Pimp Your Finances

(The following is a guest post from Mike at the Oblivious Investor)

Want to know how to succeed at investing?

Stop trying.

No, I don’t mean that in some sort of New Age/philosophical way. I mean it quite literally.

Far too many investors waste time and money engaging in what history has shown (repeatedly) to be fruitless endeavors:

• Timing the market
• Picking stocks to outperform the market
• Predicting the next move in interest rates, real estate, commodity prices, or anything else.

Just stop trying. Instead, how about focusing on one of the things that you really can control? For example…

Asset Allocation

Without a doubt, an investor’s asset allocation will have an enormous impact on what his/her returns look like (both year-to-year returns as well as long-term returns).

The more heavily you weight your portfolio toward equities (stocks), the greater your long-term return will be. On the other hand, more equities also means more volatility, so it’s important not to go too heavily into stocks if you’re going to be retiring soon.

For younger investors, I often suggest a 100% stock allocation. After all, if you’re not going to be using the money for another 20-30 years, a temporary market decline has literally no negative effect on you. (Unless you let it scare you into selling at a market low point!)

Minimizing Costs

Investment costs are overlooked surprisingly often. It’s easy to understand, I suppose, given that the difference between low-cost funds and high-cost funds is really just 1-2% per year. But over a long enough period of time, a 1% difference is huge.

Example: $1,000 invested at a 9% rate of return over 40 years turns into $31,409. $1,000 invested at an 8% rate of return over 40 years turns into just $21,725. That’s more than a 30% decline in ending value.

When selecting mutual funds, it can be tempting to ignore investment costs and simply look at historical returns instead. The big problem with this strategy, however, is that funds have a very strong tendency to revert to the mean. (In other words, after a period of outperforming the market, they generally have a period of underperforming.) Investment costs, however, tend to stay the same from year to year. As a result, the expense ratio of a fund has proven to be one of the best predictors of its long-term performance.

Minimizing Taxes

There’s no sense in paying more taxes than you absolutely have to. Take advantage of the preferential tax treatment given to 401k’s and IRAs. If you have a 401k at work, make sure that you’re contributing enough to get the maximum matching contribution from your employer. If your employer doesn’t offer a 401k (or doesn’t make matching contributions), it’s probably best to open a Roth IRA.

In Summary

Again, given that history has shown us that things like picking stocks and timing the market tend not to be successful, why bother wasting your time and money on them (especially when there are other things that you could be doing that really do improve your investment results)?

About the Author: Mike writes at The Oblivious Investor, where he regularly reminds readers not to bother with things they cannot control, and focus instead on things they can. If you like this post, subscribe to his blog to read more.