The world of investing is vastly complex, but only if you let it be. There are some great books and websites on which to get started, but even these can be a bit much for someone looking to put their first few dollars (or hundred or thousand) into a retirement account. Before you look any further, though: hurry up and wait – remember that there is no rush to figuring out the perfect portfolio when still in the early stages of funding it. That said, here are some general guidelines that many folks follow with their portfolios, and which may help you frame the core decisions you want to make.
1) Past results do not dictate future returns. Investing lies somewhere between the realms of science and humanities, mathematics and reality. Many investors start by considering it like Newtonian Mechanics, but the facts are counter-intuitive: assets and classes tend to revert to the mean over time. What goes up does not keep going up – it comes back down. So if you catch yourself ogling the last decade’s out-performance of this or that, remember: those may well be the worst performers going forward.
2) Don’t confuse strategy with outcome. Once you do get started, you might find that the short-term results of your strategy are not what you expected. Even the most diversified portfolio with non-correlated (or negatively-correlated) asset classes can see multiple assets suffering at the same time. Remember the reasons why you built your portfolio in the first place, refer to your investment policy, and stay the course.
3) Stay the course. This is the opposite mantra than that of active investors, who try to read market currents and avoid downturns while catching updrafts. Their approach, as many studies show, is the inferior one on the whole – when in doubt: do nothing, or at least force yourself to wait before taking action. Unless your investing strategy was flawed in the first place, it does not serve you to second-guess it in the middle of a crisis. If you are really worried about what you will do at a market bottom, write out your goals, reasons and back-up plans ahead of time, not in the heat of the moment.
4) Risk does not entail reward. Not all risks are compensated in the market, nor are costs. An expensive fund might just be expensive and not better (this is often the case) and taking on the risk of active management or excessive foreign currency exposure is not a way to make a risk-adjusted gain (though you could get lucky, of course).
5) When it comes to stocks and bonds, don’t go over 75% or under 25%. This comes, paraphrased, courtesy of Benjamin Graham, famous modern-day advocate of broad-market investing and wise diversification. The idea is simple: diversifying is the only ‘free lunch’ with investments, so while a 100% stock portfolio might sound appealing to someone young and looking for risk (or 100% bonds might appeal to someone risk-adverse) neither extreme is efficient nor ideal. That is not to say some people are not well-served by counting themselves as exceptions, but in most circumstances this is a good rule of thumb to use when framing the question of asset allocation. Also, this rule does not address commodities or cash or other alternative classes, but with good reason: for someone truly just starting out and trying to keep things simple, it is well worth reading a book (or three) before jumping in beyond equities and bond funds.