Volatile markets make everyone nervous. Investing in stocks involves risk. Risk means you can lose money. No one likes that.
What if you could increase your returns without taking any risk? You can, and with limited effort. Here are some suggestions, gleaned from Allan Roth’s excellent book, How a Second Grader Beats Wall Street:
1. Maximize your cash. Where is your cash deposited? I suspect you could obtain greater returns on it without taking any more risk. The trick is to use the Internet to find out who is paying the highest rates on certificates of deposit and money market accounts. Remember, if your bank is FDIC insured, and your deposits are within coverage limits, your deposit is backed by the full faith and credit of the U.S. government. Go to Bankrate.com and find the FDIC-insured bank paying the highest rate.
If you have access to a credit union, check to be sure the National Credit Union Administration backs it. If it does, you get the same U.S. government–backed assurance. Credit unions are able to offer higher rates of return than banks because they return profits to their owners.
2. Reduce your debt. Debt comes in many forms: mortgages, car loans, and credit cards are the most common. It makes no sense in this low-interest-rate environment to have cash earning 1 percent while paying 15 percent (or more) on credit card debt.
I am not suggesting you deplete your emergency cash resources. Most financial planners agree you should have at least six months’ worth of expenses in cash. However, it would be far better to have a home equity line of credit, which you could use for emergency cash, than to pay obscene rates of interest on nondeductible debt.
3. Buy low-cost index funds. Investors have two choices: they can buy expensive, actively managed funds (where the fund manager attempts to beat a designated benchmark) or they can buy far less expensive index funds. The right decision is counterintuitive. The less expense index funds are more likely to outperform the more expensive actively managed funds over the long term, based on extensive historical data. This is an excellent example of how you can actually reduce your risk and improve your returns. Just limit your investments to a globally diversified portfolio of low-cost index funds in an asset allocation appropriate for you.
4. Put your assets in the right buckets. It’s not what you make—it’s what you keep that counts. Investments that throw off taxable income (like bonds) belong in your tax-deferred or tax-free accounts (like traditional and Roth IRAs). Index stock funds are very tax efficient. You should hold them in your after-tax accounts. Tax efficiency is another reason you should not purchase actively managed funds. They are tax inefficient due to much higher turnover in their portfolios.
With some modest effort, you can significantly increase your returns without taking any risk. It’s the holy grail of investing.
Dan Solin is a Senior Vice-President of Index Funds Advisors. He is the author of the New York Times best sellers The Smartest Investment Book You’ll Ever Read and The Smartest 401(k) Book You’ll Ever Read. His latest book is The Smartest Retirement Book You’ll Ever Read.