As a financial advisor, the most common question I receive is: “How do you invest your money?”
I think it is extremely important to put my money where my mouth is and invest the same way I recommend any person my age — 29 years old — should invest.
As a young person, I actually invest in 100 percent equity to fund my long-term financial goals.
Overall, for young investors the objective is to grow wealth as much as possible, as early as possible. Personally, I will not be selling my investments for decades. For this reason, I have 100 percent of my money invested for long-term goals (retirement) in a diversified stock portfolio.
Stocks have a higher expected return than bonds or cash, and this return difference magnified over long periods of time can be staggering. I view any money I have that is not invested in the stock market as potentially missing out on the returns I need to materially build my wealth.
As a bonus, the temporary declines that are typically considered the downside of investing in stocks are actually a benefit to a young investor like me who is still purchasing stocks. I get to buy the same stocks I intended to purchase at lower prices, and have plenty of time to wait for a recovery. The major price swings we have experienced lately should not be a cause for concern for young investors, but a golden opportunity to buy at lower prices.
I have to specify that I invest all in stocks because it works for my long-term goals. If someone is setting money aside for an emergency fund or is looking to buy a house, for example, holding cash or bonds is a more appropriate investment strategy.
More from Personal Finance:
Last-minute tax savings opportunities for entrepreneurs
You’re probably out of time to withhold enough pay for taxes in 2018
New divorce tax rules could leave you with a big disadvantage
With that said, I always emphasize there is a cost to holding any amount of bonds or cash, especially for young investors whose investment decisions will be compounded over decades.
I don’t try to beat the market. Markets are incredibly efficient at incorporating all available information into prices; any attempt to outguess them is likely to end in failure. The vast majority of professional active managers underperform their benchmarks. I can’t image amateurs or semiprofessionals fare any better.
I follow a simple, diversified, buy-and-hold approach using low-cost index funds instead of playing the guessing game of attempting to own the right investments at the right time.
Instead of trying to pick the right stocks, I buy thousands of stocks in an asset class using a low-cost index to reap the returns of that asset class in the most reliable way possible — by holding them over long periods of time.
I diversify globally. Companies in the United States make up around half of the investable universe in stocks. I hold both U.S. and international stocks in my portfolio, and the international portion of my portfolio includes both developed countries and emerging markets.
The performance of international stocks can be very different from that of companies in the United States. Though the U.S. has been the better performer lately, there have been long periods of time when the opposite was true.
There is no way to predict in advance which will be the better performer. The only way to ensure you will reap stock market returns wherever they show up is by owning everything.
I strategically overweight certain areas of the market. If there was a secret sauce as far as my investment portfolio, this would be the closest thing to it. I strategically overweight specific areas of the market that have historically been associated with higher expected returns. However, this is really no secret and is based on decades of academic research.
As researchers looked through stock returns, they found that some groups of stocks historically provided higher returns than others — that is to say, there was a “premium” an investor received for investing in them. For example, over long periods of time, small company stocks tended to provide higher returns than large company stocks; value stocks tended to provide higher returns than growth stocks.
My portfolio strategically overweights specific groups of stocks that have a premium associated with them but does not bet the house on any single group of stocks. If small company stocks make up 10 percent to 15 percent of the stock market, I may hold 20 percent to 30 percent of my portfolio in small company stocks.
This isn’t a departure from risk and return, but simply a way to dial up risk in a way that is appropriate for me as a young investor. These premiums are not positive every year and can be negative for long periods of time. I only feel comfortable pursuing them because my time horizon is so long.
The bottom line is that I practice what I preach as both an advisor and investor. I encourage any investor to search for a financial advisor who does the same.
— By Paul Ruedi, financial advisor at Ruedi Wealth Management