Index Investing Makes Sense
From time to time, I’m asked for advice on how to get started in investing, or how to respond to a bad investing experience. Putting aside mistaken ideas about investing is a very good first step. You can get 80% of the results for 20% of the effort if you keep it simple.
ADVICE FOR NEW OR UNHAPPY INVESTORS
These suggestions do not replace in-depth self-education or objective, knowledgeable professional advice, but they should prove helpful as a good place to start.
|Common Mistakes||Things You Should Know||Pretty Good Answers|
|1.||Mistake price inflation for real investment returns.||Real returns are provided by economic growth. Price changes and taxes just affect who owns it.||Remember to subtract inflation and taxes from your returns. Think about whether the average investor can earn more than economic growth.|
|2.||Think that it is easy to earn above-average returns.||If you want more, someone just as intelligent as you must give up the difference.||Invest in stock index funds or ETF’s. Add enough bonds and cash to fit your risk tolerance .|
|3.||Buy stocks of only well-managed growth companies.||The stock is not the company. You need more diversification.||Buy broadly diversified stock index funds or ETF’s, or hold
many different kinds of stocks.
|4.||Pay high fees for active management based on past performance.||Competition converts predictable economic events into nearly unpredictable stock price movements.||Allocate assets to stocks assuming you cannot time markets or pick managers.|
|5.||Make decisions on isolated individual securities without thinking about diversification. Hold more than 10% of your portfolio in the stock of your employer.||The relationships among returns across different elements of your portfolio determine much of what you will experience.||Diversify holdings between stocks and bonds, and within stocks, among various industries, across big and small, growth and value, US and international.|
|6.||Think fees, trading costs, and taxes are unimportant.||An extra 1% in fees, trading costs or taxes can dramatically affect compounding of wealth over a long period.||Keep turnover low and keep fees low.|
|7.||Avoid the stock market entirely.||People will pay you to bear risk that is hard to diversify or hedge. Otherwise, your long-term real return is likely to be less than economic growth.||Keep a risk-appropriate fraction of your wealth invested in a broadly diversified stock portfolio.|
|8.||React with emotion when the stock market rises or falls a lot.||Expected return for the market has only a small relationship with past performance.||Make modest adjustments in stock-bond proportions as your
financial circumstance, not the apparent return of the market, changes.
|9.||Spend lots of time reading the financial press, financial TV, and Internet news sites.||Risk, tax and fee knowledge retains its value even if widely shared. Ideas for extra return do not.||Forget picking stocks or timing the market.|
|10.||Rely on advisors who can do well only by getting you to churn your portfolio. Pay high fees for unproductive management.||Most financial service companies are structured in ways that produce conflicts of interest.||Consider fee-only financial planners, brokers who want lifetime relationships, or money managers with low costs who emphasize risk management and reduction of any tax impact.|