Red Eye Radiance

Introduction to personal investing

Introduction and disclaimers

This post is purely informative and does not claim to provide financial advice. Invest at your own risk, employing your best judgment and reasoning.

This is a live document, it is heavily based on the The Bogleheads’ Guide to Investing.

Before your first investment

Pay off credit card and high interest debts

For example, the typical household today carries an average credit card balance of approximately 8000€. Let’s assume this household makes the minimum monthly payment of 160€ and is being charged an interest rate of 18.9 percent. If no additional charges are added to the balance, it will take about 8 years and more than 7000€ in interest charges to pay it off. That means the credit card holder will spend more than 15000€ to buy 8000€ worth of goods and services. If you think that’s a good deal, seek medical attention.

Establish an Emergency Fund

How big of an emergency fund you need depends largely on your net worth and job stability. On the one hand, if you have a very stable job, such as that of a tenured university professor, a cash reserve of as little as three months’ living expenses may be more than ample. On the other hand, if you are self-employed or work in a profession where layoffs are common, you may want to have as much as a year’s worth of living expenses stashed away. For most people, six months living expenses is adequate.

Keep your emergency fund in an account that is safe and liquid. Bank savings accounts, credit union accounts, or money market mutual fund accounts are all satisfactory. With a good emergency fund you’ll sleep better at night. It also lessens the possibility that you will have to invade funds invested toward achieving your long-term financial goals. If you know your net worth, have paid off your high-interest

Graduate from the paycheck mentality

Make it a habit to calculate your net worth once a year. Charting a course to financial freedom begins with and requires knowing where you are.

Invest regularly

The Magic is in the compounding

On the surface that may not seem like such a big deal, until you realize that every time the money doubles, it becomes 4, then 8, then 16, and then 32 times your original investment. In fact, if you start with a single penny and double it every day, on the thirtieth day it compounds to 5.3M €.

Saving is a key to wealth

In 2000, the National Bureau of Economic Research published a paper titled “Choice, Chance and Wealth Dispersion at Retirement”. The paper reports the results of a study done by economists Steven Venti and David Wise that compared the lifetime earnings of several thousand American households with their net worth at retirement. The purpose of the study was to determine what factors influence the accumulation of wealth. As you might suspect, Venti and Wise found some households with high lifetime earnings and relatively low net worth at retirement. Conversely, they also found households with modest lifetime earnings and relatively high net worth at retirement. Their next step was to determine why some people accumulated more wealth than others. Was it because some people enjoyed better health? Were some people smarter or luckier in their choice of investments? Was it due to receiving large inheritances? The economists concluded from their research that none of these factors had a significant impact on wealth at retirement. They only found one significant factor: Some people choose to save more than others.

Finding the money to invest

  • Pay yourself first - Reducing your spending is financially more efficient than earning more money. For every additional dollar of earnings you plan to save, you will likely have to earn 1.40€ because you have to pay income taxes. How ever, every dollar you don’t spend is a dollar that can be invested.
  • Commit future pay increases to investing - If you change jobs and it comes with a handsome pay increase, go on living at the spending level you have become accustomed to and channel the new money into buying your financial freedom. Someday you will thank yourself profusely.
  • Don’t drive yourself to the poor house - The way to lower your cost of driving is to buy a good used car and pay cash for it. A good rule of thumb is that the annual cost of driving a new, mid-priced car is about 2500€ higher than driving a three-year-old used car.
  • Move where the cost of living is cheaper - The cost of life (COL) is the biggest factor affecting our investment power.
  • Not all debt is bad debt - For example, there are times when carrying a mortgage on your home is a better option even when you have the funds to pay it off. Let’s assume you are borrowing at an effective, fixed rate of 5 percent. At the same time, you believe that you can earn an average annual return of 8 percent in a balanced portfolio over the long-term. Paying off the mortgage is a can’t-miss 5 percent return. However, investing the money at 8 percent earns an average of 3 percent more per year. With the money invested in liquid assets, you have access to it if needed, and the value of the house will likely appreciate whether it’s mortgage-free or not. Or, perhaps you would rather spend the money than leave a mortgage-free home to your heirs. Is it a risk? Yes, but it’s a calculated risk, and one where the odds are likely to be in your favor. Whether it’s a risk worth taking is for you to decide.

Know what you are buying

Exchange-Traded Funds (ETF)

Exchange-Traded Funds (ETFs) are basically mutual funds that trade like stocks on an exchange. Perhaps one of the biggest bene fits of owning ETFs is the low cost. ETF expenses can be as low, or even lower, than many mutual funds that track the same index. Unlike regular mutual funds, which are priced at net asset value (NAV) only once a day at the close of business by the fund company, based on the value of the securities owned by the fund, ETFs are priced continuously throughout the day, by an open market system, as are stocks, whenever the stock market is open. However, being able to trade ETFs during the day is of no benefit to Boglehead investors because we are buy-and-hold types. If you’re interested in day-trading funds, you’re reading the wrong book. Another potential downside is the difference between the market value of an ETF share and the NAV of the underlying securities that make up the ETF. Because ETFs are market traded, they can trade at a slight premium or discount to the value of the underlying securities held in the fund. Generally, the premium or discount is not very large, but you need to be aware of it. However, ETFs may be appropriate for investors who can make large, one-time purchases with the intention of holding them for a long period of time. In this situation, the one-time commission may well be more than offset by the reduced expenses incurred over a long period of time. In addition, ETFs may also be appropriate for investors who can’t find a low-cost index fund to cover a particular segment of the market that they’re interested in.

Bonds

It’s important to understand that bonds and bond funds price have a low correlation (they don’t always move in the same direction at the same time) to stocks, so bonds can be a stabilizing force for a portion of your portfolio.

Determining how much of your portfolio should be invested in bonds and how much should be held in equities (stocks) is an asset allocation decision.

However, here are a couple of general guidelines that you might find useful:

  1. Mr. Bogle suggests that owning your age in bonds is a good starting point. So, a 20-year-old would hold 20 percent of his/her portfolio in bonds. By the time this investor reaches 50, the bond portion of the portfolio would have gradually increased, in 1 percent increments, to now represent 50 percent of their portfolio.
  2. Increase your percentage of bond holdings if you are a more conservative investor, and decrease your percentage of bond holdings if you want to be more aggressive with your portfolio.

Funds of Funds

In an attempt to simply investing, a recent trend has developed that allows investors to obtain a nicely diversified portfolio by choosing a single mutual fund that meets their desired asset allocation. These offerings invest in other mutual funds, normally from the same company, and usually include stock, bond, and money market mutual funds—thus the name funds of funds. The more recent products introduced by some fund companies include life-cycle funds of funds that automatically get more conservative as time goes by. As with other funds of funds, the investor simply picks the nicely diversified fund that satisfies their present desired asset allocation. However, unlike other funds of funds that maintain a fairly constant percentage of stocks, bonds, and cash, these life-cycle funds lower the percentage of stocks and increase the percentage of bonds and cash over the years.

Preserve your buying power with inflation-protected bonds

Unlike the burglar who takes our visible assets, inflation is much more insidious because it steals something that we can’t really see—our future buying power. An inflation rate of 3 percent means that when a 25- year old investor retires in 40 years, she’ll need 3262€ to buy the same basket of goods and services that she can buy for 1000€ today. If inflation were 4 percent over that same period, she’d need 4801€. Of course, if inflation were still higher, it follows that the amount needed to purchase those same goods and services would be even greater.

Conventional wisdom states that equities should be the investment of choice for outstripping inflation. However, conventional wisdom doesn’t come with any guarantee, and there have been overlapping periods when both small-company stocks, (as defined by the Center for Research in Stock Prices) and large-company stocks (as defined by the S&P 500 Index) have failed to outpace inflation.

There have also been long periods when some “ultra-safe” Treasury investments, such as one-month Treasury Bills and long-term Government Bonds, haven’t posted positive real returns.

How much do you need to save?

Points to consider when answering that question:

  1. The amount we save. Obviously, the more we save the better off we’ll be.
  2. Our current age. This helps to determine how many years we have to save and invest, and how long our retirement investments will be able to work for us. Of course, the earlier we start saving and investing, the better chance we have of reaching our goals, thanks to the powerful effect of compounding over a larger number of years.
  3. The age at which we plan to retire.
  4. How many years we’ll have to live off our retirement account, based on our life expectancy.
  5. Whether we plan to leave an estate, or if we simply want to make sure that we don’t run out of money before we run out of breath.
  6. The expected rate of return on our investments.
  7. The rate of inflation over our accumulation period.
  8. Whether we can expect an inheritance prior to retirement.
  9. Our other sources of income in retirement. These would include pensions, Social Security, reverse mortgage, and part-time work.

Estimating future returns

Estimating the future returns on our portfolio may seem like an impossible assignment to many investors. It can be the single most daunting task we’ll have to face when it comes to determining all of the variables we’ll need to use as input to help us determine approximately how much we’ll need to fund our retirement. Therefore, we’ll spend a bit more time on this issue. Fortunately, there’s a much better way to arrive at a reasonable portfolio return estimate than checking our foggy crystal balls or throwing darts.

Example

Here’s an example of how you would calculate the expected return on a portfolio that contained 30 percent U.S. large-cap stocks, 10 percent U.S. small-cap value stocks, 20 percent international developed country stocks, 10 percent REITs, and 30 percent intermediate-term high grade corps.

  1. U.S. large caps expected return = 2.4 percent (30 percent × 8 percent)
  2. U.S. small caps expected return = 1.0 percent (10 percent × 10 percent)
  3. International expected return = 1.6 percent (20 percent × 8 percent)
  4. REITs = 0.8 percent (10 percent × 8 percent)
  5. Intermediate-term corp. expected return = 1.5 percent (30 percent × 5 percent)

So, in this example, the portfolio’s total expected return would be 7.3 percent (2.4 percent + 1.0 percent + 1.6 percent + 0.8 percent + 1.5 percent). If these estimated return figures seem low to you, especially in light of the exceptionally high returns you might have experienced in the previous bull market, you’re most likely a victim of recency bias (projecting recent events into the future). To overcome any recency bias, you need to be aware of and understand the powerful magnetic market force known as reversion to the mean (RTM). Take a look at this calculator

Make index funds the core or all of your portfolio

With a very simple, no-brainer investment strategy called passive investing you have, at the very least, a 70 percent chance of outperforming any given financial pro over an extended period of time. And over some 20-year periods, passive investing outperforms as many as 90 percent of actively managed funds. The reason is because this system allows you to keep more of your money working for you, which means less money for the brokers, investment houses, mutual fund managers, money managers, and the government. It may sound too good to be true, but this time it really is true, and it’s backed up with a preponderance of empirical evidence.

Some bullshit you can meet in the wild

  • Don’t settle for average. Strive to be the best.
  • Listen to your gut. What you feel in your heart is usually right.
  • If you don’t know how to do something, ask. Talk to an expert or hire one and let the expert handle it. That will save you a lot of time and frustration.
  • You get what you pay for. Good help isn’t cheap and cheap help isn’t good.
  • If there’s a crisis, take action! Do something to fix it.
  • History repeats itself. The best predictor of future performance is past performance.

Index investing: it pays to be lazy

Here is the crux of the strategy: Instead of hiring an expert, or spending a lot of time trying to decide which stocks or actively managed funds are likely to be top performers, just invest in index funds and forget about it! Most investors, both institutional and individual, will find that the best way to own common stocks is through an index fund that charges minimal fees. Those following this path are sure to beat the net results (after fees and expenses) delivered by the great majority of investment professionals." Another important point to keep in mind: It’s common for actively managed funds to have great before-tax returns and not-so-great after-tax returns, due to the trading that goes on in actively managing the funds. For that reason, we recommend keeping any actively managed funds in tax-deferred or tax-free accounts, such as 401(k)s, SEPs, Keoghs, or Roth IRAs.

Asset allocation

Asset allocation is the most crucial factor in investing, general concepts are:

  1. Diversify stocks - use index (S&P 500)
  2. Diversify types of investments - stocks + bonds + money market
  3. Increase relative percentage of bonds in portfolio as you age.

Diversification

Diversification offers two distinct benefits to investors. First, it helps reduce risk by avoiding the “all the eggs in one basket” scenario that we just discussed (all of your money invested in a single company). And, second, you could increase your return at the same time. In order to diversify your portfolio, you want to try to find investments that don’t always move in the same direction at the same time.

  • Diversify stocks - own index (market)
  • Diversify instrument - include bonds, and of course, diversify those too

Performance chasing and market timing are hazardous to your wealth

No matter what happens, stick to your program. I’ve said “Stay-the-course” a thousand times and I meant it every time. It is the most important single piece of investment wisdom I can give to you.

– Jack Bogle

Simply put - do not ever do this until you have sound insider information.

  • Past performance does not predict future returns
  • Market timing is virtually impossible to do over long-term
  • Be uber-critical thinker when it comes to financial magazines, headlines and other prognostications, remember, people who write it have quite different incentives.
  • Predicting bonds and interest rates is more than impossible.

Do you need an advisor

Most Bogleheads are do-it-yourself investors (DIY investors). Some of us have used brokers in the past and at some point came to realize that they weren’t looking out for our best interests when they sold us those high-cost, loaded mutual funds and other expensive investments, such as annuities, that earned them big fat commissions. Sometimes we learned (too late) that the investments they sold us weren’t even appropriate, such as that annuity with a long surrender period for an already tax-deferred IRA.

In case you want go for advisor or planner, check if he or she is certified, there are a ton of self-educated “financial specialists” our days. So why not to become one yourself? Armed with the information in this chapter, you should now understand that even if you’re considering hiring a financial professional, you still need to do your homework first in order to become a better-educated consumer. When it comes to your financial future, remaining an uninformed consumer simply isn’t an acceptable option. And, perhaps by the time you’ve finished reading this book (and a few others) and discover that investing isn’t rocket science, you may just decide that you can handle the task, and that you, too, will become a DIY investor.

Track your progress and rebalance when necessary

There is no foolproof “one-size-fits-all” system for rebalancing your portfolio. Each investor must choose a rebalancing method that’s right for them.

Principles of rebalancing

Rebalancing is simply the act of bringing our portfolio back to our target asset allocation after market forces or life events have changed the percentages of our various asset classes and segments of those classes.

Rebalancing controls risk. It brings our portfolio back to the level of risk that we determined was appropriate for us and that we were comfortable with when we first established our asset allocation plan.

Rebalancing forces us to sell high and buy low. We’re selling the outperforming asset class or segment and buying the underperforming asset class or segment. That’s exactly what smart investors want to do.

Often, investors who don’t rebalance are simply letting their winners run in the belief that doing so would produce much higher returns. Contrary to what these investors might believe, the article reported that the increased returns were actually found to be small or even nonexistent when compared with the additional risk (as measured by the volatility) taken on by those investors who didn’t rebalance.

In addition, the study showed that portfolios that were never rebalanced had the lowest Sharpe ratio s of all the rebalancing methods studied. Since the Sharpe ratio measures the additional return an investor receives for taking on more risk, this lower ratio indicates that investors who didn’t rebalance were not being compensated for the additional risk they were taking.

Rebalancing may also improve your returns, since asset classes have had a tendency to revert to the mean (RTM) over time. By rebalancing, you’re selling a portion of your winning asset classes before they revert to the mean (drop in price) and you’re buying more of your under-performing asset classes when their prices are lower, before they revert to the mean (increase in value). So, you’re selling high and buying low. If you believe in RTM, rebalancing could increase your returns. Jack Bogle believes in RTM, and we do, too.

Assessing a portfolio

The second thing we need to know is where our portfolio currently stands in relation to our target asset allocation. Do not rebalance frequently, remember about costs and taxes. Maybe, rebalancing with a time span more than a year will be beneficial for taxes. Morningstar found that investors who rebalanced their investments at 18- month intervals reaped many of the same benefits as those who rebalanced more often, but with less costs. Another advantage of the Morningstar method in a taxable account is that you’re assured of having long-term capital gains, since you’ve held the fund for longer than 12 months.

Tune out the noise

What investment media don’t want you to know

  • Create a simple, diversified asset allocation plan.
  • Invest a part of each paycheck in low-cost, no-load index funds according to your plan.
  • Check your investments periodically, rebalance when necessary, then stay the course.

You can’t attract an audience by being boring, but sound investing is about as exciting as watching grass grow.

There are many excellent sources of advice available for people who want to learn about investing. They can be found in every conceivable media form: books, radio, television, newspapers, lectures, seminars and investment courses, magazines, newsletters, audio and video courses, and the Internet. That’s the good news.

The bad news is that there are many more bad sources of investment advice dedicated to selling than helping. Separating the two isn’t easy, but it can be done.

Mastering your investments means mastering your emotions

Be aware of:

  • Greed
  • Fear
  • Ego and Overconfidence
  • Loss Aversion
  • Paralysis by Analysis
  • The Endowment Effect
  • Following the Herd
  • Mental Accounting
  • Anchoring
  • Financial Negligence - understand how investments work, you can not delegate it.

The Recipe

  1. Begin by writing down your major financial goals on one sheet of paper with dates when you will need the money. Need money for college? How much and when? Need money for a new home? How much and when? Need money for retirement? How much and when? Good planning begins by setting financial goals and target dates.
  2. Second, if you consistently practice the techniques recommended in this book, you will automatically side-step most of the emotional investment traps. Pay off your credit card and high interest debts and stay out of debt. Formulate a simple, sound asset allocation plan and stick to it. Systematically save and invest a part of each paycheck in accordance with the asset allocation plan. The earlier you start, the richer you become. Invest most or all of your money in index funds. Keep your costs of investing and taxes low. Don’t try to time the market. Tune out the noise, rebalance your portfolio when necessary and stick with your plan. By doing those things, you will intelligently manage risk. You will buy low, sell high and have the power of compounding working in your favor. You will slowly but systematically build wealth and a nest egg for a comfortable retirement. With a little luck, you will have more money than you dreamed you would ever have. These time-tested techniques have worked for millions of other people and they can work for you, too.
  3. Third, forget the popular but misguided notion that investing is supposed to be fun and exciting. Investing is a process with the goal of building and preserving wealth. It’s not Disney World, Las Vegas, the lottery, or the Super Bowl. If you seek excitement through investing, you’re going to lose money. It’s a short trip from the penthouse to the outhouse.
  4. Fourth, don’t expect to be perfectly sane and rational all the time about investing. We are all emotional creatures, and sometimes our emotions get the best of us. If you make a poor, emotional investment decision, resolve to learn from it and not repeat it. That’s all you can do. Author Elbert Hubbard wrote, “Everyone is a fool for at least 5 minutes a day. Wisdom consists of not exceeding the limit.” During those few minutes a day, we highly recommend not making any investment decisions.

How to escape the emotional traps

  • Recency bias. Never assume today’s results predict tomorrow’s. It’s a changing world.
  • Overconfidence. No one can consistently predict short-term movements in the market. This means you and/or the person investing your money.
  • Loss aversion. Be a risk manager instead of a risk avoider. Believing you are avoiding risk can be a costly illusion.
  • Paralysis by analysis. Every day you don’t invest is a day less you’ll have the power of compounding working for you. Put together an intelligent investment plan and get started. If you need help, seek out a good financial planner to assist you.
  • The endowment effect. Just because you own it, or are a part of it, doesn’t automatically mean it’s worth more. Get an objective evaluation. Invest no more than 10 percent of your portfolio in your employer’s stock.
  • Mental accounting. Remember that all money spends the same, regardless of where it comes from. Money already spent is a sunk cost and should play no part in making future decisions.
  • Anchoring. Holding out until you get your price to sell an investment is playing a fool’s game. So is blindly assuming that your financial person is doing a great job without getting an objective reading of what’s really going on. Get a second opinion.
  • Financial negligence. Take the time to learn the basics of sound investing. It’s really pretty simple stuff. Knowing it can make the difference between having a life of poverty or one of prosperity.

Making your money last longer than you do

How much of my portfolio can I spend each year without running out of money?" That’s the big question that all retirees and near retirees want answered in no uncertain terms. This is almost impossible to answer.

Two common mistakes it to overspend and to underspend.

Two best ways to ensure income for life

Choosing your yearly withdrawal rate is a good starting point for planning purposes, but realise that your withdrawal rate may have to be adjusted as the years go by. Stock market returns go through long periods of feast and famine. High inflation rates may come along and diminish purchasing power. Unexpected happenings in your life can raise or lower living expenses in ways you never anticipated. If the Boy Scout’s motto is to “Be prepared” the retiree’s motto is to “Be flexible”.

  1. You need to have the flexibility of spending less during bear markets and more during bull markets. When the market has a great year, you can spend some of the profits. Take that round-the-world cruise or buy a new car. When the market is down, if your budget is tight, you put those purchases on hold for a year or two.
  2. The second way to increase spending flexibility is to have a viable way to earn income if needed.

A prudent plan for tapping your portfolio

Most of the credible studies of 30-year portfolio survival rates conclude that you can withdraw from 4 to 6 percent of the portfolio value per year with a good chance of not exhausting the portfolio, depending on your portfolio’s asset allocation. However, once spending rates rise over 6 percent, the odds of survival diminish rapidly. As you probably suspect, the lower the spending rate, the greater are the odds of survival. How long does your portfolio have to last? The answer is, “Longer than most of us think.” For example, a 65-year-old man has a 20 percent chance of living to age 90. A 65-year-old woman has a 32 percent chance of living to the same age. If they are married, there is a 45 percent chance that one of them will live another 25 years to age 90. Remember, this is just average life expectancy. Half of all retirees live longer than their life expectancies.

You may have noticed that the primary change in our recommended portfolios as a person ages is the reduction in stocks and an increase in bonds to reduce the risk of loss when the bear market strikes— as it often does. When a retiree no longer has employment income, it’s imperative to understand that keeping what we have is much more important than risking what we have in an attempt to gain even more. In summary, the most important key to making your money last is to be financially flexible, particularly in the early years. Keep your fixed expenses low and have a viable way to earn extra income if needed. It may be reassuring to have an ironclad rule telling you to withdraw no more than a certain percentage of your portfolio each year.

Protect your assets by being well-insured

Important types of insurance:

  • Life insurance for anyone in your family on whom others depend for financial support
  • Health care coverage for everyone in your family
  • Disability insurance on any breadwinner whose future income is vital
  • Property insurance in case of fire, theft, or other disasters
  • Auto insurance
  • Liability protection against expensive lawsuits
  • Long-term care for older family members to prevent nest-egg erosion

To be a successful investor requires being a good risk manager. Managing risk means having a plan to cover the downside. That’s what insurance is all about — damage control to prevent the unforeseen from smashing your nest egg. Basically, people tend to make three types of insurance mistakes:

  1. Insuring the unimportant while ignoring the critical - extended warranty on TV vs. liability coverage.
  2. Insuring based on the odds of misfortune - here’s a good rule of thumb to keep in mind: never fail to buy insurance because the odds of something happening are small. If the odds of a flood are small, the price of insurance will be cheap.
  3. Insuring against specific, narrow circumstances - If you need life insurance, buy a policy that pays off no matter what the cause of death. Buy a comprehensive health care policy to cover all contingencies.

Three key rules

  1. Only insure against the big catastrophes and disasters that you can’t afford to pay for out of pocket.
  2. Carry the largest possible deductibles you can afford. The larger the deductible, the more you are self-insuring and the cheaper the premium will be.
  3. Only buy coverage from the best-rated insurance companies. You need insurance companies you can depend on when you need to file a claim.

Although bad things happen to everyone, it’s important to remember that you can reduce the odds of many of them happening to you by following a few simple rules:

  1. Don’t smoke.
  2. Exercise regularly.
  3. If you drink, limit yourself to two drinks a day.
  4. Wear seatbelt, and don’t drive under the influence.
  5. Eat the right foods, and maintain your proper weight.
  6. Get enough rest.
  7. Get regular medical, dental, and vision check-ups.
  8. Keep a positive attitude, smile, and laugh a lot.

Following those rules doesn’t mean you won’t need insurance, but it’s an almost sure bet that you’ll lead a better life.

You can do it (probably)

  • Choose and live a sound financial lifestyle. We need to pay off our credit card debt, establish an emergency fund, get our spending under control, and most importantly, learn how to live below our means, since that’s really the key to financial freedom.
  • Start to save early and invest regularly. The earlier we start, the longer we’ll enjoy the powerful benefits of compounding.
  • Know more about the various investment choices available to us, such as stocks, bonds, and mutual funds. For most investors, mutual funds offer great diversity in a single investment. Don’t invest in things you don’t understand.
  • Figure out approximately how much you might need for your retirement, so you’ll know if you’re on track. You can’t reach your goal if you don’t have a target!
  • Indexing via low-cost mutual funds is a strategy that will, over time, most likely outperform the vast majority of strategies. If you decide to own actively managed mutual funds, choose managed funds with low expenses and place them in tax-advantaged accounts.
  • An asset allocation plan is based on your personal circumstances, goals, time horizon, and need and willingness to take risk. Risk and higher expected returns go hand in hand. There’s no free lunch. Make your investment plan as simple as possible.
  • Costs matter. We can’t control market returns, but we can control the cost of our investments. Commissions, fees, and mutual fund expense ratios can rob you of much of your investment returns. Keep costs as low as possible.
  • Taxes can be your biggest expense. Invest in the most tax-efficient way possible. Put tax-inefficient funds in your tax-deferred accounts, and select tax-efficient investments for your taxable account. Remember the importance of diversification. You want some investments that zig while others zag.
  • Rebalancing is important. Rebalancing controls risk and may reward you with higher returns. Stick with your chosen rebalancing strategy.
  • Market timing and performance chasing are poor investment strategies. They can cause investors to underperform the market and jeopardize financial goals.
  • Invest for your children’s education. There are several tax-deferred and tax-free options available.
  • Know how to handle a windfall, if you receive an inheritance or get lucky and hit the lottery.
  • Answer the question of whether you do or don’t need a financial advisor, and some of the reasons for and against.
  • Understand the importance of protecting the future buying power of your assets by investing in such things as inflation-protected securities. Remember, inflation is a silent thief that robs you of future buying power.
  • Tune out the noise and do not get distracted by daily news events. Avoid hot investment fads and following the herd as it stampedes towards the cliff ’s edge. Believing that “It’s different this time” can cause severe financial damage to your portfolio.
  • Protect your assets with the proper types and amounts of insurance. Insurance is for protection. It’s not an investment. Don’t confuse the two.
  • We need to master our emotions if we want to be successful investors. Letting your emotions dictate your investment decisions can be hazardous to your wealth.
  • Make your money last at least as long as you do. Overly optimistic withdrawal rates may cause you to run out of money before you run out of breath.
  • Proper estate planning ensures that assets pass to heirs in a reasonable time and with minimum taxes.

Books for those who want learn more

Asset Allocation by Roger C. Gibson (New York: McGraw-Hill, 2000). One of the best books on the subject.

The Bond Book by Annette Thau (New York: McGraw-Hill, 2000). The bond investor’s plain-English answer book.

Capital Ideas by Peter L. Bernstein (New York: Wiley, 2005). The founder of the Journal of Portfolio Management gives a fascinating history of the financial revolution of the past 30 years.

The Intelligent Investor by Benjamin Graham, with Jason Zweig commentary (New York: HarperCollins, 2003). A beautifully written book with updated commentary by one of the most respected financial writers in America.