My Recommendations for Investing

I struggled for years with managing my portfolio, gaining and losing a lot of money by following different advice. The ultimate  investment strategy is one that requires a minimal amount of management time but gives me piece of mind that I’m securing my financial future. I have read hundreds of books on personal finance, attended seminars, read magazines, and more. I came to realize that there is a lot of noise out there not relevant to the average investor. I have boiled down the investment essentials for the average investor to the following:

1. Indexing should be a core strategy for most of your investments. I recommend following an ETF asset allocation model.

Most brokerages have portfolio tools that will select a set of ETFs for you based on your profile (e.g. if you’re a younger investor, you should choose to invest more aggressively than someone approaching retirement.) These tools will take the amount of money you want to invest and based on a strategy matching your profile, will determine  an ETF portfolio and how many shares to buy of each fund. The ETF portfolio will be comprised of a dozen or so funds in different asset classes. You can simply hit one single button to make all the trades. At least once a quarter during the calendar year, you should make sure you are in balance and make trades as needed to get to the original asset allocation.  Fidelity and Schwab have this tool for account holders. Look for ‘ETF Portfolio Builder’ under the section of the website for investment tools.

Alternatively, there are websites such as FutureAdvisor that will not only give you the information about what ETFs to buy,  but will also make trades on your behalf to keep the portfolio in balance. There is a cost for the trading service, but it’s nominal compared to hiring a financial advisor. You can also opt for a lower fee in websites such as JemStep to receive emails about the needed trades and then make the trades yourself. I recommend going this route of receiving email alerts  to minimize the fees and because generally the frequency at which you need to make changes is low (2-3 times a year typically).

Below is a screenshot of an ETF Portfolio Builder tool from Schwab.

2. Restrict stock picking to a relatively small part of your portfolio and to a fixed dollar investment amount.

I don’t recommend the average investor spend time picking individual stock and funds. The track record for average investors picking stocks is not good. Also the average investor won’t put the time in to track those investments on a weekly or even monthly basis and determine when it’s time to sell the position.  If you truly want to stock pick, then assign a fixed amount of money to invest that you’re comfortable losing. For example, I allocated $25,000 as money I would play with for stock picking. I could have invested more but didn’t want to take a chance. So if I really feel strongly about a stock, I can buy it. I just don’t make individual stocks my core strategy.

3. Maximize contributions to retirement accounts.

Putting as much money as the IRS will allow into retirements accounts will enable you to grow your investment tax-deferred which will net you more money in retirement. Also it will lower your gross income so you pay lower in taxes in the present. Of course, take your company 401K match if it’s offered.

4.  Find a good mutual fund newsletter.

While,  I follow an indexing strategy for most of my portfolio,  indexing can slightly underperform the overall market because of reduced risk in using asset allocation. In other words, asset allocation lowers the riskiness of your portfolio (as it contains bond components and other less aggressive funds). This can lower your overall portfolio return compared to the market average.

I’m willing to take on a little more additional risk with the chance of getting a higher payout by using mutual fund newletter recommendation. Mutual fund newsletters are offered by investment firms. You basically buy the recommended portfolio. Every week, you get an update as to whether or not to make any changes to that portfolio. I follow a newsletter called  “Fidelity Insight and Monitor” for my rollover IRA account.

Hulbert Interactive is newsletter that ranks investment newsletters. You can use this to see the highest rated newsletters. But note, there is no one newsletter that is always on the top.  However, you can still see the newsletters performance compared to others. Check the published performance numbers of the newsletter to help you find a good one.

With Fidelity Insight, I looked at the newsletter performance compared to the S&P 500 performance for the history of the newsletter (over 25 years). There were years where it underperformed the S&P 500 but overall it had more years where it met or exceeded (very slightly) the S&P. Diversifying and buying several funds simply helps you get the market average but with lower risk than if you bought only one fund that tracks the S&P 500 only. Again, you won’t see returns that wildly surpass the market average, but you may achieve the market return or very slightly surpass it with a lower risk than buying an S&P index fund.

5. Own alternative investments like REITs in your IRA.

A good way to diversify your stock portfolio is to own REITs or Real Estate Investment Trusts. These are funds that buy real estate stocks. I follow a simple strategy to buy a REIT index fund, for example Fidelity Real Estate Fund (FRESX). It’s best to own these in your IRA as REITs have a lot of turnover and therefore result in capital gain taxes when the fund sells any of its holdings. In your IRA, you can avoid paying these taxes.

401ks typically don’t offer REITs. So the IRAs would have to be ones like ROTH, Individual, or Rollover IRAs. Again, indexing should be your core strategy. But diversification with REITs gives you some diversification into real estate without dealing with the hassle of buying actual property.

Taxable vs. Tax-Deferred Accounts

It’s important to consider the types of investments you make in your taxable and tax-deferred accounts. Tax-deferred accounts include retirement portfolios such as 401ks and IRAs. Everything else is generally a taxable account. The difference between taxable and  tax-deferred accounts is that you can defer or avoid all together paying taxes (in the case of Roth IRAs)  until you are ready to withdraw the money at retirement. This means you can freely defer taxes on any profits. This is advantageous because you can reinvest the money you would have otherwise paid taxes on and therefore grow your investments even more. For some (not all), your tax rate at retirement will be lower assuming you are withdrawing less from your IRA than what you made when you were salaried.

Tax-deferred account are an ideal account to hold mutual funds that tend to generate a lot of distributions. As an example, funds that have a lot of turnover (changing of stocks that comprise the fund), will generate distributions when selling the existing positions in the fund. As a result, even if you personally don’t sell the mutual fund, you will be required to pay taxes on the distributions since the distributions are shared amongst all investors in the fund. For example, REIT funds tend to have high turnover. So personally, I own all my REITS in my IRA accounts and not in my taxable account. Furthermore, it’s preferable to own ETFs in your taxable accounts over equivalent mutual funds since ETFs are treated like regular stocks where you only pay taxes when *you*  sell and have a gain (as opposed to being taxed on distributions in the mutual fund even when you don’t sell the fund).

The Simplest Investment Strategies

It is very important to not take a random approach to investing. In talking to many average investors about their strategies, I found that often  a random approach is taken when selecting what to invest in for 401Ks and other investment accounts. This is perpetuated  by the overwhelming amount of information about stock picks, mutual fund and ETF options. Between all the books, TV programs, and friendly-advice, it can become very confusing determining the best approach for you.

There are some simple strategies that you can follow. While these strategies may not outperform the market, they are still very effective. Remember it’s very hard to outperform the market average even for the most experienced investors. Rather than figuring out how to beat the market, instead focus on how to get the market average with the lowest possible risk.

Target Date Funds

This is the simplest strategy. You only have to invest in one mutual fund that has a specific retirement date. These are offered by all the major brokerages. For example, Vanguard offers Vanguard 2040 (VFORX) which is optimized for those planning to retire in 2040. The fund is a composition as of 12/31/13 is 63% of the Vanguard Total Stock Market Index Fund,  27%  Vanguard International Stock Index Fund,  8.1% Vanguard Total Bond Index Fund,  and 1.9%  Vanguard Total International Bond Index Fund.  As the years progress, the allocation will change to be less aggressive with more invested in bonds.

Not all target funds are created equally.  So choose the target fund offering carefully. You should find a target fund with expense ratio under 1% and one that relies on indexing.

The nice thing about target funds is that it’s the closest to a ‘set and forget’ strategy that you can find. You don’t have to concern yourself with rebalancing as it’s done for you. You can easily set up an automatic investment schedule where you regularly schedule purchases of the target fund in order to dollar cost average your new investments.

Three Fund Diversified Portfolio

This is a simple strategy recommended by books such as Armchair Millionaire and several books written by Daniel Solin. The idea is to maintain a portfolio of 3 index funds. One fund is a domestic US stock fund, an international fund, and a bond fund. There are varying levels of percentages to own in each fund depending on how aggressive a portfolio you desire. Check out the book by Daniel Solin called “The Smartest Investment Book You’ll Ever Read” for specific fund recommendations.

Diversified ETF Portfolio

ETFs are touted as a way to reduce expenses since management fees are usually less than equivalent mutual funds. Several online website and brokerages offer free ETF portfolio builders to help you select the exact funds to own and how many shares to buy based on your desired investment profile. These portfolios are usually comprised of 10-12 ETF in a variety of sectors including US domestic stocks, bonds, emerging markets, real estate, European stocks, and commodities. You basically purchase shares to meet a specified allocation in each sector. As ETF values change, eventually you will fall out of balance within your asset allocations. For a nominal monthly subscription fee, some of these tools such as MarketRiders  will  alert you when you go out of balance in any of your asset allocations and send you specific alerts about what to buy and sell in your account to get back to a balanced portfolio. For a higher fee, some services will make the rebalancing trades for you. Or you could choose to manually check your portfolio every quarter and determine if your portfolio is still balanced to the original allocations.

Mutual Fund Newsletter Recommendations

There are numerous investment newsletters that  provide model portfolios maintained by experienced investment experts. (Note, I don’t recommend stock picking newsletters since these are less diversified). Hulbert Financial Digest regularly ranks newsletters. I personally follow “Fidelity Insight and Monitor” which offers several portfolios with varying degrees of risk that are comprised of 5 Fidelity Investments funds. I follow their moderately aggressive portfolio. There are weekly updates on the stock market along with alerts if trades are planned in the portfolio. In my experience with using the newsletter, there haven’t been more than 2 trades per year usually consisting of selling part are all of one position in a fund in exchange for another. It’s been very easy to follow and the performance has been good.

Portfolio Management Websites

There are now numerous portfolio management websites that provide investing guidance for a nominal cost. I will review these in a future blog entry. The gist is that some sites such as FutureAdvisor and MarketRiders  recommend an ETF portfolio, monitor performance and alert you when it’s time to make a trade. FutureAdvisor will even make the trades for you for additional fees.   Other sites such as Betterment charge a percentage of your portfolio to manage your investments as opposed to giving you specific recommendations to trade. You pay more when the portfolio is managed for you.  The intention of these sites is not to beat the market but to get the market return while managing risk. Trades are thus relatively infrequent.