Getting Back to Investing Basics

The stock market is all the rage recently. The Dow has reached 20,000 for the first time ever and even hit 21,000 at the beginning of March. (If you’re not sure what these numbers mean, you should read this.) Everyone is now wondering what comes next. Will it continue too rise? Will the bubble burst?

The truth is no one knows.

We’ve seen the market rise and fall — and bubbles grow and burst — for decades.  And instead of getting caught up in the mania and making decisions based on emotions, I thought it would be good to get back to the fundamentals this week.

Today, I’ll discuss fundamental considerations when building a portfolio, some ways to do it simply and efficiently on your own and why you may still need additional help to get you where you want to be.


The Fundamentals 

When it comes to the question “how should we investing and where?” I use three fundamental principals:

  1. Keep costs low
  2. Stay diversified
  3. Invest for the long haul

1) Keep Costs Low 

Research shows that lower mutual fund costs consistently produce higher returns. You don’t have to take my word for it.  Have a look at this interview with industry mavens Warren Buffet and Burton Malkiel discussing this very subject. For many years, investment advisors have charged around 1% of assets under management — so if you invest $500,000 with them, you’ll pay around $5,000 a year for their management.  However, with the emergence of robo-advisors like Betterment and Ellevest, people have now found that they can build portfolios for much less.

When building your portfolio make sure you understand what you are paying for advice or the platform (i.e., the advisor or platform fee) and what it costs you to be in certain investments (expense, ratios, transaction costs, etc.) You should consider the total cost when making your decision. Many Vanguard Index funds have expense ratios of .05% to 15%. You can purchase those directly through Vanguard or use a management platform like Betterment or Ellevest for a fee of .25% – .50% (again, this is on top of the fund expense ratios).

Full disclosure: I use Betterment as my custodian for my advisory services but I do not get any commission or kickback for recommending their service.

You may hear some active managers say that you pay the extra fee for them to beat the market. However, I’ve already talked about the SPIVA reports that prove this wrong 80-90% of the time.  Another caveat, just because something says “Index Fund” doesn’t automatically mean it’s low cost.  So stay cognizant of these fees.

2) Stay Diversified

Staying diversified helps reduce market or systemic risk (that is, the losses you incur with the whole market goes down). The good thing is you don’t need 20 different funds or 25 individual stocks to do that. You can diversify across the entire market with total market funds. For example, Vanguard uses the following in most of its Target Date Funds: Total Market Index fund (for domestic stocks), Total International Fund (for international stocks), Total Bond Market Fund (for domestic bonds) and a Total International Bond Market Fund (for international bonds).

3) Invest For the Long Haul

Lastly, make sure to keep your eyes on your long-term goal. A friend told me recently that he’s had his money out of the market for the past eight years out of fear of a market crash. Unfortunately, that means he’s missed these most recent market surges and the big push in 2013.

It’s better not to worry about what the market does from year-to-year or try to anticipate crashes and bear markets.  Market averages will go up and down, as they have for decades.  But overall, the trend is up. You want to be IN the market, so you can benefit from the highs as far as returns and the lows when you can buy investments on sale.


Where You Can Set Up Your Portfolio

In short, keeping your costs low, diversifying your investments (simply) and investing for the long haul can get you 80% of where you need to be. Here are a few examples of places to do that, if you like that strategy:

Target Date Funds

I mentioned Vanguard Target Date Funds before. These are all-in-one mutual funds that can cost .15% of your investment. They contain the four funds I mentioned that keep you diversified. They adjust the mix of these funds as you grow older to reduce overall risk, that is, you’ll have more stocks if your target date is far off and more bonds if it is just around the corner.  You may also hear these funds referred to as life-cycle funds or age-based funds.  Many brokers like Fidelity, Blackrock, and T. Rowe Price also have a version of these types of funds. The key is to check the underlying asset allocation of the funds to make sure it matches your risk tolerance and you know the expense ratio. As with index funds, target date funds can vary in costs.

Robo-advisors like Betterment

To deal with the more added complexity of taxable accounts, you could go with a place like Betterment. Betterment offers low cost, diversified investing, but it also adds features of like tax-coordinated portfolios that make sure your overall portfolio is as tax-efficient as possible. The platform fee is .25%. Plus you will have to pay the expense ratio for the funds, most of which are .5% to .20%. And while I use Betterment, there are other robo-advisors out there like Ellevest and Charles Schwab that offer similar features.



The Last 20%

Keeping these three principles in mind will get you 80% of where you want to be. But having an advisor still plays a crucial role in good planning.  An advisor takes into consideration things like cash flow, risk capacity and other principles like insurance planning, tax planning and estate planning. He or she can also help you avoid harmful behaviors (like getting out of the market after a correction, because you’re afraid) and are there to help with changes when they inevitably arise.

Fiduciary-based, comprehensive advice is key to making smart decisions for your overall financial picture. You can find fee-only advisors through the CFP board or organizations like NAPFA. Brokers like Vanguard and Betterment are also offering portfolio advisory services as well, at low cost.



I hope this was helpful. I would love to hear what you think. Do you use these principles when it comes to investing? Message, tweet or email at the links below.