Every investor wants to know how to invest better, end up with more money, and do well. And while it seems hard, here’s the truth: there’s actually a road map to follow. It’s not exciting, and it doesn’t involve secret tips or hot stocks…but it does likely leave you with greater wealth. It’s not what the market advertises and we can’t say it’s sexy, but it’s been shown to work — isn’t that all we care about in the end?
So, for those that are interested in investing smarter, here are the five things you need to know to be a better investor and end up with greater wealth.
Passive beats active
The industry says actively managed mutual funds that are trying to beat the market returns are the way to go, and over $1 trillion of Canadian investor’s dollars have bought into that story. However, the numbers say passive investments like ETFs will give you better returns over time.
The goal of active management is to beat a benchmark – but studies continue to show that it is almost impossible to beat the average market return over the long term. In fact, each year the passive benchmark will beat more than two-thirds of actively managed mutual funds.
Some people believe they can research and analyze individual companies to buy stocks with the expectation of beating the market. In reality, stock picking has been shown to destroy wealth over the long term and you’re much better off acknowledging this fact and choosing to “be the market” instead of spending your hard-earned money trying to “beat the market”.
Those pesky management fees seem small but they aren’t. What’s more, the industry is pretty stealthy at hiding costs from investors. 1 percent or 2 percent may seem like a small number to give up each and every year, but compounded over time, that 1 percent or 2 percent can eat up almost half of your potential wealth.
Let me say that again. Paying 2 percent per year can cost you hundreds of thousands of dollars over the course of your investment life.
High returns start with low fees!
When you minimize the fees you pay, you take the first step to maximizing your returns. The investment industry is the only industry that time and time again demonstrates that the more you play, the less value you get. The higher the fees, the lower the returns. When you combine that with the lost ability to compound returns, never is there a penny saved, or a penny earned, that matters more than in investing.
We’re sure you’ve heard the expression “don’t put all your eggs in one basket,” and it couldn’t be truer! When it comes to returns, single asset classes and single stocks can move from the top of the heap, right down to the bottom.
Let’s use raincoats and suntan lotion as an example. If you only hold stocks in raincoats, you’ll make money on rainy days and lose it on the sunny days. If you only hold stocks in suntan lotions, you’ll make money on the sunny days and lose on the others. However, if you hold stocks in both you have the potential to make money every day, rain or shine.
Diversification is the only free lunch that exists in investing, and you’d be wise to take advantage of it. That being said, don’t go crazy – six or seven asset classes are enough and they don’t have to be exotic to do the trick.
Re-balancing adds value
It’s standard to have a plan when you start investing, however, a plan left alone will become different than intended.
It’s inevitable that over time stocks and bonds will drift away from their intended target ratio, leaving you with an asset mix you never intended to hold. You need to make sure that you make the necessary adjustments to bring your portfolio back in line with your investment goals. This means that every now and then, you sell the things that have done very well and use that money to buy the things that haven’t done as well. This is called rebalancing and it forces you to sell high and buy low. Even better, because of something called “mean reversion” it also tends to add positive returns to your portfolio over the long term.
Adjust your portfolio as your life adjusts
Let’s be honest – you’re not the same person today that you were 5, 10, 20, or 30 years ago – and you won’t be the same person in 20 years that you are today. As your life changes, you’ll find your goals and needs will change too, and as an investor your tolerance towards risk will change as well.
It’s important to ensure your portfolio adjusts with you so that 20 years from now, you aren’t holding a portfolio suitable for someone 20 years younger. By asking yourself a series of questions and providing truthful answers (at least once a year), and by adjusting your holdings to reflect your current life situation, you’ll be keeping your investments in line with your goals and plans.
The Final Word
There it is!
Adopting a passive investing strategy, lowering your fees, diversifying your portfolio, re-balancing your portfolio, and adjusting it as you age are the five keys to being a smarter and better investor.
It may be boring, but it works. And boring isn’t so boring when you can retire seven years earlier or afford things you never thought you’d be able to afford.