When I started off as a financial advisor in the early part of the 2000’s, the topic parents found most confusing was investing.
The thought of investing led them to paralysis analysis and most of the time they ended up ignoring this part of their financial plan.
It was frustrating because I had just earned my Series 7 (stock certificate license) a few years prior and I was a walking thesaurus of investment knowledge.
I could talk to you about shorting stocks, exotic derivatives, and how to implement the rule of 72t to withdraw money from your qualified plans without penalty to retire early.
Personally, I thought I was pretty impressive. Unfortunately, my knowledge was rarely successfully relayed to potential clients at the beginning of my career.
The problem with investing for most people is they feel it is confusing. I wasn’t making their problem any easier by talking above them.
Throwing around terms like 1035 exchange, tax harvesting, and rebalancing just made them more confused and made me look like an asshole.
I realized I needed a better way to explain how to be a successful investor. So I went to work. I studied the markets, read reports, and tried to understand what people wanted.
Finally, I realized successful investing was simple.
To achieve good results from investing you don’t need any of the following:
- MBA from Harvard
- A Day Trading Account
- Insider Information (right Martha Stewart)
- Devote 8 Hours a Day to Research
- Pick the best stocks
- Or even your Series 7
Successful investing encompasses three things. If you can follow these three rules, you will significantly outperform most investors.
The 3 Rules for Successful Investing
Rule # 1 – Time
The number one rule to be a successful investor is time. The longer you have and the longer you keep your money in the market, the easier it is to achieve higher returns.
Let’s take a look at this example of the S&P 500 and the returns after investing right before Black Monday. This is the day the stock market lost over 22% in one day.
- September 1987 – September 1988 – (-12.9%) (one year)
- September 1987 – September 1989 – 7.9% (two years)
- September 1987 – September 2002 – 9.1% (five years)
- September 1987 – September 1997 – 14.6% (ten years)
If you are like most people, you would have gotten scared and taken your money out of the stock market within the first year. This mistake would have been devastating to your portfolio. A $50,000 investment would have fallen to $43,550.
The quandary most people have with their investments is they can’t handle short-term losses. Their flight or fight response kicks in and they RUN when the market drops.
The key to investing is to withstand market losses, stay in the markets, and remember the markets alway recover over time.
If you think I’m wrong, look at this chart showing what would have happened if you invested a few days before some of the worst market crashes in history. The 10 year mark is an average.
I can’t emphasize enough how important it is to keep your money invested for the long haul. Remember it is time in the market, not timing the market.
Rule #2 – Diversification
It is easy to get caught up trying to figure out what stock will be the next Google or Apple. It’s sexy to talk about those stocks.
The problem with chasing the next big thing is most people rarely know what the next big thing is until it has already happened.
Who knew Google was going explode after its IPO? Who knew the iPod would lead to Apple’s resurgence? Who knew the major banks would nearly go extinct?
It’s hard to predict anything. That is why I suggest most people don’t invest in individual stocks.
There are three reasons you should avoid creating a portfolio of individual stocks:
- You don’t have enough money to properly diversify
- You aren’t analyzing their financial statements
- You aren’t informed enough to properly make a decision
Out of the above reasons, the main reason you need to avoid individual stocks is the lack of diversification. Unless you have over a million dollars, you can’t properly diversify.
Diversification is important because if you have a portfolio of five stocks and one tanks, then 20% of your portfolio is in jeopardy.
That’s why when you invest in index funds or ETFs, your money is invested in 100s or even thousands of stocks. This means if one stock out of 100 plummets, it is only one percent of your portfolio. A far cry from 20%
You can also diversify between large companies, small companies, and international.
So What Should You Invest In?
Most people are investing in their 401(k) plans at work. So I recommend trying to find a balance of 70% stocks and 30% bonds. A good portfolio would be something like this:
- S&p 500 Fund – 35%
- Mid-Cap Fund – 10%
- Small-Cap Fund – 10%
- International Fund – 15%
- Long-term Bond – 15%
- Short-term Bond – 15%
A well-diversified portfolio will help you avoid massive market losses. There is no guarantee your portfolio will never decrease, but it is more prepared than being invested in just a few stocks.
Rule #3 – Low Fees
One area most people overlook is the fees they are paying for their investments. Paying high fees can be the difference between retiring at 65 or 75.
According to some reports the average fees for mutual funds is over 3%. To learn more about fees check out this article I wrote about your investment fees.
Three percent may not appear to be significant, but a 3% fee over 30 years can be detrimental to your portfolio. Let’s take a look at two $100,000 portfolios over 30 years. Portfolio “A” is charged a 3% fee and Portfolio “B” is charged a 1% fee. Both portfolios average 8% a year before fees.
Porfolio A = $432,194
Portfolio B = $761,225
The difference between the two portfolios is $329,031. The difference is 43.3%.
Fees do play a major role in returns. Make sure your fees are low! To ensure your fees are low, look at ETFs or index funds as opposed to mutual funds.
As you can see, investing doesn’t have to be difficult. The rules are simple. Invest for the long-term, diversify with ETFs or Index funds and keep your fees low. When you follow these boring rules, you will have excellent returns over the long term.