Despite all our good intentions, it is often said that we are our own worst enemy for the many foolish things we do that come back to hurt us. Nowhere is this saying more relevant than in the world of finance, where bad decisions are the norm not the exception. Even the smartest superstar fund managers will readily admit their mistakes and chalk them up to some contorted form of tuition.
It is in this spirit that veteran investor, advisor and commentator Barry Ritholtz penned a recent column extolling the virtues of simplicity when it comes to portfolio planning.
In this installment of Investing 101, the CEO of Fusion IQ and author of The Big Picture blog lays out five tips to keep things simple and increase your chances for success.
1. Go Passive
Simply put, Ritholtz says, "Most investors are far better off with a passive index than trying to pick the next great manager." Sure it is tempting to chase a highly decorated fund or hot performer. However, "80% of managers underperform each year and that it's a different 80% each year," which is enough to give Ritholtz pause. He will tell you the behavioral ramifications just aren't worth it when you add in the "cost, taxes and expenses of constantly chasing the hot hand."
2. Diversity Across Asset Classes
According to Ritholtz, when it comes to diversifying your investments it isn't just about stocks, bonds and cash anymore. He suggests that a broader selection will serve you well. He goes on to say that investors would be wise to add some real estate or REITS, perhaps a 10% exposure to commodities, as well as other types of bonds than U.S. Treasuries, including corporates, high yield, municipals and maybe even some foreign debt too.
3. Dollar Cost Averaging
This next technique happens by establishing a plan where you put the same amount of money into the market week after week or month after month. By removing the decision-making process and automating your purchases, Ritholtz says your chances to succeed over the long haul will go up. "A lot of the rules we put together to keep it simple were to defeat your own behavioral errors," he explains. Few things can compete with the mindless discipline that comes from dollar cost averaging and the fact that it forces you to buy more when things are cheap and less when the prices have risen.
4. Watch Expenses
By making a concerted effort to keep costs down, Ritholtz says you will avail yourself to "the only thing on Wall Street that I know of that is a free lunch." As he describes in the attached video, the lower the fees and the longer you invest, the bigger the benefit.
5. Rebalance and Review
As much as he urges investors to automate, Ritholtz says that is not an excuse for abandonment. By selecting a mix of different investments you achieve your goal of diversification. But those original ratios change over time due to market performance which makes it critical to bring things back in line by regularly rebalancing. "What it allows you to do is to sell a little bit of what has gotten expensive and buy a little bit of what's gotten cheap." By doing so, he says you will be "buying what's advantageously priced."
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