One of the most frequently asked questions I get when talking to clients is "What should I invest in?" It reflects the belief of many out there that success in investing is complicated and involves investing the precisely right amount in the right company, at the right time. And then selling at the top of the market. The reality is that the answer I give clients is not what you might think.
Passive v. Active Investing
I believe in passive investing. A general definition of passive investing is:
"Passive management (also called passive investing) is an investing strategy that tracks a market-weighted index or portfolio. The idea is to minimize investing fees and to avoid the adverse consequences of failing to correctly anticipate the future."
The key items in here are diversification (no hot stocks!), avoiding fees, and not trying to time the market. Active management is pretty much the opposite - choosing which stocks/assets to invest in, charging a fee to pay all that brainpower doing the choosing, and trying to trade at the right time to maximize returns.
Research has shown that over time, passive investing brings higher returns. Over shorter periods of time, active management can outperform passive, but the problem is that you (and I) don't know when those periods will occur.
Increase Your Chance of Success
I typically talk with clients about 4 important factors that weigh into their investing plan.
- Risk v. Return - Investments that are more risky should deliver a higher return to compensate you for that risk. That's why stocks over time have delivered a higher return on average than bonds, for example. "Average" returns are just that, average. Over any period of time, returns will swing between really bad, bad, zero, good, and really good.
- Time Horizon - The longer your investment time horizon, the more swings you can endure and the likelihood that you will catch some of the good and really good returns goes up. If your time horizon is short, you don't want to be worrying which way the market is swinging day after day.
- Diversification - No one really knows which kinds of assets are going to have a good year. Is it Stocks? Bonds? Gold? Beanie Babies? The best strategy is to invest across many asset classes, not just single stocks. Again, this increases the likelihood that you will catch some of those good returns.
- Personal Behavior - Each person needs to assess their own personality and see how comfortable they are taking risk. If a drop in your portfolio of 10% will make you freak out, you might want to invest in less riskier options. If you know you really like to gamble, you might want your financial planner to talk you out of making a dumb mistake.
Why Women Need to Understand Investing
According to Pew Research, 40% of women already out-earn their spouses and nine in 10 women are expected to be the sole financial decision maker in their household at some point. This is because women are staying single longer, and living longer. They often outlive their partners and end up managing their finances alone during a very difficult time in their lives.
The good thing is that women have a few things going for them:
- They are earning more money than ever and typically save more of their income than men.
- Women are more likely to diversify their portfolios and less likely to engage in risky trading.
What's the Point of Investing Anyway?
This brings me back to another reason I like passive investing. I want my clients to focus on what they are investing FOR, rather than what they are investing IN.
The whole point of investing is to put today's money to work so that you can reach your life's goals tomorrow. Depending on what your goals are, you may not need to invest as much as you think, or take as much risk as you think. Maybe you need to take more risk, or invest more. But you need to understand the "Why?".
To me investing is the means to an end, not an end in itself.