Choosing an Investment Strategy
In a previous post, I talked about the four rules that any good investor will follow. Rule #4 was “Pick a ‘Good-Enough’ Strategy and Stick With It”. Today I want to explain what I mean by picking a strategy.
The most important part of your strategy is what’s called your asset allocation. This just means the percent of your money that you dedicate to different kinds of investments. At the highest and most important level, this is the percent invested in stocks and the percent invested in bonds, with stocks and bonds being considered two different asset classes. Your stock portion will provide you with the biggest returns over the long term. Your bond portion will protect you from huge losses when the stock market goes down, which it will from time to time. Your choice in how to allocate across these two classes with be the biggest determinant in your eventual returns.
Sounds simple right? Well it actually is. The hard part is believing that this is all you really need to do, since there’s so much information out there trying to convince you to do something more complex. But in reality, the simple split between stocks and bonds will be the most important factor in determining your strategy’s return.
So how do you choose your allocation? This is much more a question of personal preference than it is a science. If you don’t have experience investing, I would start somewhere in the neighborhood of a 50-50 split. This will give you upside when the stock market is doing will, but will also give you a good amount of protection when it isn’t. Once you’ve experienced a big market downturn, like the one in 2008, evaluate how you felt about your portfolio. If it was terrifying, maybe you’ll want to decrease your stock portion a little bit, possibly to something like 40-60 (stocks-bonds). If you were totally comfortable, maybe you keep it the same or increase the amount in stocks.
Once you’ve decided on the allocation you want, you can pick some simple funds to help you get there. Vanguard’s LifeStrategy funds allow you to pick a basic allocation without worrying about rebalancing, which I’ll talk about in a bit. So do their Target Retirement funds, although these funds will change their allocations from more aggressive (i.e. more stocks) to more conservative over time, whereas the allocation in the LifeStrategy funds remains constant. Note that if you’re picking a target retirement fund, you don’t have to pick the one for the year that lines up with your retirement. Look at all the options and pick one that fits your target allocation.
Alternatively, you can pick specific stock and bond funds. I would stick with what are called index funds from a good company like Vanguard or Fidelity. These funds will represent an entire market, such as a fund that represents the entire US stock market and another that represents the entire US bond market. Using funds like this will allow you to control your allocation more than if you use something like the LifeStrategy or Target Retirement funds. But it will also require some more work on your part.
In the end, you shouldn’t stress too much about trying to pick the perfect allocation, because the perfect allocation doesn’t exist. The best allocation is the one that’s “good enough”, that is it has a diversified mix between stocks and bonds, and is something you can stick to. Whether you’re 40-60, 50-50 or 60-40, if you can stay consistent through the years, you’ll do well.
