This is the first article in a series that will discuss and explain basic investment concepts in hopefully an understandable and meaningful way. Whether you work with an investment advisor or choose to do your own investing, there are some things you just need to know to be successful. Here is my take on what those things are.
You need to own some stocks in your portfolio, and probably more than you think. Bonds are guaranteed and are perceived as safe. However the 10 year government bond, as of this writing, is paying about a guaranteed 2%. Take away taxes and inflation and you didn’t have much of return. It is highly likely that you won’t be able to retire and live happily ever after on a 2% investment return from your nest egg.
Stocks, although at times much more exciting than bonds, have historically over the long term provided a greater return than bonds, after you take away taxes and inflation. Real return from an investment is defined as what is left after taxes and inflation, and what you really get to spend. Said differently, the only way to gain wealth is to earn more with your investments than taxes and inflation take away from you. You need to have some percentage of stocks in your portfolio to preserve or grow your wealth.
The intent of these articles is not to give advice, but inform. That said, here are my thoughts on age and stocks. You shouldn’t own bonds in your retirement plan until you turn 50. Early 50’s is something like 75% stocks and 25% bonds. Late 50’s to mid 60’s is something like 60% stocks and 40% bonds. Maybe you stay with that mixture forever. Maybe you consider dropping to a 40% stock and 60% bond allocation in retirement. Maybe not. I personally think that your stock percentage should never be below 40%.
Invest in lots of stocks for safety. The catastrophic risk in owning stock is that company goes bankrupt and out of business. If you own one stock in your retirement plan and it goes belly up, you are in deep trouble. Protecting against this risk is really easy. Buy lots of stocks. The S&P 500 is a list of America’s 500 biggest companies, and a proxy for the “stock market”. Long term returns on the S&P 500 have been attractive. There are many investments available where you can own the whole 500 companies in the S&P 500. There is a pretty good chance that those 500 companies won’t all be going out of business simultaneously any time soon. Sure, three of four of those companies might disappear in the next 12 months, but you won’t notice. Mutual Funds and Exchange Traded Funds are investment vehicles that own stocks that you can and should invest in. Do not buy individual stocks. Buy them in bunches. Diversification!
Own different flavors or stocks for even more diversification (protection). Diversify geographically. Own some high quality U.S. stocks. Own some high quality international stocks (developed markets). Own some stocks from emerging countries with high growth potential (developing markets). Diversify by size. Own some small, medium and large stocks. Now we have a diversified, global stock portfolio.
Michael J. McNamara Ph.D., CFP®
CERTIFIED FINANCIAL PLANNER™
*Any financial advice in this article is intended to be generic in nature. Readers should consult with their own financial advisors before implementing any advice or suggestions above.