In earlier columns, I’ve suggested that 2011 is likely to be a year of superior returns for the stock market. Now is the time to review your investments and reset your strategy for success. Too often investors allow themselves to be frozen by the fear of what has transpired over the recent past and wait to shift to a more stock oriented allocation until it is obvious to everyone that stocks are in a bull market. Here are five tips to help you be more successful:
1. Develop a concise investment strategy. I find that many people invest like a ‘leaf blowing in the wind’…first this investment, then that one, with no strategy or decision-making process. You should be able to articulate your strategy in just a few sentences. What is your overall allocation between equities (stocks and stock mutual funds) and fixed income (money markets, CDs, and bonds)? Are you going to use a mutual fund strategy or use individual securities?
2. Diversification is still in vogue. I’ve seen an awful lot of people get enamored with a single stock to the point where the bulk of their wealth was in a highly concentrated position only to have disaster befall that security. Many people learned this lesson the hard way when they allowed bank stocks to dominate their portfolio. My preference is that no single stock should exceed five percent of your portfolio. If you’re investing in individual stocks, make sure you have a minimum of twenty different companies across a number of different sectors.
3. Include a rebalancing strategy. Make sure that your investment process includes a methodology for rebalancing your portfolio. Rebalancing periodically forces you to take some of your profits and invest in underperforming securities. Realize that for the long-term investor, the ‘dogs of today, will be the stars of tomorrow’ and you’ll have systematically bought more shares at lower prices. A simple approach is to rebalance once a year. For taxable accounts, pay attention to tax consequences. If you sell a profitable position within twelve months, you could owe taxes at rates as high as 35%. By waiting twelve months and one day, you receive long-term capital gains tax treatment which is taxed at a maximum federal rate of 15%.
4. Expenses do matter. Commissions, trading fees, mutual fund management fees can all add up fast. I recently reviewed an annuity that had annual fees of nearly 3%. That’s a lot of expenses coming straight out of returns. Low cost alternatives include using discount brokers such as Charles Schwab or Scott Trade when buying individual stocks or using index mutual funds and exchange traded funds.
5. Invest systematically. I was recently visiting with a very successful fitness trainer who asked me, “Stewart, is investing $500 or $1,000 per month enough to really make a difference?” Not only was my answer a resounding ‘yes’, systematic investing is one of the keys to wealth accumulation. My wife is fond of saying, “Bloom where you are planted”, meaning no matter what your situation is, start there. I know one lady who was dead broke but committed to saving one dollar per week while systematically increasing her savings. She got so hooked on saving and investing that she managed to become financially free within three years!