We overpay for a lot of things on the presumption that price and quality are closely connected — perfumes, wine, certain restaurant experiences, travel.
While it’s true that some things are much better than others, it’s also true that just about anything can be commoditized and made more cheaply. Just recently, a $6 bottle of wine sold by Walmart in Britain won an award.
That’s right, a $6 bottle sold by a mass market retailer is considered one of the best wines in the world. You can get La Monda Reserva Malbec, a Chilean red, only at Asda stores in the U.K. Good luck with that; their website crashed with news of the award.
The larger point is that commodification is not a bad thing, especially when it brings quality into a price range that anybody can afford. The very same thing has happened with investing.
It used to be that investing was hard work. You needed a stock broker to even get access to common stocks, and commissions were high.
Even so, knowing which stocks to buy was important. Trading was slow and illiquid. It was hard to get into a company at the right price and easy to make mistakes.
Faster forward a decade or two and now millions of ordinary people invest in common stocks. The sheer demand has created a much more liquid market.
Access to the tools you need to invest safely have declined in price, too. First through mutual funds and then, soon after, through index funds and exchange-traded funds.
Now it costs very little to create a risk-adjusted portfolio that can hold its own against even highly paid professional money managers. The value of trying to “trade against” the markets virtually has been eliminated.
Not that it’s impossible to beat the market average, just that it’s very unlikely to do so consistently and the cost of trying easily overwhelms any advantage you might have accrued in the effort.
In fact, trying to trade against professionals (and plenty of amateurs still, it must be said) only increases your risk of loss.
The cheap route
Why not go the cheap route, save the trouble and have as good or better an experience as anyone out there at a fraction of the cost? Why not have that $6 bottle of wine and just enjoy it?
The reason, for many investors, is that their own egos won’t let them. They really do want to try to “win” at investing, even if that means greatly increasingly the likelihood of losing.
Retirement investing isn’t a contest with winners and losers. Your investments will grow and compound so long as you invest and avoid emotional mistakes along the way.
Will you make more than your neighbor when it comes to annualized returns? Most probably, since you are less likely to blow it all late in the process on an ill-advised gamble.
Even if you do about the same as most investors, that’s good enough to retire, then spend your golden years enjoying a few $6 bottles of really nice Malbec, and perhaps a few laughs.
The data on retirement saving is stupefying. Many of us will never retire, studies suggest. Half of Americans have no savings set aside at all and instead spend every cent they earn.
The answer, it might seem, is to start worrying. People buy loads of self-help books and follow personal finance gurus online. They clip coupons and seek better credit card deals.
In short, they do everything but the most obvious and effective thing — spend less and save more.
That’s because saving money is hard. It means having less stuff and doing less fun things, such as eating out, taking vacations and shopping.
These activities often create debt, which then feeds a cycle of spending on debt repayment and more worry. It can feel like there’s no escape.
Yet there is, and it’s actually pretty simple: Pay yourself first. Invest automatically. And stop thinking about retirement at all.
Let’s consider this step-by-step. It’s disarmingly simple, I know, but follow along:
Pay yourself first
If you have a job with a paycheck, paying yourself first means joining your company 401(k) and setting aside a significant chunk of each paycheck. Aim for 10% at a minimum. Have it diverted into your retirement plan and make sure it’s at least enough to get your company match, if you have one.
Your spending habits quickly will match your new base paycheck, minus the automatic savings you’ve just imposed on yourself. It’s important to limit access to credit cards in this phase, since you might be tempted to offset the missing income with debt.
Just put the card away, in a closet or bank deposit box, not your wallet or a desk drawer.
Many people think it’s enough to save and that they can worry about investing later. Then later comes and they’ve failed to invest at all. Cash is not an investment. Because of inflation, cash is a guaranteed money-loser.
Put your money instead into a portfolio or automated fund such as a target-date fund. If you put your money into an IRA and need to create portfolio, that also works. Just don’t sit on cash and think you have things set. You might have a savings plan, but it’s not a retirement plan.
Now, stop thinking about retirement
Here comes the easy part. Check in on your progress a few times a year. Once or twice if you want. At the most quarterly. But now that you’ve automated saving and investing, you are free to literally stop thinking about retirement.
The less you engage with your investments, the more likely you are to come out way, way ahead. Your emotional reactions to temporary downturns in the markets are now the biggest risks you run as a retirement investor, a problem solved by ignoring the issue entirely.
As you near retirement, a move toward more conservative investments is in order. But in the meantime the less you think, the less you worry. And the less you worry, the better you will do.
The one thing you can count on, besides death and taxes, is that someone somewhere will try to talk you into owning gold instead of stocks and bonds.
The reasons vary: It’s the only “real” money. It’s a hedge against inflation. It adds to your long-term returns. And so on.
But what do the numbers say about gold? J.P. Morgan publishes a helpful book of charts every quarter, called the “Guide to the Markets.” Among its 71 pages of data, there is a regular report on annualized asset class performance.
Over the past 20 years, the latest report shows, gold returned 5.9%. Compare that to bonds at 6.2% and stocks at 9.9%.
A 60/40 portfolio of stocks and bonds typical of a retirement investor returned 8.7%. Only real estate outperformed stocks, returning 11.5% over the 20 years ending in 2014.
So what happened to a retirement investor over those years? If you held only stocks, a $10,000 investment turned into a bit more than $66,000. If you owned only bonds, you came out with a little more than $33,000.
Gold? Your $10,000 turned into $31,472. Yes, you beat inflation, but stocks absolutely walloped gold and even a super-safe bond portfolio did better.
The problem with such a calm, rational analysis is that the annualized data doesn’t show volatility, that is, the up and down movement in price of any investment.
Stocks would have been plenty volatile. You only need to remember 2008 to understand how volatile. Bonds crashed in 1994, the year before the J.P. Morgan chart begins.
Of course, gold was volatile as well. It was at less than $300 an ounce until 2002. Just nine years later it topped $1,837 an ounce. It’s currently down to $1,269.
The really neat trick, if you could somehow see the future, would be to buy gold when it’s cheap and sell when it’s expensive. Just holding gold, however, is a tremendous risk because gold pays no dividends and no interest.
Most stocks pay a dividend, regardless of price. Bonds pay interest, regardless of price. Real estate pays income, regardless of what the market thinks of any given real estate investment trust (REIT).
That’s why gold does so poorly over long periods. Dividends and interest are reinvested in your stock, bond and real estate holdings.
That’s dollar cost averaging, automated. Money flows into your accounts with no effort, creating truly passive investing. The free cash buys more when prices are low and less when prices are high.
Betting or investing?
You only make money from gold by selling it, which means you have to take action all the time to make it work out, and what’s more you have to be right all the time. Guess wrong and you might sell gold high and then buy low — racking up unrecoverable losses.
It is prudent to own some gold in a portfolio, but only as a rebalancing tool. Since gold is volatile and a bit of an “anti-stock,” you cash out when speculators bid up the price, then use that cash to buy more stock while prices for equities are lower.
When others bid gold down, take some of your stock dividends and interest and rebuild your small gold position. Over time, rebalancing will smooth the volatility of your entire portfolio and add to total return.
Any other strategy toward gold, frankly, is not investing. It’s betting, plain and simple.
Surely you remember the “Dummies” series of self-help books. They had bright yellow-and-black covers and offered to explain complex ideas in simple terms. “A reference for the rest of us!” was the slogan on every book.
It’s a powerful message, one that led the series to bestseller status many times over. Planetary physics, business accounting, orchid cultivation for profit — no subject was too technical for their writers to tackle and bring down to ordinary human terms.
I mention the Dummies books because one of the principle concepts of retirement investing, diversification, is often misunderstood by the very people who need most to understand it. So let’s “dummify” diversification.
A lot of investors think diversification is owning a lot of stocks, and that’s not wrong on the face of it. But let’s start with a simpler metaphor: Don’t put all your eggs in one basket.
If you invest in a single stock, or even 20 stocks that are similar, you have put all of your eggs in one basket. For instance, owning most or all of your retirement investments in stock at the company where you work is definitely the opposite of diversification.
Selling those company shares and buying other stocks helps, but not if you just buy five or six of your company’s close competitors. You might feel better about owning stock in an industry you understand, but you’re still investing in one small, industry-focused basket.
Spreading your money out over a lot of companies from a lot of different economic sectors is starting to diversify. It’s also expensive. The way to get diversification on the cheap is to buy an index fund that tracks an entire index, say the S&P 500 Index.
Feeling pretty good about your basket? Well, you are diversified in the sense that you no longer have all of your money on one stock or even one sector, but you are in one asset class — large company stocks.
You should now add small-cap stocks and get even more diversification by owning a bond index fund, then add foreign stocks and foreign bonds, again with broad index products. Add in some real estate and now you’re getting close to a portfolio that actually is broadly diversified.
Dumb no more
Any one of those companies could collapse and your portfolio won’t founder. Any one of those thousands of bonds can default and it won’t matter. If the stock market declines, the other asset classes often rise as investors move money out of stocks.
Rebalancing allows you to passively capture such market movements at a low cost without having to get into the high-risk business of predicting the future. Indexing keeps costs low. And your eggs are definitely in a large number of very different baskets.
Feeling a little less dumb? Next time an advisor or investor friend starts talking about “diversification,” all you need to do is remember eggs and baskets. It really isn’t any more complicated than that.
Advisors like to toss around diversification math terms to build mystique about what they do (and charge you more for their work), but diversification is just lowering risk by spreading money out over a lot of different investments.
Anyone can do it, even an investing “dummy.”
Summer vacation is upon us. The pools are open and the sun is beating down. It’s the classic summer lull for stock markets, too.
It’s a predictable pattern of “sell in May and go away” that can stretch into a summer of lackluster trading. A survey from the American Association of Individual Investors finds that less than one in five small investors is bullish on stocks now.
Meanwhile, the percentage of investors who call themselves “neutral” on stocks has hit 53%, the highest in more than a decade and a half. It can feel like nobody is buying stocks.
There are any number of reasons why, besides warm weather and typical summer trading patterns. The Federal Reserve might raise the interest rate. Britons are voting on leaving (or not leaving) the European Union.
The U.S. presidential election is heating up, increasing uncertainty among investors. And so on.
What does the “smart money” do in these scenarios? Absolutely nothing, or at least nothing different from the previous six months, year or five years.
The problem is this: Past is not prologue. If you choose to get out of your stock holdings for a few months on the bet that equities will be flat all summer, you run two important risks.
First, you will miss two or more quarterly dividend payments. If you have $250,000 in a retirement fund, your dividend yield on an S&P 500 Index investment is $5,325 a year. Sit out six months and you leave $2,662.50 on the table.
Over two decades that money could compound into $10,695, but if you don’t collect, well, it isn’t yours. Do that for 10 summers and it’s $130,292 you don’t have. Starting to feel like real money yet?
The other problem is gains. Remember all that risky “bad news” from earlier in this article? Now consider this: Investors have long known the Fed would raise rates, few think Britain will leave the EU and election years often are good for stocks.
Since 1970, stocks have put on about 1% during the summer months. The up summers averaged 5.6% and the down summers averaged a negative 8%. If we have a typical, truly average summer, that’s another $2,500 you don’t collect by being in cash.
Price of patience
Feeling better? What if I told you (and you know it’s true) that how you “feel” about stocks is irrelevant to their ultimate performance? What matters is not making choices based on your feelings.
The long view is simple: Don’t buy and sell stocks. Look to own them instead, and rebalance to stay on track. Collect dividends and reinvest them steadily. Cash is a negative investment. You will not collect meaningful interest on it and inflation never stops eating away your purchasing power.
You might be slightly calmer at the beach, summer novel in hand, taking your money out of stocks and stuffing it in a low-interest but safe money market account. But you won’t be any richer, likely $5,000 poorer and maybe significantly less rich at retirement.
The price is patience and a willingness to reinvest in a go-nowhere market, buying stocks even in a flat summer market. That’s just good investing.
Retirement investing isn’t often about what you might do wrong, a sin of commission, but what you don’t do at all — the sin of omission.
What is a sin of omission? An inaction that you commit, and one that hurts really only you. After all, if you don’t save for your own retirement, who will?
The days of forced retirement investing through pensions is long gone. Social Security was always meant to be a safety net, a way to keep older Americans from falling into poverty by accident.
Neither system is perfect, but they had the very powerful feature of taking choice out of the matter. Pension plans require participation. Social Security taxes are not optional.
What can go wrong now? Consider these five mistakes, these sins of omission, that can sink a retirement plan:
Not saving at all
Seems like an obvious one, but an amazing percentage of Americans, roughly one in three, has saved literally nothing for retirement. Half of us own no retirement accounts whatsoever. Those with retirement savings accounts don’t have much, either, about $60,000 on average. Still, they’re doing better than the folks with zero.
Saving too little
We save about 5% of income as a nation. We carry debts that must be paid. Assuming normal economic growth and inflation rates, that’s a recipe for stagnation. Ten percent savings is a better target, and 15% is better still.
Starting too late
Many people put off retirement saving until they are well into their 40s. They pay for kids, for cars, they buy houses and vacations. They do anything but save and invest. But those years from the early 20s to about 40 are a huge boost to long-term returns. You need your money to be invested for decades if you expect it to grow into enough to retire.
Paying unnecessary taxes
You’ve heard it before. We’ll say it again. If you have a job with a 401(k) and don’t participate, you are paying taxes on income you could easily avoid. More than likely, you also are missing free money from your employer in the form of matching funds. If you don’t have a 401(k) but you do have a job or your own company, an IRA will achieve the same goal of paying less taxes now while saving more for retirement.
The omission here is not investigating ways to lower your investing costs. Principal among these is using index funds to own a portfolio of diversified investments. If you own mutual funds instead, you pay a high cost for management of that money, most likely. If you pay an advisor on top of that, it’s a double-whammy of costs upon costs.
You can fix these problems in about a week or two of visiting your HR department to see about your 401(k), setting up automated contributions, opening an IRA and looking into buying a small handful of index funds.
Inaction is the enemy here. Doing nothing is, in the end, the most expensive way to go.
The most common investment article you’ll find on the Internet is the basic stock tout. You’ve seen this one. “Six Stocks To Watch Now” or “Three Stocks Set To Pop” or similar headlines.
It’s called a “tout” because that’s the purpose of the article, to drive your interest toward the headline, get a click and pull you off into a website you might otherwise ignore.
If the promised article on stocks is there, it’s vague and very long. Then you have to enter an email address to get a “free report” that details the actual investments.
Can six stocks make a difference to your long-term investment performance? Yes, of course. They could mean outperforming the broad market by a significant margin.
Owning just six stocks also might turn out to be the worst choice imaginable, too. The wrong six stocks might dramatically underperform the market or even go out out of business entirely and leave you broke.
The reason you diversify a portfolio is to greatly reduce the chance of losing all of your investment yet maintain the advantage of owning stocks at all, namely, price appreciation and dividends.
Over decades, stocks rise in price. They also generate steady dividend income, free money which can be reinvested. That reinvested income is why the long-term return on a stock portfolio greatly outperforms bonds, cash, gold and other investments.
And that’s why people own stocks. If you bought just one stock index fund, say, the Vanguard Total World Stock ETF (VT), you would own 7,728 stocks.
That’s nearly all of the stocks in the entire world considered “investable” at all. That one investment would spread your money across 46 countries, every type of economy and you would own companies in dozens of economic sectors.
Waves at the beach
You also would pull in a steady 2.26% yield from dividends, at recent pricing. Not bad in a world of rock-bottom interest rates.
More importantly, you don’t have to worry about which stocks to sell and which to buy. Owning a broad, index-style ETF means you get the rebalancing effect automatically as the fund buys and sells stocks to track its benchmark.
When you own something as broadly diversified as that, you should not expect to outperform anyone. But you won’t underperform, either. And the dividends just roll in like waves at the beach, lapping at the sand.
If you wanted to be a bit more aggressive — only a bit more — build a portfolio of ETFs that holds all of the major investment asset classes and rebalance them periodically. Just selling high and buying low is enough to grab extra return year in and year out.
The final reward is true calm, the ability to look right past the stock tout articles and pay attention to other things instead. That can be a huge relief for anyone concerned about investing their money correctly over the long term.
Ignore the touts and just buy it all. Years from now, you’ll be glad you did.
Investment advice comes in many forms, with many purposes. Some of it is about budgeting, insurance and spending, some about actual investing for retirement.
But take a step back. Does everyone need a financial advisor? Surely there are millions more people out there trying to save and invest than there are advisors to serve them?
That’s true, and it’s okay. Not everyone needs or even wants an investment advisor. Here’s how to know if you need an advisor for your retirement portfolio.
Question No. 1: Are you comfortable with your basic understanding of money?
A lot of people know the ins and outs of savings and checking accounts, how interest rates affect home and vehicle loans, how to check their credit scores and file taxes.
Is that you? If yes, then you probably can handle the fundamentals of investing money for retirement. It’s important, for instance, to be able to read investment fund literature and grasp why one investment is higher or lower risk than another.
If you can manage these basic concepts, chances are you can manage your own retirement investing without having to pay for help.
Question No. 2: Are you financially literate, or at least a quick study?
Investing is not a game that holds still. No, you don’t need to starting watching cable money shows or read tons of newsletters (actually, you shouldn’t). Rather, you have be able to keep up on broad changes in how investing works.
A few decades ago, index funds didn’t exist. Same with exchange-traded funds (ETFs). Their impact on low-cost, long-term investing has been profound, and that trend continues.
Likewise, the benchmark interest rate is very low, still, and looks likely to stay low for a while longer. That affects investments across the board. You’ll need to be able to follow along and understand the impacts of such trends as they unfold over the years.
Question No. 3: Can you recognize when deeper advice might be worthwhile?
Everyone needs help sometime. Using software to create a portfolio is a great starting point for seeing the ideals of risk-adjusted investing put into practice.
Yet you might run into a situation where professional direction would be useful. Hiring an hourly fiduciary planner to advise you on taxes and insurance, for instance. If you can recognize the limits of your own abilities in the financial arena, then getting started on your own is less of a risk.
Nobody can do everything. But using good tools can get you a large part of the way toward a solid, responsible retirement investing plan. Whether you need an advisor or not is a question you can answer for yourself, assuming the basics are in place.
A Princeton professor has made waves online by publishing his own resume of failures — grants he did not get, schools that turned him down. He’s not the first academic to do so, as he notes, but it’s an interesting exercise nonetheless.
The professor, Johannes Haushofer, took on this masochist effort not to punish himself but, as he put it, to give some perspective on his successes.
“Most of what I try fails, but these failures are often invisible, while the successes are visible. I have noticed that this sometimes gives others the impression that most things work out for me,” he wrote.
It’s instructive to think about his approach to failure in terms of retirement investing. A lot of people think that the best approach is to buy a small number of investments and never sell.
Others take the view that you should try lots of things, getting in and out of the market often. After all, why spend months or years on investment failures when so many clear winners are out there to buy?
It’s counterintuitive, but you should do both: It’s important to buy investments and hold them for long periods and to avoid trading. But it’s also important to try to own the best-performing investments.
How do you know which are which? Here’s the beauty: You don’t have to know anything at all.
Portfolio investing is about owning asset classes, not individual stocks or bonds. Index funds allow investors to buy and hold whole markets. Since the funds rebalance automatically by market cap, you don’t have to worry about buying and selling.
Likewise, you don’t have to try to guess which asset class is going to do better or worse in the coming months or years. Rather, you just to be sure to own an appropriate amount of each investment type, be it stocks, bonds, real estate or commodities.
Over time, one investment class or another will surge ahead and be an obvious winner. When you go to rebalance, you end up taking those gains while they exist. The resulting cash is available to buy other investments that are down, relatively speaking.
That’s selling high to buy low, which is exactly how you should invest for long-term retirement planning.
If you do it right, the long-term effect is to diminish the impact of your “failures” in comparison to your “successes.” In fact, the portfolio indexing strategy turns those relative failures into real successes over time.
More importantly, this approach erases the huge emotional risk entailed in focusing on individual investment failures. It also takes your attention off of relative successes, which can be important, too. You get to worry less.
And one more unseen risk: Nothing is worse for a long-term investment plan than a string of accidental “wins” early on in the process. It can give the young investor the impression of knowledge in a business that relies far more on chance, and that can lead to terribly risky decisions in the future.
The Dow Jones Industrial Average just surpassed 18,000 points, overcoming a hurdle of sorts. The market hasn’t hit that specific round number since last summer.
There was no shortage of commentary on the Internet on the big 18K number. And why not? It’s interesting, and that’s what news organizations are about, filling up airtime and empty web pages with mildly interesting facts between bouts of actual news.
Should you care? Absolutely not, for a number of reasons:
1. It’s a fallacy to attach importance to round numbers. The Year 2000 came and went and we all got worked up over a supposed global computer shutdown. Remember that?
2. We pass interesting milestones all the time. Dividend yields rise and fall. Inflation consumes more or less of our total return. There are a lot of moving parts here that aren’t being taking into account.
3. Did you feel any different at 30? How about turning 40 or 50? Neither does anybody else.
4. Most importantly, number watching tends to lead to market-timing trades. And those can be truly dangerous.
Do you know for a fact that passing 18,000 on the Dow means we’ll hit 19,000 by year end? You can probably find “evidence” to back up that assertion, if you look for it.
Do you know for fact that passing 18,000 — or 17,000, or any round number — means we’ll soon see a major collapse in stocks back to some previous low, or even lower? Look for it, and you’ll find evidence to support this viewpoint too.
And that’s the problem. Both the round-number optimists and round-number pessimists are guessing. Just guessing.
There is some data somewhere to show either and both outcomes are possible. But there is no data anywhere that proves either outcome is guaranteed.
But let’s step back and just think about optimists vs. pessimists. It’s contrarian to say this, but at least some investors should see rising stock prices as bad news.
Young people, for instance, need a stock market that is tethered to reality. If the price of “getting in” to the stock market goes too high, their risk of a lower long-term return goes up.
Round number reality
An older person, of course, wants stocks to rise and never return to earth. Irrationally high stock prices mean they are richer, at least on paper.
Stock markets are, as Warren Buffett often points out, a voting machine in the short term and a weighing machine in the long term. That is, prices can be wrong, even very wrong, for a while.
But in time they correct to a realistic level and then usually build higher from there. Does it matter that we must passed a round number with a lot of zeroes after it? For the retirement investor serious about building a portfolio, not at all.
What matters is owning stocks consistently, rebalancing periodically and adjusting that portfolio to avoid unnecessary risk as you get age. Round numbers in the stock market are a distraction, a passing headline — and nothing more.