How To Invest Passively For Retirement Success

Posted on November 18, 2013 at 10:24 AM PDT by

To invest, you have to be wily trader, up to date on market news and a lightning-fast decision maker, right?

Yes, but that’s not the only way to invest. If you learn how to invest passively for retirement, you can ride along on the coattails of all those speed demons and, in time, even outperform them.

The reason why this works is that passive investing gives you all of the advantages of being mostly right most of the time while greatly minimizing investment risk: Being very wrong even once at exactly the wrong time.

how to invest passively

Young investors tend not to understand the second part as risk. If you are in your 20s and only have a few thousand bucks in the markets, a big dip in stocks doesn’t seem like a problem.

And it isn’t a problem. If you have decades of recovery time ahead of you, lower stock prices are an opportunity to buy more at better prices. As Warren Buffett says, nobody complains when hamburger goes on sale, so why worry about a decline in stock prices?

If you’re older, though, that kind of “sale” can feel pretty bad. Your retirement plans go from “good enough” to “missing by a mile” in a few days or weeks. Ask the near-retirees of 2009 how they felt about the Dow falling in half.

The trick is to learn how to invest passively in an age-appropriate manner. Here are the steps:

1. Keep costs low

This is not an afterthought. It’s crucial. Use index ETFs instead of trying to pick and choose individual stocks. Most broad ETFs trade commission-free and their fees are a tiny fraction of those charged by actively managed mutual funds.

2. Buy asset classes, not stocks

Diversification is the key to sanity. If you put all of your retirement savings into five or even 10 stocks, one bad pick can seriously undermine your long-term return. Index ETFs give you reasonably priced exposure to whole indexes instead.

3. Rebalance regularly

The markets will move, sometimes chaotically. But nothing last forever. Every stock seller is meeting a stock buyer to make the transaction. If you own a balanced portfolio of asset classes, you can sell as they rise in value and buy the ones that fall, programmatically.

4. Keep risk in check

As you get older, move your mix of investments steadily toward less-volatile asset classes. That way, another big decline won’t matter as much to you personally.

5.  Compound

Compound interest is how you get to retirement. Earning a market return of 7%, every dollar you save now is worth $2 in a decade, then that same $2 turns into $4 a decade later, then it doubles again to $8.

These five steps, taken together, are how pension funds and university endowments manage their wealth. You can use the same tools cheaply to achieve the same effect, with minimal trading and minimal stress.