The Best Strategy for Long-Term Investing: Be Lazy!
There are few times in life where you’re rewarded for being lazy. Believe it or not, investing can be one of them.
I’m not suggesting that no work is required. I’m just saying that, once you establish a game plan, very little needs to be done other than occasionally checking in to make sure it’s still working for you, and then make any necessary adjustments. [Note: A good financial planner will be able to help you with all steps in this process.]
Step One:
Determine what you need or want from your investments: Growth for a nice nest egg at retirement? A down payment on a home? A college education for Junior? A yearly trek to explore some new corner of the world?
Step Two:
Evaluate your current assets (i.e. cash, retirement accounts, insurance products, brokerage accounts, etc.) to determine their advantages and disadvantages. For example, cash is great if you need to spend the money in the next year or two, but inflation will eat into its purchasing power if held for too long. The stock market may give you the best returns over long time periods (at least five years), but may have low or even negative returns during shorter periods. Anyone remember 2008? Also, make sure your total investment portfolio is diversified across not only stocks and bonds, but across geographic boundaries (US and non-US), credit strength (high and low quality bonds), and types of companies (size, industry, dividend payouts).
Step Three:
Compare your current investments listed in Step Two and ask yourself if they meet your goals stated in Step One. If they match up, great! You may advance to Step Five. If not, read on.
Step Four:
Create a diversified investment plan that meets those needs determined in Step One. Get rid of investments that haven’t performed in the top quartile of their peer group for the past five years. Now, don’t make the mistake of getting rid of a stock or mutual fund just because it has recently done worse than the general market. If it’s a small-cap fund that had a -2% return for the year when the S&P 500 returned +8%, but the average small-cap fund’s return was -6%, then you’re invested in a winning fund with which you should hold. A good source to evaluate different investments is Morningstar.com. Morningstar has a star rating system, with “1” being the worst and “5” being the best. Generally, I’d stay away from investments whose star rating isn’t a “4” or “5”.
Step Five:
What did they say in that infomercial years back? “Set it and forget.” Well, that’s what you should do, too. Don’t worry if we dip into another recession or inflation begins to take off. You’re diversified across many asset classes so if one area lags, it’s likely another area will soar. Don’t try to time the market. In my example in Step Four, if you get out of your small-cap fund because it has had negative returns, it will likely have phenomenal returns the next year if for no other reason than to get your goat. (Just kidding. The market isn’t malicious—it just can seem that way at times!)
One statistic that I love (is my financial nerdiness showing?) is the one from Morningstar which illustrates the importance of being in the market at all times. It shows that if you were invested in the stock market from 1994 to 2013 (the latest data available at the time), your yearly return would have been 9.2%. If you were out of the market (i.e. sold your stocks and parked the proceeds in a cash account) for 10 of the days with the highest returns your return would have been only 5.5%. If you were out for 20 of the highest return days your return would have been 3.0%, and for 40 days it would have been -1.0%. So, if you were invested for the full 20 years, except for those top 40 days, your yearly return would have been 10 percentage points lower than if you had stayed in the market the whole 20 years.
The fact is we, being mere mortals, are hard pressed to say, as we’ve experienced days, weeks, or months of declining returns, “OK, the market has steadily been going down but I know that tomorrow it will begin to rise and therefore I’m going to get back into the market today.” More likely, we’ll wait until the market has begun to heat up before we’ll put a toe back into the investment waters.
Step Six:
About once a year, but no more frequently than every 6 months, review your investment goals against your current investments. If they’re no longer aligned, do a little tweaking to get them back where they need to be. But otherwise, stop listening to the latest guru telling you where the “hot” investments are and just be lazy!
