There are two kinds of investors in the world: Hands-on and hands-off. Investment management either requires daily attention from an experienced manager — or it doesn’t.
Most of us would vastly prefer the latter approach. The attraction of passive investing is that it doesn’t require one to delve too deeply into the “why” of the market. Why one stock rises and another falls. Why a headline that seems positive provokes a decline in the indexes.
That’s an important distinction. Investment management isn’t about stock picking. Rather, investors should focus on asset classes.
Let me explain a bit. Owning an oil company, say, Exxon, is an investment. Once you buy shares in a company like that (or any blue chip), you own a piece of the company.
Like any owner, you have the right to sell your investment later at a profit. Or hang on to it and earn periodic payments in the form of dividends. At this writing, for instance, Exxon yields 2.67%.
Add up the cumulative effect of those dividends, quarter after quarter, year after year, and either add or subtract the change in the share price from the moment you buy to the moment you sell. That number is the total return on the investment you made.
If you decide to go that route, then you have to make sure you buy stocks that are 1) likely to rise in value and 2) either pay a dividend or have managements that can intelligently reinvest into opportunities that will increase earnings.
That’s what potential future buyers of your shares will be looking for. Time and again, data show that rising earnings feeds investor interest, often translating into higher share prices.
Simple enough. But you have to be right about a number of things here: That a stock is not already overpriced. That the dividend is reliable or that management is reinvesting well. That a given company is not nearly bankrupt or about to be overtaken by competitors.
If you use the asset class perspective, you don’t care about Exxon or any single energy company at all. You own all of them, using index funds or index ETFs. Currently, that’s 43 energy companies in just the S&P 500 Index.
You still get the aggregate dividend payment. But now it matters much less which are winners and which are, in time, losers. What matters is that a portion of your investments are in stocks at a reasonable fee.
Now repeat the strategy with bonds, also using ETFs. Now real estate, commodities and foreign stocks and bonds. From there, you build a balanced portfolio of these investments and rebalance them as the markets churn higher or lower.
It doesn’t matter which direction. Over time, true investment management helps you smooth out those highs and lows and dial back risk as your retirement nears.
That’s exactly how big pension funds and universities do it, and it’s how serious savers should approach retirement as well: Always seeking balance, safety and prudent growth.