They worked hard and saved enough to retire with dignity—or so they thought. In the stock market crash of 2008 and 2009, few were spared the market decline, and even fewer hung around for the rapid recovery beginning in 2009.
Instead, relying on their brokers and advisers, many “fled to safety,” heeding the doomsday predictions of Nouriel Roubini (“Dr. Doom”) and many others.
We can’t change the past, but we can learn from it. Here are two simple decisions you can make that could significantly increase your investment returns over time:
1. Stop using a broker.
Why are you using a broker? Brokers can’t time the markets. They can’t pick stocks that will outperform other stocks. They can’t pick mutual funds that will outperform other mutual funds. They don’t understand risk, much less measure it.
It gets worse.
If you suffer losses due to misconduct of your broker, you are unlikely to recover them. Why? Because brokers game the system.
When you opened your brokerage account, you agreed to arbitrate all disputes before a panel appointed by the Financial Industry Regulatory Authority (FINRA), a misnomer for a trade association of brokers. Basically, the judge and jury of your dispute will be part of the same industry you are suing! I don’t like your chances.
Most of the sad stories investors send me involve misconduct by brokers who represent themselves as having an expertise that doesn’t exist.
The solution is simple: don’t use brokers to manage your money. Instead, learn how to do it better yourself.
2. Don’t try to “beat the markets.”
As an investor, you have a clear choice: you can rely on emperors with no clothes who tell you they can “beat the markets” (also known as “adding alpha”) or you can capture market returns, less low transaction costs, with 100 percent certainty.
Here’s the dirty secret your broker or adviser doesn’t want you to know: Your chance of “beating the market” is very slim. It’s statistically far more likely your returns will be a fraction of market returns.
Here’s a better way to invest:
1. Understand your tolerance for risk. This will guide you in dividing your assets between stocks and bonds (also known as asset allocation). You can determine your asset allocation by taking a free risk-capacity survey. Find one on my website: SmartestInvestmentBook.com.
2. Buy three low-cost index funds.
Vanguard, Fidelity Investments, T. Rowe Price, and other major fund families offer low-cost index funds that will allow you to diversify your risk without spending a lot of money. You’ll want to buy:
- A total stock market index fund. Put 70 percent of the amount allocated to stocks in this fund.
- A total international stock index fund. Put 30 percent of the amount allocated to stocks in this fund.
- A total bond market index fund. Put 100 percent of the amount allocated to bonds in this fund.
These three Vanguard funds are good examples of what kind of index fund to look for: Total Stock Market Index Fund (VTSMX), Total International Stock Index Fund (VGTSX), and Total Bond Market Index Fund (VBMFX).
3. Rebalance your portfolio once or twice a year. Rebalancing will keep your asset allocation intact or allow you to change it if your investment objectives or tolerance for risk change.
That’s it. You’re done.
Depending on your asset allocation, the long term average annual returns of these portfolios have ranged from roughly 8 percent to 11 percent. The portfolios with the highest allocation of stocks have yielded the highest returns.
Don’t be fooled by how easy it is to implement these decisions. Using this strategy instead of using a broker can dramatically impact your returns and make you one of the smartest investors!
Does this make sense to you?
Dan Solin is a best-selling author, a wealth advisor with Buckingham, and the director of investor advocacy for the BAM Alliance.