Investment Strategy
Traditional investment strategies typically look something like this: invest 60% of your money in equities and 40% in fixed income using a wide range of mutual funds. Using this strategy your portfolio will be somewhat well diversified, not too volatile, will have less than average gains and will make your advisor/fund provider a lot of money.
How about a portfolio consisting entirely of stocks? Equities have great long term performance, they’re cheap and easy to buy and sell and they have no expenses of any kind. On the down side they are rather volatile and a portfolio consisting only of equities would not be well diversified. Besides, who has the time and expertise to choose individual stocks and manage such a portfolio? Let’s try to address these shortcomings.
Volatility: How can we prevent this? We can’t! What we can do is realize that investing for retirement is a long term proposition and in that context volatility isn’t really a big issue. Yes, on a month-to-month basis your portfolio value will swing like a tree in a hurricane but if you look at your portfolio in five year intervals the only thing you’re likely to see is more money.
Diversity: What is the purpose of diversity? Its main use is to lower volatility. We just decided that volatility wasn’t really an issue so there’s no need to worry about diversity.
Time and Expertise: Instead of purchasing stocks outright let’s buy an index fund. The index defines what stocks we are buying so there’s no time consuming research or maintenance. All we have to do is pick the right index fund.
Index funds are conceptually similar to mutual funds. The performance of the fund is designed to match the performance of the index it is tracking. With index funds there’s rarely a transaction fee to purchases and sales, the expense charges are very low and they normally don’t have 12B-1 fees. They’re as close to free as you’re going to get. Never heard of index funds before? Not likely. I’ll bet you’ve seen commercials on TV for “Spider” funds for years. Well, Spider is just a brand name; it’s like saying “Kleenex” instead of “tissues”. Index funds have been around for years and they’re available from just about any brokerage.
That leaves just one problem: what index fund should we buy? How about The Standard and Poor’s 500 index or S&P 500?
The S&P 500 is the gold standard by which all other investments are measured. Whenever anyone talks about how their portfolio performed they speak about it relative to the performance of the S&P 500. Professional money managers spend their careers trying to figure out how to best the S&P 500 year after year. Very few succeed. While it may not be possible for us mortals to beat the performance of the S&P we can match it without any effort at all.
So, what kind of returns can you expect? I’ve prepared a data sheet (click here) that shows the performance of the S&P 500 since its inception in 1928. There are several things worth noting…
- The index has been VERY volatile
- Since 1928 it has returned an average of 11.42% each year
- In the past 30 years its ranged from a high of 37.20% to a low of -36.55%
- In the past 15 years the average return was 8.28%
- In the past 30 years the average return was 11.51%
In summary, if you’re investing for the long term, want a good return on your money, don’t want to pay high fees and don’t want to spend a lot of time managing your portfolio investing in an S&P 500 index fund might just be a good way to go. If you have any questions or need more information please don’t hesitate to contact me.
Next up, let’s talk about goal planning.
(How many times can I say this – I am not a professional financial planner. This article is meant only for illustrative purposes. You should check with your own financial advisor before embarking on any retirement plan.)