Four Ways to Simplify Investing
There's no need to try to construct a perfect asset mix. You will add value by simply being disciplined.
We are big believers that people should stick to what they're good at. In investing, though, you have to make decisions whether you're good at it or not -- and even doing nothing is, by default, a decision. One of the reasons we like mutual funds is that they allow us to focus on what we're good at: analyzing asset classes (stocks, bonds, commodities, etc.), setting suitable allocations for our clients and finding skilled fund managers to pick the investments. But while the fund industry was built on the premise of giving regular Joes access to professional management, it has, for many investors, become anything but simple.
It's easy to see why fund investing feels more complex. Fund companies tout their hottest performers and seem to jump on every hot new product to bring more assets into their coffers. The media add to the din, with advice on building a sound long-term portfolio conflicting with articles on the seven hot stocks to buy now. But like kids playing whack-a-mole at the arcade, many investors try to pounce on every opportunity they come across -- and miss most of them. These distractions create stress and, in aggregate, almost never add value. So here are four simple rules that will help you make better investment decisions.
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1. Don't sweat timing
Investors have been able to time markets consistently only in reverse. Because most come into a fund after a period of strong returns and leave after a period of weakness, investors on average earn far less than what they'd have gotten if they simply bought and held. This brings us to our second point...
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2. Don't chase performance
Funds on the top of the charts are usually there because they were in the right place at the right time. Investors pile into them, thinking a strong record reflects investing talent, when in many cases all it really reflects is the good performance of an asset class. In buying the strongest short-term performers, you are likely making a bet on an asset class rather than on a manager's skill. Also, you are likely buying in nearer to the top of the cycle for that asset class. When the cycle turns, you will be disappointed with the fund's performance.
3. Get the right mix and stand pat
It's important to own a mix of asset classes to dampen volatility. There's no need to try to construct a perfect asset mix. You will add value by simply being disciplined. Like Ron Popeil with his rotisserie grill, you want to "set it and forget it." What do you do if you don't currently have a good long-term allocation? Small-company stocks, which have had a strong run over the past six years, are a good case in point. They are no longer cheap in relation to large-company stocks, but if you are a long-term investor, you still want small-company exposure. We recommend that long-term investors hold between 5% and 15% of assets in small caps, depending on risk tolerance. But don't bet the farm on them and expect the performance of the past six years to persist for the next six. And if you've held small caps all along, think about rebalancing because their strong performance has probably left them overweighted in your portfolio. That brings us to rule four...
4. Rebalance at least once a year
Directing new savings into whatever class is below its target weight will help you buy undervalued asset classes while reducing transaction costs and taxes. Again, don't sweat the small stuff. It won't ruin your performance if you are a bit off target. You will do better if you remember these basic tenets and replace your urge to chase the hot investments with discipline and patience.
Steve Savage and Jeremy DeGroot are partners in Litman/Gregory, which publishes the No-Load Fund Analyst newsletter and also advises the Masters' Select mutual funds(www.litmangregory.com).
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