The Low-Risk Tried-and-True Approach to Investing

If you are reading this blog post, it should come as a no surprise to you that diversifying, cost consciousness, and buying & holding are the basics of smart investing. Taken individually or over a short-term, they may not seem to add much to the return on investments. But, taken together and over a long-term (30 years), the basic rules of smart investing are powerful.

Diversification

Diversifying means spreading your money across many asset classes such as domestic vs. foreign, small-cap vs. large-cap, value vs. growth, stocks vs. bonds, individual stocks vs. mutual funds, active mutual funds vs. index funds. Diversifying helps to lower your risk because it one or more of your investments from wrecking your portfolio. Since 1926, US stocks have returned 10% annualized if 100% of your money was invested in stocks. If your money was split 50-50 between stocks and bonds, the portfolio returned a healthy 8.3% annualized, did so with far less volatility.

Costs

You can't control how the economy fares or whether the stock market goes up or down. But, costs of your investments are certainly within your control. Favoring low-cost mutual funds, index funds, or exchange traded funds and lowering your transaction costs is a surefire way to grow your investments. Cutting your costs by 0.5% points per year should add precisely that much to your return. This is why I hold 95% of my investments in low-cost index funds.

Buy-and-Hold

I advocate buy-and-hold approach to investing. Once you have bought your holdings, the emphasis is on holding. Sticking with a well-diversified portfolio during recessions is tough, but it is an important ingredient. The opposite of buy-and-hold approach is to time the markets. But, timing the market means that you not only have to be right about when to get out of falling markets, but also you have to pick the time about when to get back in. Many people who pulled their investments 2007-2009 bear markets, subsequently missed huge market recovery and did not get back in until late 2012 or 2013 when the market had already gained 100% since the March 9, 2009 lows.

To help maintain discipline of buying and holding, dollar cost averaging approach works best. With this approach, you buy your investments are regular intervals such as every week, every two weeks, or every month (or any of choosing) and you keep buying investments during those times regardless of whether the market is up or down on those days. This helps in two ways. If the market is up on that day, it prevents you from buying too much at high prices. If the market is down on that day, your money goes a little further because you get buy shares at low prices of the day. To avoid emotions from interfering in these decisions, you simply automate buying investments at regular frequencies.

Low-Risk Portfolio

So, what does a low-risk portfolio looks like? If you are investing for retirement, then take your current age, subtract ten and consider that portion of percentage of bonds, and invest the rest percentage in stocks. Also, tweak as necessary to reflect your personal tolerance for risk.