Have you ever played the arcade game Whac-a-Mole?
Armed with a mallet, the game’s object is to try and whack as many moles as you can as fast as you can as they pop up randomly in one of the multiple holes on the game board.
It reminds me of investors eager to throw money at the “next big thing” or continually chasing last year’s big winners. Jumping from one strategy to the next without a long-term plan, they’re off again this year whacking a different mole in a different hole. I recommend a much simpler strategy. It’s so simple that I recommend you do it yourself, without the help of a broker or investment advisor.
Given a paycheck and the desire to acquire wealth, anyone can succeed by following my 5 stock investing tenets. They’ll help you maximize your returns and minimize your risk. They’ll make you a better stock investor whether you’re just starting, ready to retire, or somewhere in between.
Stock Investing Tenet #1: Minimize Investing Expenses
There has been a revolution of sorts against high stock investing costs as of late. Investing expenses have never been lower for us personal investors. Still, plenty of rip-off artists disguised in suits are out there ready to take your money. Keeping your investment expenses as low as you can is fundamental to your investing success.
That’s why I favor indexed mutual funds and exchange-traded funds (ETFs). I’ve found these vehicles have the lowest costs and beat most actively managed funds that follow the same benchmark. Go ahead and add more active elements to your investment plan if you want, but only if you can dedicate the time necessary to manage them.
Seek out funds with the lowest of the low expense ratios, which should be your only cost of investment. iShares®, Schwab®, and Vanguard® are among the brokerages offering low-cost index funds that don’t charge a fee to trade them.
Stock Investing Tenet #2: Utilize Risk Management Strategies
Risk can never be eliminated from an investment plan. It can, however, be managed. Let me re-introduce you to 3 risk management strategies, inspired by Modern Portfolio Theory, which should be incorporated into all your investment plans:
Risky to Not-So-Risky Ratios
If you’ve read the last couple of newsletters, Risky to Not-So-Risky Ratios (last month’s newsletter) and Risk Tolerance for Investing (March 25th newsletter) should sound familiar. Following is a quick recap:
Decide beforehand how risky you want your plan to be, based on both your time horizon and risk tolerance. Make decisions on your risk level for the coming year as well as all subsequent years before you invest.
This is accomplished by setting percentages for both sides of your risky to not-so-risky ratio for all the years of the investment plan. Start with year one. On the risky side are your stock investments and any other risky investments. On the not-so-risky side are bonds and other less risky investments like CDs and money markets.
Diversification
For most investors, including myself, stock is the prominent investment on the risky side. Why? Stocks have proven in the past to be a great wealth builder for longer-term goals like financial independence, retirement, and education.
Unless you’re up for a game of Whac-a-Mole, you’ll want to diversify your stock portfolio. Another advantage of using indexed no-load mutual funds and ETFs is the amount of diversification you can achieve. Hundreds of top-performing companies can be bought with a single fund.
If a quality target or all-in-one index fund is available, that’s the perfect choice for persons wanting to “set it and forget it.” Otherwise, construct your own investment plan using index funds featuring different investing styles and market capitalizations.
Start your diversification with domestic large-growth and large-value index funds. Make those two funds the cornerstone of your diversification. Add riskier medium cap, small cap, and international stock elements if appropriate for your time horizon and risk tolerance.
Below are trading symbols for high-performing ETFs that duplicate the performance of domestic large growth and large value stock indexes at a low price. I challenge you to compare 1-, 3-, and 5-year returns against your large growth and value holdings.
Rebalance and Reassess
At least once a year, investment plans need to be rebalanced back to the risk level defined by the plan, which may get knocked out of whack due to the volatility of the stock market. Brush up on rebalancing and reassessing by revisiting my 2/24/2024 newsletter.
Stock Investing Tenet #3: Invest Tax-Advantaged
If you’ve got earned income, no matter your age, tax-advantaged accounts are where you want to invest. I insist you invest in tax-advantaged accounts first before you use what I call a “regular brokerage account.” Why? You’ll earn a higher after-tax return in tax-advantaged accounts versus returns in a regular brokerage account.
Tax-advantaged accounts also have restrictions on withdrawals, forcing you to invest for the long term. Don’t overlook the positive power of those restrictions. Even the most disciplined investors among us are vulnerable to succumbing to the desire to liquidate early, for whatever reason.
Maybe you have a regular brokerage account in addition to your tax advantaged ones: You participate in your employer’s ESPP or similar plan, you’ve inherited assets, or you’ve maxed out all your tax-advantaged options. Just make sure you look at your tax-advantaged options first.
401(k)-Type Plan
If you’ve got a quality 401(k), 403(b), 401(a), 457, TSA, or another employer-sponsored plan with a Roth option, count yourself lucky. If you’ve got a quality 401(k)-type plan with a match, congratulations! You’ve got the best wealth-building account on the planet.
I favor quality 401(k)-type plans and self-employment options over IRAs and other tax-advantaged accounts because of their higher contribution limits. However, all 401(k)-type plans are not created equal.
In my former capacity as a corporate trainer, I’ve seen lots of spectacular plans, like the 401(k) offered at Microsoft®. If you’re a service member or government employee and have access to the TSP (Thrift Savings Plan), that’s another one of the best of the best. Consider yourself extremely fortunate.
What’s so great about these plans? They offer indexed mutual funds and exchange-traded funds with no trading fees like many, but they do it at a much lower cost than most.
Unfortunately, some employers, either out of ignorance, apathy, or economics, offer what I call a dog plan. If you’re stuck with one of those, you have my sympathies. Luckily, there are other options.
IRAs
Unlike with 401(k)-type plans where your employer picks the custodian, you get to pick where you open an IRA. There are lots of great custodians out there, including the 3 highlighted earlier. They offer low-cost indexed mutual funds and exchange-traded funds without trading fees.
The bad news is the yearly IRA contribution limits are much lower than 401k contribution limits. Plus, if you or your spouse are covered by an employer retirement plan, there are income limits on contributions to traditional IRAs. There are also Roth IRA income limits regardless of whether you or your spouse have an employer plan.
Picking the best tax-advantaged accounts can be confusing. There’s a lot to know. That’s why I wrote A Beginners Guide to Roth IRAs and 401(k)-Type Plans.
Health Savings Accounts
Of all tax-advantaged accounts, a Health Savings Account has the most tax advantages, thus boosting your after-tax rate of return higher than any other tax-advantaged account, everything else being equal. If you can afford to pay your health expenses out-of-pocket, I want you to consider using your HSA as a wealth-building tool.
If you’re interested in becoming an “HSA millionaire,” I’ll write more about investing in HSAs in the coming months.
Stock Investing Tenet #4: Make Timely Investments
Spend most of the money you earn as you wish. That’s your business. I’m only concerned about a sliver of those earnings, that percentage of net income you take right off the top of every paycheck. I’ve found that’s the best way to save and invest for any financial goal: Do it every paycheck.
Even the best stock investing plan with the greatest number of tax advantages does you no good if you don’t have the money to feed it. Call this small fraction of your income saved your prosperity percentage, savings percentage, or whatever. It’s your most important money.
Stock Investing Tenet #5: Have a Plan
Never invest in stocks without a purpose. If you do, your investment will be much like a rudderless boat: You’ll go this way and that and never really get to where you want to go.
Right now, I’d like you to allot at least an hour of your time for an important meeting. With yourself. If you have a significant other, invite them to the meeting too.
You’re going to make some very important decisions during this meeting (see tenets 1-4), so set it at a time when you’ll be at your best and won’t be distracted. Keep in mind even a small amount of time spent on financial planning and goal setting pays huge dividends.
Revisit my Leveraging the Blue Moon newsletter from 8/30/2023 and plan that meeting now!
Your 250-Page Stock Investing Guidebook
Maybe you want to find out the “why” behind my stock investing recommendations, learn more about my 5 tenets and risk management strategies, or are finally ready to get serious about investing for the future.
Read DIY Stock and Securities Investing. Click on the title to download my e-book version from Amazon®. Or check out the paperback version.
Keep the book, along with the detailed table of contents, handy to help answer all your questions on your journey to financial independence.