A Wise Investment Plan
You're probably shellshocked from the investment bombs that have exploded all around you. Now more than ever, you need to develop and stick to a carefully thought out investment plan.
Don't have one? Take some advice from Larry Swedroe, director of research for St. Louis-based Buckingham Asset Management, and author of several useful investing books, including The Successful Investor Today and The Only Guide to a Winning Investment Strategy You'll Ever Need.
Swedroe first notes how few investors even have a plan. "You wouldn't start a business without a business plan, but many or most investors jump in without any investment plan," he says.
You're best off mapping out a customized plan with an investment adviser, but you can get a head start with some suggestions from Swedroe. First, he says, focus on asset allocation, not stock-fund or mutual fund selection because asset allocation drives the bulk of returns. (Swedroe is also a strong proponent of investing in broadly diversified passive index funds.)
When it comes to taking risks in investing, he suggests thinking in terms of a three-legged stool: ability, willingness and need. Your ability to take risks, for example, may depend on your employment, or "labor capital," as he calls it. A worker with little employment risk and a stable income, such as a tenured professor or a police officer, can afford to take more investment risks. A young worker with a long investment horizon can also take more risks. In any case, Swedroe says you should invest in the stock market only money you can commit for at least three to five years.
Willingness to take risks depends on the person. Ask yourself if you'll pass the sleep-well test in a bear market, he suggests. "Most people are overconfident in their ability to take risks," he notes. You want to make investment decisions with your head, not your stomach, he explains.
Here's what Swedroe says about the need to take risks: "The very people with the most ability to take risks -- the rich -- have very little need." Sadly, many people with high net worths took more risk than necessary by investing heavily in the stock market prior to the bear market, he notes.
When constructing portfolios, Swedroe layers on some personal preferences to modern portfolio theory, which teaches that high, risk-adjusted returns are likeliest to be achieved with a well-diversified basket of low-correlating assets.
In stocks, Swedroe recommends holding a globally diversified portfolio with at least 20% to 40% in international stocks. He likes to put a healthy dose of emerging-markets and small-company international stocks in his clients' international portfolios because these two classes have relatively high expected returns and particularly low correlations with U.S. stocks. Stocks, of course, have been a disaster the past 13 months, but Swedroe notes that based on history, the returns over the next ten years should be quite rewarding because of today's low valuations.
In normal times, and especially today, Swedroe doesn't like to take risks in bonds. He sees them as a dampener of portfolio volatility, enabling investors to stay the long-term course in volatile stocks. "You need high-quality, fixed-income investments so that you don't panic and sell stocks," he says. Thus, he shuns high-yield bonds (which tend to follow the up-and-down swings of stocks) and prefers bonds with maturities of three years or fewer, which have lower volatility and less correlation to stocks. The best diversifiers, he believes, are high-quality bonds such as Treasuries, Treasury inflation-protected securities and triple-A-rated municipals.
Here's some parting advice from Swedroe: Educate yourself about investing and personal finance. "Most Americans would much rather spend time watching a reality show or soap opera on TV than five or six hours reading a high-quality book," he says. Swedroe's books are accessible and practical, and he recently published a new volume, The Only Guide to Alternative Investments You'll Ever Need. To help draw up an investment policy statement for yourself, we also highly recommend Charles Ellis's Winning the Loser's Game.