Retirement investors often struggle with understanding the right mix of investments for their goals. And that’s understandable. If investing were easy anybody could do it, right?
Wall Street takes full advantage of the nagging doubt we feel about our investment choices. If you are a self-directed investor, the overwhelming message from investment sellers is to “take action” before it’s too late!
That leads to a lot of turnover as investors scurry from one fashionable investment to another, hoping to be early enough to have bought low and to stay long enough to sell high.
The bottom line, however, is simpler than that: The very movement of people from investment to investment is how Wall Street makes money.
Buying and selling generates commissions which go directly into the pockets of brokers. Often, too, those same brokers attempt to convince you to buy one mutual fund over another. What they don’t explain is the money they are paid for making the recommendation — by the mutual fund itself.
You might want to believe that such practices are rare, but they are alarming commonplace. You might also want to believe that the government regulates against conflict of interest. While there are regulations, at best they require notification of compensation practices, terms which are promptly buried in small print.
How can you undo the damage? It’s pretty simple really. Don’t worry about the name brand of your investments or the strategies they employ. Just own index funds in a portfolio.
Using index funds you are assured of two things. One, you own the entire market, so the upside experienced by some sectors will be yours. So will the downside, but that’s why you rebalance, as I will explain.
The other big advantage is cost. An index fund will cost you a tiny fraction of what an active mutual fund will charge and give you the full market return, not a “maybe” return that is nevertheless socked by high fees. It’s consistent investing.
As to the mix of investments, that’s where rebalancing comes into play. If you are 22 years old and have decades of working ahead of you, it makes sense to own mostly stocks. If you are 62 and looking to retire in a few years, then you will need a portfolio that is lighter on stocks, of course.
Both portfolios are going to own foreign investments, commodities and real estate, in small degrees. These types of investments are proven to give your portfolio a solid boost while not necessarily increasing risk.
Then, the rebalancing does it magic. Rather than try to guess which investments will “win” in a given period of time, you own them all and participate in their growth. If one or another outpaces the group, rebalancing means you get to sell high programmatically.
It also means you are buying low by distributing the gains across investments that have lagged. Over time, that kind of discipline will provide you with an extra return, year after year, rather than losing money in fees to active managers.