A Great Year for Investing
ALL investment classes did well in 2017. Yes, some did better than others, but it is rare to find a category that did not have a positive return last year. Lets take a look at some of the more common indices that we use to measure investment performance.
Dow Jones Industrials + 25.4% S&P 500 + 19.8% NASDAQ + 28.9% EAFE+21.9%
Very desirable numbers indeed. Especially when compared to the return of various Bond indices which are in the 1%-4% range. Low interest rates have become a way of life for the last several years and although they are inching up, there doesn’t appear to be a reason for a substantial increase anytime soon.
How can we use this information to manage our money in the most prudent way? There are several principles for us to understand. If we apply them consistently we can prosper.
- Stocks are inherently more risky than bonds. Owning a stock means you own part of a business which you hope will be profitable, thereby increasing in value. A bond holder is playing the role of a bank loaning money to a business in exchange for an interest payment, which we call a dividend.
- Over time Stocks as a group return more to their owners than Bonds do. Although 2017 is a year when stock performance far exceeded bond returns, we normally expect stocks to outperform bonds by 3-5%, year after year.
- Prudent investing says we cannot put all our eggs in one basket; can’t buy just one stock; can’t own just one asset class. Big companies or real estate are examples of asset classes. Think about all of your money being invested in real estate back in 2008! A recipe for disaster.
- If we DIVERSIFY, we can reduce the risk associated with owning stocks and still get the majority of the return. Diversify means buying hundreds–or thousands–of stocks and bonds thereby minimizing the impact, positive or negative, that any one stock or bond could have on your portfolio.
- The easiest way to diversify is to buy a mutual fund or Exchange Traded Fund (ETF). These are groups of stocks or bonds that have been packaged by “experts” for purchase by the investing public. We can select these funds according to our own preference or hire advisors who will guide us.
Getting Started, Staying Engaged with Investing
- We need to decide how much of our money we are willing to invest in stocks and how much in bonds/fixed return investments. The more risk we are willing to take, the more we can invest in stocks. Lets say we decide on an even split–50%stocks, 50% bonds. We also have decisions around the asset classes we choose–US stocks/International; Large/Medium/Small companies; Growth companies that are very popular versus companies that are seen as undervalued because of recent performance. There are more ways to slice and dice our portfolio than these choices, but these are some of the more common ones.
- Having built our portfolio, we cannot just set it and forget it. We need to monitor performance on a regular schedule. That can be as often as monthly, but no less frequently than annually. Monitoring is crucial to keeping our mix at the risk level we have chosen. If stocks rise 25% and bonds rise only 5%, we will have made a nice return, but our portfolio is now 54% stocks and 46% bonds. Thus, although we wanted an equal amount in each, we now have 20% more stocks than bonds.
The Solution – Rebalance Your Investments
- Rebalancing our portfolio by selling some of our stocks and investing the proceeds in bonds keeps us in our 50% portfolio of each. Although it may seem counterproductive to sell those investments that grew the best, remember we are “selling high and buying low.” Isn’t that the way we want to do it? By doing this consistently we will keep our risk at a level we are comfortable with and still have a portfolio that is growing when the markets are growing.
Performance in 2018 will most likely be less positive than 2017 overall. Rarely does the market grow consistently as much as it did last year. And even more rare is having sustained strong growth two years in a row. Expect less return and more volatility–up one month, down the next. Fight the urge to sell when things drop and don’t put all your eggs in one basket when a certain investment is doing great. Investing is a marathon, not a sprint. Blessings to those of you who stay the course!