your pocket. Look for mutual funds with low expense ratios (expenses as a percentage of fund assets) and low-cost stocks that can be purchased directly from issuing companies.
Buy The Market--Consider using a broadly diversified stock index fund, such as one that tracks the Russell 3000 or Wilshire 5000 indexes, as the core of your portfolio. Most index funds have low expenses and provide returns close to the stock market index that they are tracking.
Ignore Daily Market "Noise"--This includes daily stock market reports that describe the day-today volatility of stock and bond markets. Watching your investments too closely can lead to panic selling or euphoria buying. Resist the temptation to react emotionally to market events.
Know The Risks--Every investment has some type of risk. For example, cash assets have the risk of loss of purchasing power due to inflation. The primary risk affecting bond investors, especially today, is interest rate risk. When interest rates rise (as they ultimately will because they are currently very low), bond prices will decrease.