These basic yet effective moves can help you get the investment gains you need without taking on outsize risk.
With financial pundits incessantly speculating about where stock prices are headed or blathering about a seemingly endless stream of “revolutionary” new investment products, you could easily get the impression you need to constantly revamp your retirement portfolio. But guess what? You don’t.
In fact, you’re more likely to hurt your retirement prospects by focusing on the ups and downs of the market and overdiversifying into fad investments. A better strategy: stick to a few simple but effective principles that can help you get the investment gains you need without incurring outsize risks.
Here are four tips that can help you add juice to your retirement portfolio’s performance and boost your odds of achieving retirement security.
1. Focus on building a portfolio, not picking funds. Many people think smart investing starts with selecting specific funds. But that approach is backwards. Before you start homing in on individual funds or any other type of investment, you need an overall plan.
Specifically, you want to put together a portfolio that not only includes stock and bond funds, but a broad range of both (growth and value stocks, large shares and small; government and corporate bonds). The aim is to create a diverse group of investments that don’t all move in synch with one another. This way, when one part of your portfolio is getting routed, another part can be racking up gains—or at least not get battered as badly.
The mix of stocks and bonds you own should be based on factors such as your age, your investing goals and your tolerance for risk. Generally, the younger you are, the more of your money you’ll want in stocks.
For guidance on creating such a portfolio, you can check out the investing tools in the Real Deal Retirement Toolbox. If you find the idea of building your own portfolio daunting, consider a target-date retirement fund, an all-in-one fund that includes a diversified mix of stocks and bonds and that becomes more conservative as you age. Though far from perfect, target funds are a good choice for people who can’t or don’t want to build a portfolio on their own.
2. Seek to track, not beat, the market. Aspiring for “average” results by investing in index funds or ETFs that track the performance of market benchmarks strikes some as an admission of failure. It shouldn’t. If you earn the average market return—or something close to it—you can grow your retirement stash substantially over time.
If ten years ago you had invested $10,000 in a total stock market index fund—a fund that tracks the entire U.S. stock market—you would have earned an annualized return of almost 9% and be sitting on a stash worth more than $23,000 today.
Sure, some funds did better. But most didn’t, and it’s hard if not impossible to identify in advance the ones likely to outperform. Indeed, S&P Dow Jones’s latest “Persistence Scorecard” shows that very few funds can consistently outperform their peers. Besides, what sometimes looks like superior performance is just a fund taking on a lot more risk, which makes it more vulnerable to market setbacks.
If you stick to broadly diversified stock and bond index funds, you can avoid the whole fund-picking racket, and fare much better than investors who are constantly seeking out hot funds.
3. Control your emotions. When the markets are surging, people tend to get overconfident about their investing abilities and underestimate the risk they’re taking. That’s one reason investors pour so much money into stocks after the market’s been on a run.
By contrast, in the wake of a market crash investors become overly cautious and often dump stocks and huddle in bonds and cash, even though stocks are usually more attractively priced after big downturns.
You’re much better off avoiding this emotional roller-coaster ride and maintaining your composure. Once you’ve created a portfolio of stocks and bonds that makes sense for you, you should largely avoid tinkering with it whatever the market is doing, except to rebalance back to your original asset mix periodically (say, once a year). By taking your emotions out of the game and adhering to the simple disciplined strategy of rebalancing back to your target stocks-bond mix, you’ll avoid the classic investor mistake of loading up on assets when they’re likely overpriced and selling after they’ve taken a beating and may be bargains.
4. Rein in costs. People tend to gravitate toward investments that have recently posted the highest returns. But returns are highly volatile. And a fund or stock that’s topping the performance charts one year may be an also-ran the next.
Expenses, on the other hand, are much more predictable. A fund that has much higher management fees than its peers will probably stay that way—its costs aren’t likely to go down. And since each dollar you pay in expenses lowers your net return, bloated fees act as a drag on a fund’s performance. Over the long-term that can seriously stunt the size of your retirement nest egg.
That’s why low-cost funds tend to outperform their high-fee counterparts over long periods of time. Which is another argument to stick mostly to index funds, which typically have some of the lowest expenses around. You can screen for low-cost funds by going to the Basic Screener in the Tools section of Morningstar.com. (The tool is free, but registration is required.)
There are no guarantees in investing. But if you follow the four tips above, you should be able to substantially boost the value of your nest egg without subjecting it to undue risk.
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