Many investors already know that it is important to invest in a variety of asset classes and even mix up the styles of investments. However, there is another dimension to diversification that many people surprisingly miss: time.
Carefully utilizing time can be among the most powerful weapons at an investor's disposal. The good news is that it is also the easiest of all investment tricks to employ.
Many people already know that it is critical to think about the long-term picture and let the "magic of time" smooth out volatility. But it is actually more important to make sure to properly space out the period you invest and the period you withdraw.
I call it "trickle investing," because the secret is to only invest a little bit each year into various asset classes over a period of a decade or two. Then you leave it alone. Most critically, make sure that after you retire, you don't make any rash changes to your investments. For each year you are in retirement, only pull out of your investment account the amount you will live off of for that year. It would be around the same amount of money you invested each year in your 40s and 50s.
But you may ask, "What if I end up fully invested and the market crashes?"
Let's say you selected the worst possible time to be fully invested in the last century -- in other words, you were big-time unlucky! So long as you followed the philosophy of trickle investing, your portfolio still would have grown larger than if you had just left the money in the bank.
In this case, you started investing a little each year into a broad portfolio of stocks and bonds in your 40s, and then retired at 65 years old in 1930, when you had the maximum amount invested. The timing for you could not have been worse. Yet, so long as you didn't panic and only took out each year the same amount you put in during the investing years, you ended up being able to live off of your investment portfolio well into your 90s. Whereas, if you had left all your money in the bank, you would have exhausted your funds around your 85th birthday. I explain this model in greater detail in my book, "The Safe Investor."
Why did it work out so well, despite your bad luck? Because it turns out that all too often, the years preceding major market crashes are the same years when the markets have dramatically increased. Thus, during the decades when you were trickling money into investments each year, your average purchase price was substantially lower than the market peak. And furthermore, broad markets often rebound over the decades following the crash. Thus, since you are only removing a small amount each year from your investment account, you will still be able to garner the return when markets rebound.
Experts in the financial services industry often call a form of this investing "dollar-cost averaging." However, my experience has been that the average person can easily visualize a "trickle in and trickle out" approach.
The beauty of trickling money in and out over decades is that you really don't have to worry about when you invest. In any given year, you are putting in (or when retired, taking out) so little that what the markets do in any given year doesn't matter.
Some people may still feel they want to time when to be in and out of the stock market. Of course, this activity is fine to do in your trading pocket, where you limit the amount of money you are betting on market timing. However, for the majority of your long-term money, which is in your investing pocket, it is best to simply follow these three rules:
-- Invest only a little each year, but make sure you put in roughly the same amounts every year.
-- Invest across many asset classes and countries, not only in stocks and bonds, but also real estate investment trusts and even a small portion in a basket of different commodities. Most importantly, don't make any radical adjustments -- let time work its magic.
-- After retiring, only take out what you need. You should continue to have exposure to equities markets if you expect this portfolio to grow.
You may still be saying, "But I am too afraid. I want to pull out all of my money when markets are too expensive."
My reply is, "Leave it alone, or else you inadvertently add too much risk to your long-term portfolio." Remember, most experts have not demonstrated an ability to consistently time when to get in and out of markets, so it is best to use the magic of time when investing. What normally happens to even professional market timers is that they are often out of the market at the right times. The problem is that they miss getting back in at the right time.
The old saying continues to rule: The bulls surprise you. What do you do when you get a windfall? Let's say you retire and receive a giant lump sum of money, like three-fourths of all your savings. Although your broker may disagree, it is still best to stretch out your investing period, especially in the stock market or long-term, fixed-rate bonds.
Even by investing evenly over the next four years or so, you can see a strong smoothing effect to the volatility of your portfolio. Sure, the markets may go up and you would only have put a portion of your investment money to work. On the other hand, the markets could also have gone down just as easily. So, by stretching the investing period over at least four years, you will always be partially right.
Naturally, as you enter your later retirement years, you will want to slowly reduce your overall proportion of exposure to volatile asset classes, like small-cap growth equities or emerging markets. However, it is important to note that if you and your spouse are already 70 years old, conditional probability says that at least one of you is likely to live past your 90th birthday. So, you still need your money growing for the next 20-plus years. You can't do that if most of your funds are sitting in bonds. That's why the way to grow your money in the simplest and safest possible way is to stick to trickle in and trickle out investing.
Tim McCarthy is the author of "The Safe Investor," released in February 2014, and former chairman and CEO of Nikko Asset Management Co. He has also worked at other large financial institutions such as Fidelity Investments and Merrill Lynch.
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