There are no secrets. Just focus on what you can control and think long-term.
You can’t control the short-term ups and downs of the market. But you can control your costs, how broadly diversified you are, whether you to stick to your plan, and to some degree the taxes that you pay.
Control your costs
From studying the capital markets for over 50 years I have learned that we should all be very modest about what we know and don’t know. The only thing I’ll tell you that I’m 100% certain of is that the lower the fees I pay to the purveyors of the investment products and services, the more there’s going to be for me.
There are typically 3 different types of investing fees and sometimes they are bundled together: (1) investment product fees, (2) brokerage fees, and (3) financial advisory fees. Do your best to keep the whole stack as low as reasonably possible.
Investment product fees
Your first consideration is whatever you pay for the funds you use. These can be traditional mutual funds, exchange-traded funds (ETFs), hedge funds, etc. You can buy individual stocks and avoid paying fund fees but you will have to work much harder to get properly diversified and you will pay more in trading costs.
Investment product fees have been slowly trending down over time. The market for ETFs is the most competitive among investment products and you can find the best value for your money there.
My recommendation based on an accumulation of data over decades is to build a portfolio of low-cost ETFs / index funds. Vanguard is generally the best provider but you can find good, low-cost funds from iShares, Schwab or Fidelity.
Brokerage & custody fees
Your second consideration is whatever you pay the firm that holds your investments (e.g. Schwab, Fidelity, etc.). You typically pay them for trading and possibly other custodial or annual fees. They also can generate revenue on the cash balance you leave with them.
Over the years trading costs have been going down as trading is increasingly seen as a commoditized service. You can keep your total trading costs down by limiting the number of trades you make.
Financial advisory fees
The typical advisory fee is 1% annually on your assets every year. This is a very steep price to pay when you consider that you pay it every year irrespective of how your portfolio performs and when you analyze how much this translates into in total dollars over time.
Unfortunately, financial advisory fees have remained fairly static at 1% over the years. Before wealthfront.Inc your only alternative was to manage your money yourself. This is a reasonable approach but then you are responsible for managing your portfolio over your entire lifetime and you need to avoid making expensive behavioral mistakes.
Your best friend for reducing risk is to diversify very broadly. Reducing your portfolio risk is important because it will help you stay invested when the markets go through periods of turmoil.
You can see the benefits of diversification many ways but one of my favorites is to look at the annual performance rankings of different asset classes over the years.
What you will notice is that the best performing asset class in a particular year is rarely the best performing asset class in the following years. And equity-based asset classes generally perform better than bond asset classes except in tumultuous years like 2008 during the financial crisis and 2011 when Europe was really struggling.
Stick to Your Plan
One of the biggest challenges for investors is to stick to your plan and not get sucked into the latest investing mania. The best way to avoid this is to have a disciplined rebalancing strategy. The easiest approach is to look at your investments once a year and rebalance back to your desired asset mix between different stock and bond asset classes.
Ideally you would systematically put any new cash flow into underweighted asset classes to help you limit having to sell appreciated assets with embedded capital gains while rebalancing continuously over time.
Based on everything I’ve seen I don’t think it is possible to time the market successfully. Not only have I never met anyone who could time the market, but I’ve never met anyone who knows anyone would could time the market consistently.
The next best thing to market timing is to rebalance consistently. This has you buying undervalued assets when everyone is down on them and selling overvalued assets when everyone is euphoric. From a behavioral standpoint this is very hard to do and requires a lot of personal discipline.
Manage Your Taxes
To some extent you can control the taxes you pay for your investments. You can do this in a couple of ways.
Index Funds. Unlike actively managed mutual funds, index funds have very low portfolio turnover, which means you incur much lower capital gains taxes.
Intelligent Rebalancing. Using dividends and cash flows to rebalance your portfolio throughout the year minimizes sales, leading to lower realized capital gains.
Tax location. Allocating less tax efficient asset classes like REITs and taxable bonds to your tax-advantaged retirement accounts and tax efficient assets like muni bonds to your taxable accounts can improve your after-tax returns.
Tax-Loss Harvesting. Systematically selling assets when you have paper losses to reduce your taxes while maintaining your asset allocation. Given the nuance of managing tax lots and the wash sale rule I don’t recommend individual investors do this themselves.
Beyond the things I’ve outlined above I would encourage you to focus on the long-term with your investments. Most investors will be investing longer than they think – into retirement and then on behalf of their heirs. So don’t get caught up in the short-term ups and downs and use your time horizon to your advantage by investing regularly and consistently over your working career.