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Expert Insights for Smart Financial Planning

6 Keys to Successful Investing

If you adhere to these fundamental principles, your chances of achieving your long-term financial goals are great.


What better way to celebrate Financial Literacy Month than with a review of some time-tested, academically-based and elegantly simple tenets for intelligent investing? For novice investors, they're the building blocks of a successful investment strategy. For seasoned investors they are the bedrock of discipline and focus, without which they might simply follow the herd over the cliff.

Here are the fundamental principles you need to know in order to develop a successful long-term investment strategy:

See Also: 25 Great No-Load Mutual Funds

1. Invest with a Purpose and a Plan

Investing without a purpose is like taking off in an airplane without a flight plan. It can be very dangerous, and odds are it won't work out so well for you. Having a clear understanding of where you are, what you want to accomplish and your time horizon is essential to mapping out an investment strategy you can follow with confidence. Portfolio construction should be driven by your short-, intermediate- and long-term spending objectives, as well as your need for retirement income. The planning behind your strategy will dictate how your assets should be allocated, and your purpose or objectives are the benchmarks for measuring investment performance.

Academic studies conducted over decades have clearly shown that investors who adhere to a long-term investment strategy based on clearly-defined objectives outperform investors who don't. With a well-conceived long-term investment strategy, investors are more likely to stay true to their own personal benchmarks rather than concern themselves with the returns of the market indexes. They will also be more likely to maintain the discipline necessary to avoid the herd mentality of panicked buyers and sellers.


2. Fees Do Matter

Following years of exhaustive research, Nobel Laureate William Sharpe concluded that active managers generally underperform passive fund managers, not because there is necessarily anything wrong with their investment strategy, but simply because of the math. With an average management fee of 2%, along with other investment costs, active fund managers have to overcome a hurdle of 4% to 5% just to match the performance of the market, which a passive fund can do for far less than a 1% fee. For investors, a 1% difference in investment costs could result in one-third fewer assets over 30 years.

3. Diversify Globally

Most investors understand that diversification is essential to effective risk management and critical to long-term investment performance—excluding a major asset class from your portfolio could be introducing more volatility than is necessary. However, many people are surprised to learn that U.S. stocks represent just a little more than half of global market capitalization. Global markets behave differently at different times than the U.S. market, which means portfolios invested solely in U.S. stocks are under-diversified and are exposed to more volatility than is necessary.

Because it is impossible to know which markets will perform better or worse during any period of time, global diversification enables your portfolio to capture positive returns wherever and whenever they occur.

4. Invest for Tax Efficiency

Next to making poor investment decisions, taxes can be the single biggest obstacle to building wealth. However, taxation in and of itself is not the problem. The problem is a lack of understanding of how to construct a portfolio in a way that produces the greatest amount of tax efficiency. For example, funds with high turnover ratios will generate more taxable transactions than funds with a low turnover ratio. That is typically the difference between investing in actively managed funds versus passively managed funds.


Also, pay special attention to how certain investments are held. Investments that generate a high amount of income or dividends should be held in tax-qualified accounts such as an IRA or 401(k). Investments that generate long-term capital gains should be held in taxable accounts. Investing for tax efficiency can make a big difference in the wealth-building phase, and it is absolutely critical to the income distribution phase.

5. Risk and Returns are Related

When all is said and done, portfolio returns are largely based on their relative exposure to the various asset classes (i.e. equities, bonds, small cap stocks, international stocks, etc.) and the levels of risk associated with each. The higher return you expect from an asset class, the greater the risk you must assume in order to achieve it. For example, over the long term, portfolios more weighted towards equities offer higher expected returns than those weighted towards fixed income securities. Portfolios that contain small cap and value stocks are expected to outperform portfolios that don't contain them. Generally, investors seeking higher returns must include investments with greater underlying risk.

6. Exercise Patience and Discipline

When investors shift their focus from long-term objectives to short-term performance, the results are almost always negative. For example, when investors bail out of a declining equity market with the intention of getting back in when it turns around, very few successfully achieve that feat. Even Warren Buffet quipped, "The stock market is a highly efficient mechanism for the transfer of wealth from the impatient to the patient."

In the face of extreme events, you should exercise discipline and stay the course, insulating yourself from the emotion-inducing hyperbole of the media and the panicking herd. As a disciplined investor, you must accept the facts that markets come with risks and negative returns at one time or another are a very real likelihood. But the longer you hold your portfolio, the more likely you are to experience extended periods of positive returns.


Bonus Tip: Don't Go it Alone

Although it's not exactly a key tenet, enlisting support when approaching investing does amount to sound, practical advice. Investing is not rocket science. However, it does require a certain body of knowledge and the ability to match your investment objectives, preferences and risk profile with the most appropriate mix of investments. An experienced, unbiased, independent registered investment adviser (RIA) can provide all that. RIAs are fiduciaries who are required by law to act in their clients' best interests.

On top of being the best-equipped professionals to work with you to develop a customized investment strategy, their greatest value is their ability and willingness to be your investment coach—to educate you in the tenets of investing; to keep you focused on your target; to hold you accountable for your decisions; and to keep you from making the costly behavioral mistakes many investors make. That's really how they earn their fees, and it can be worth every penny.

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Pete Woodring is founding partner of San Francisco Bay area Cypress Partners, a fee-only wealth consulting practice that provides personalized, comprehensive services that help retirees and busy professionals to enjoy life free of financial concern.

Craig Slayen, a new partner with Cypress Partners, contributed to this article.

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This article was written by and presents the views of our contributing expert, not the Kiplinger editorial staff.