(Laura’s note: I’m on maternity leave, and while I’ll be blogging occasionally over the next few weeks, I wanted to take the opportunity to run guest posts by my favorite bloggers. Enjoy!)
by Manisha Thakor
What are the 4 most dangerous words to your portfolio?
“How should I invest?”
Surprised? Probably. As the stock market goes up and down, the financial media are full of commentary addressing this question. On the surface it seems like a logical query.
But if you were getting ready to go out, would you ask “What Should I Wear?”… without describing where you are heading? Of course not. The clothes you’d wear to shovel snow in will be very different from the clothes you’d wear to a wedding.
That’s why “How Should I Invest?” are the four most dangerous words to your portfolio. The answer to that question is often given as if one size fits all, when it’s anything but. To protect yourself, here are 5 things to think about to make sure your hard-earned money is invested in a way that is appropriate for your specific situation.
- When do you need to spend that money? If it’s in the next 5 years you typically want to protect that money against inflation in savings accounts, money market funds/accounts or CDs rather than take market risk in stocks or bonds.
- Do you have any outstanding high-interest debt? If so, paying off that debt may be the best investment you can make as it gives a “guaranteed” return – especially when interest rates on savings vehicles are so low.
- How steady is your income? A professor with tenure may feel more comfortable taking higher short-run risk than an entrepreneur with variable cash flow.
- How old are you? The older you are, the less time you have on your side to bounce back from volatile markets and thus the more conservative you’ll want your portfolio to be. For women, a rough rule of thumb is to take 110 minus your age to arrive at the ideal maximum percentage of your portfolio in stocks. For example, if you are a 40-year old woman… 110 minus 40 equals 70. So up to 70% of your portfolio could be in stocks and 30% in bonds (for men, who have shorter life spans, use John Bogle’s oft quoted 100 minus your age).
- How interested are you in investing to begin with? Unless you are inherently passionate about picking individual stocks or studying active money managers, you don’t need to do these things. I love target date retirement funds and/or utilizing low cost index funds and ETFs. My favorite “basic portfolio recipe” comes from Boglehead Mel Lindauer. His recommendation: for the percentage of your portfolio devoted to stocks, put 1/2 in a total US stock market index and 1/2 in a total international index. For the portion that goes into bonds, put 1/2 in a total US bond market index and 1/2 into Treasury Inflation Protected Securities (“TIPs”) via funds, ETFs, or direct purchase. From there you can add some additional investment spice in the form of REITS or commodities, but for most people this core recipe will do just dandy.
Bottom line, always remember that before anyone can give you meaningful investment guidance they need to understand where it is that you specifically want to go.