3 Steps to Maximize Investment Gains With Less Risk

Posted on March 24, 2014 at 8:55 AM PDT by

If you’ve ever been on the losing side of a stock market investment, you know the feeling: An optimistic bet turns sour, the pit of your stomach rumbles, then the news gets worse and worse. The whole world seems to be against you.

And the whole world is against you, sort of. Taking highly concentrated positions in the stock market is not for the faint of heart.

maximize investment gains

So where do retirement investors fit into this melee? They don’t. Rather, they should seek to steadily grow their pot, reducing risk while taking full advantage of the gains that free financial markets can provide.

How? It’s simple and can be done in three steps:

1. Diversify

The more you know about your individual holdings, the greater the illusion that your tiny position matters. Even if you owned 10,000 shares of ExxonMobil (XOM), nearly $1 million in one investment, you would have only a tiny fraction of the $409 billion of Exxon market cap. You would end up highly exposed to one firm’s fortunes with no say in its management at all.

If you know for a fact that Exxon, or Apple (AAPL), or Pfizer (PFE), to name just three constituents of the S&P 500, hold the keys to reliable, constant total return over decades to come, you should put all your money into one or another. But nobody knows that. We only know what has happened in the past to any given firm.

The solution is to diversify, to own the entire stock market through an index fund or ETF. You get the gains of all the biggest stocks plus their dividend payments while avoiding the pitfalls of concentration.

2. Rebalance

Can you make money just by owning the market? Yes, of course. Dividends and interest payments flow into ETFs and index funds, cash which you are free to reinvest automatically. But you also have the power to rebalance, that is, to sell off some of that fund when stocks outperform compared to other parts of your indexed portfolio, such as bonds, real estate or commodities.

Burton Malkiel, author of the investment classic A Random Walk Down Wall Street, figures that just rebalancing with discipline grew investor portfolios at a rate of 1.5% over the stock market alone during the past 15 years. It’s the only free lunch in finance, Malkiel says.

3. Compound

Money reinvested cannot help but make more money, thanks to compounding. By building a solid portfolio that’s inexpensive to run over the long term, retirement investors can pursue the real source of investment gains over time — compounding. Every dollar you earn in interest now becomes a dollar earning into the future on your behalf, and so on.

And that’s it. If you follow these three simple ideas to their logical end point, you end up in a far better place than most investors who, in spite of their intentions, fritter away gains by chasing worn-out strategies that ultimately fail to provide steady returns.