Many Americans think that investing is difficult. They spend time searching for the best performing funds or asset classes, yet most investors consistently underperform the market. If your portfolio is still recovering from the financial crisis and you are looking for a way to get back on track, here is a way to KISS your investment plan to maximize your returns. The KISS method uses some time-tested principles that can help even novice investors outperform the majority of Americans.
Know your risk; Keep your emotions in check.
The greatest determinant of your long range return is how much of your portfolio you are allocating to stocks and how much you are allocating to bonds and cash. This mix is based on your risk profile which includes your willingness, ability and need to take risk. For example, an older, conservative investor, who has already accumulated a lot of wealth, may require a 30-70 mix while a younger, more aggressive investor may desire a 70-30 mix. Your expected rate of return will depend on this allocation. A more conservative investor may only be able to expect a 6% return whereas an aggressive investor can expect a long range rate of return of over 7% before inflation.
Maintaining this allocation through thick and thin is what smart investors do to maximize returns over the long haul. Most investors get sabotaged by their emotions and end up selling and buying at inopportune moments. Knowing about the Investor Psychology Cycle and maintaining your “cool” during volatile periods (by not buying frantically at market tops and selling in the midst of downturns) allows you to stay invested when the market invariably rebounds after a precipitous drop and lock in gains after a large run up.
Invest in low cost index funds that represent diverse asset classes.
Many investors spend more time picking funds and asset classes and they would be better served by constructing a low cost portfolio of index funds that represent a diverse set of asset classes. Research indicates that, on average, roughly one third of active funds outperform their benchmarks. Unfortunately, many times the outperformance is not enough to offset the added costs associated with the fund and over time the particular fund may not continue to outperform.
Set your asset allocation strategy to conform to your risk.
As discussed above, consider investing in several asset classes such as US stocks (large, mid and small), international stocks (in both developed and developing countries), real estate (via publicly traded REITs), natural resource and commodity funds, and high quality bonds (corporates, treasuries, and/or municipals). You can work with a financial planner to construct a plan or employ a simple method for allocating among these by referring to these suggested books on the topic.
Strategically re-balance yearly or as needed.
Rather than trying to time the market, smart investors re-balance once year or as needed when allocations drift from a predetermined target range. In doing so, they consistently buy low and sell high.
Here is a summary of the KISS approach:
Know your risk; Keep your emotions in check.
Invest in low cost index funds that represent diverse asset classes.
Set your asset allocation strategy.
Strategically re-balance yearly or as needed.
For more information on this approach view this complimentary video.
