To succeed as an investor isn't hard, but it
takes planning and discipline. What if
you're not disciplined by nature? Put
together an investment plan and set it in
motion. Through automatic investments to
your employer-sponsored plan, an IRA, and
other accounts, you can start to accumulate
assets. PlainTalk's
How to Create Your Investment Plan can
help you develop a plan that suits your
goals, temperament, and financial situation.
Start by living beneath your means. It
sounds simple, but in today's material world
it can be hard to do. Unless you spend less
than you earn, you'll have nothing to
invest. So decide how much you'll set aside
before you decide how much you're
going to spend, and you'll have taken the
first step toward successful investing.
The following five rules also will be
useful for your investment program:
Diversify, diversify, diversify
You can't predict which way the markets
will move—or which investments will go up or
down—but you can spread the risk around by
investing in a mix of stocks, bonds, and
cash investments and diversifying your
investments within each of those asset
classes.
That way, when some investments aren't
growing—or are even falling in value—other
investments may carry the day, helping to
even out the ups and downs of your total
portfolio.
The best way for many investors to ensure
portfolio diversification is to invest in
mutual funds that hold a broad range of
securities. Since it's a good idea for your
portfolio to reflect the market as a whole,
investing in index funds that mirror the
entire stock and bond markets can make your
job easier. Keep in mind that
diversification does not ensure a profit or
protect against a loss in a declining
market.
Keep costs down
If you're a careful shopper, you know you
generally get what you pay for. When you're
buying mutual funds, however, high costs
don't mean you'll get more for your money.
Instead of ensuring quality, high costs
actually reduce how much of a fund's returns
you get to keep. Think about it. The
investment manager of any mutual fund has to
deliver enough returns to compensate for a
fund's expense ratio before chalking up the
first dollar of return for the fund's
shareholders. The higher a fund's costs, the
higher that hurdle is.
Suppose you have $50,000 to invest. Let's
say you invest half of it in Fund A with an
expense ratio of 1.3%, and you put the other
half in Fund B with an expense ratio of only
0.3%. Assuming an 8% rate of return, see
what can happen to your investment in 20
years.
Investing in Fund A could cost you
$19,751!
This hypothetical
illustration does not represent the return
or expense ratio of any particular
investment.
The advertised performance of a fund
reflects some fund costs, such as the
expense ratio, which includes 12b-1 fees.
Other costs, such as any front-end and
back-end loads, you have to take into
account yourself. These costs can be hefty.
You can't control which way the market will
go next, but you can certainly control what
you pay to own a fund.
Pay attention to taxes
After investment costs and inflation,
taxes take the biggest bite out of your
return. To reduce your investment taxes,
make maximum use of tax-advantaged investing
opportunities, such as employer-sponsored
retirement plans, traditional IRAs, and
college savings plans.
For your taxable accounts, consider
investing in:
- Municipal bonds or municipal bond
funds, which are exempt from federal
(and often state and local) income
taxes.
- Tax-managed mutual funds, which use
special strategies in seeking to reduce
taxes on investment returns.
- Index funds, which tend to have
lower turnover and so are less likely
than actively managed funds to pass
along taxable gains. (This may not
always be the case for index funds that
track a benchmark for a narrow market
segment or industry sector.)
Finally, make sure you have the right
types of investments in the right accounts.
In general, hold the least tax-efficient
funds (such as taxable bond funds) in your
tax-advantaged accounts, and hold the most
tax-efficient funds (such as stock index
funds) in your taxable accounts.
How to Be a Tax-Savvy Investor offers
more details on tax strategies.
Although the income from a
municipal bond fund is exempt from federal
tax, you will pay tax on capital gains
realized from a fund's trading or from the
redemption of shares. For some investors, a
portion of the fund's income may be subject
to the alternative minimum tax. Income may
also be taxed by state and local
governments.
Buy and hold for the long run
No one can predict the ups and downs of
the market often enough to make
market-timing a consistently winning
strategy. Even if you were smart enough to
beat the odds, frequent buying and selling
could increase your taxes and trading costs
enough to wipe out any gains. Besides,
market rallies often occur suddenly and over
very short periods of time. If you happened
to be out of the market during those few
days, you could miss most or all of the
gains for that year. Don't waste your time
trying to predict the market. Be a
buy-and-hold investor.
Know yourself
Some people can shrug off big market
swings; others cannot. If you can't sleep at
night because the value of your investments
is bounding around, you need to build a
portfolio with a more conservative mix of
assets and, if you can, increase your
savings rate to increase the chances of
achieving your goals. You may not reach your
goals quite as fast, but you'll likely be
more rested along the way.
