Finance Blog
Four Rules for Solving the Investing Rubik’s Cube
I get a lot of requests from investors who want to know what to invest in now. I have to confess that I don’t understand the question.
Investing is not like eating. You don’t want to try something new every day. Your investing strategy should be like eating the same meal day after day. The only time it should be adjusted is when your tolerance for risk or your investment objectives change.
If you’re doing it right, sound investing makes watching grass grow seem exciting.
I have put together four basic rules that should guide your investment decisions. Following them will help you solve the investing Rubik’s Cube.
Investing Rule #1: Ignore the financial media.
I know this piece of advice seems counterintuitive. The financial media want you to believe you need to be up on the latest business news or you’ll risk a devastating blow to your investment returns.
Of course, the financial media are conflicted by self-interest. Ratings and readers mean higher advertising rates. It is this quest for revenue that motivates the breathless reporting from the floor of the NYSE, rather than advice grounded in sound principles of investing.
Understand this: Today’s news does not affect stock prices or stock markets. Tomorrow’s news affects both. The financial media doesn’t know what tomorrow’s news will be.
Ignore them.
Investing Rule #2: There are no financial “gurus.”
This investing rule is a lot like breaking the news to a child that there is no Santa Claus.
But here’s the truth: There are no financial gurus out there who can pick stocks, time the markets, or pick hot mutual funds. Not Jim Cramer, not your broker or adviser, not any software program with green (“Buy now”) and red (“Sell now”) lights, not the authors of newsletters, not the anchors at CNBC or on the misnamed Fast Money TV show—despite the great confidence with which they dispense their opinions.
They are all selling an expertise that doesn’t exist: the ability to predict the future.
Investing Rule #3: Don’t buy individual stocks or bonds.
I don’t understand why so many investors buy individual stocks and bonds. Doing so will increase the risk of your investment portfolio significantly but won’t increase your expected returns.
Here’s what I mean.
Let’s assume your broker recommends the purchase of Exxon Mobil Common stock (XOM). Exxon is one of the stocks in the S&P 500 index. Should you buy Exxon or an index fund that benchmarks the S&P 500?
With Exxon stock, you are assuming the risks unique to it, like a major oil spill caused by one of its tankers that could send the stock into a precipitous decline. With an index fund, you have diversified away that risk. Of course, the index is still subject to the ups and downs of the markets, but it is far less volatile than any individual stock.
It’s really a no-brainer. The index trumps the individual stock because the expected return of the index is about the same as the expected return of the stock, but with far less risk.
Investing Rule #4: Focus on factors that really matter.
Here are the factors that really will affect your returns over time:
Asset allocation: Nothing is more important than the division of your portfolio between stocks and bonds.
Global diversification: We live in a global economy. Your stock and bond portfolios should be globally diversified.
Low-cost index funds: Your portfolio should consist only of low-cost stock and high-quality bond index funds, available directly from major fund families, like Vanguard, Fidelity, and Charles Schwab.
Following these four simple investing rules will keep you on the narrow path toward investing success.
Where have you had investing success?
Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read and The Smartest 401(k) Book You’ll Ever Read. His latest book is The Smartest Retirement Book You’ll Ever Read.
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Should potential increases in cap gains taxes influence your asset allocation decisions (i.e., shift allocation for new investment $ from stock index funds to tax free muni funds?)
Good advice Dan – I recently retired and would like some general info rearding asset allocation in terms of %'s of Stock Funds / Bond Funds / Global diversification Funds / Low-cost index Funds mix for a retired person? Thank you!