Tuesday, May 09, 2006
Kiplingers - 4 ways to simplify investing
Kiplinger's Magazine had a great article this month about how to simplify investing for people who don't have the time and/or the knowledge to trade stocks everyday.
1. Don't sweat timing.
2. Don't chase performance.
3. Get the right mix and stay put.
4. Rebalance once a year.
Don't sweat timing - Timing the market is very tough to do, professional will tell you they can do it, but the reality is, that over time, most professional investors may have a good year or two, but they will eventually revert to the mean. The best way to overcome timing is to use "Dollar-Cost Averaging". This is where you contribute a set dollar amount each month instead of investing a lump sum. This will help to even out the highs and lows of investing.
Don't chase performance - The ups and downs professional investors have is why you also do not want to chase performance. As I stated before, an investor may have a good year or two, but odds are he is eventually going to average at or below the market, and his fees are going to be higher, so in the long run, you will make less. There are exceptions of course, Warren Buffett has beat the market for the last 30 years (incredible). There are a handle full of others that have beat the market for a few years running. But to pick these few out years ago, before they were stars, when it really counted, out of the thousands of investors would have been near impossible.
Get the right mix and stay put - Getting the right asset mix is the key, and then sticking with it through thick and thin. The general strategy for a mix is that your age is the percent of your assets you have in bonds. So if you are 20 years old, you have 20% of you assets in bonds. You can sway this either way depending on what your level of aggressiveness is, but most people are loss averse, so this is a good strategy.
Rebalance every year - It may be tough to sell those funds that are doing so well and buy the ones that aren't but when the tide turns, you will be glad you did it. When you hear about all of the money that people lost in the "Crash", if they had stuck with an asset allocation of 60% stocks and 40% bonds/cash, they would have lost only 60% of their money. Instead, people were riding the good times and putting all of their money in stocks. Also, by rebalancing, if after the crash you had reinvested your 60% in stocks, you would have made back most of your money. The majority of the gains after the crash were made within the first year, but everyone was too scared to reinvest.