I'm sure there are investment brokers worth the fees and commissions they charge, but I haven't met one. I burned through five brokers before realizing that no one cares as much about my money as I do. Brokers are salespeople. Naturally, they care more about their bottom line then mine.
Each year, I'd compare my broker-managed portfolio's long-term performance with stock market indexes (Wilshire 5000, S&P 500, Dow Jones Industrial Average, NASDAQ, MSCI EAFE, etc.). I found that despite paying a decent sum to brokers for their expertise, my portfolio was under-performing the standard index benchmarks.
In 1999, I decide that it was worth my time and energy to learn how to manage my own investment portfolio. My efforts have paid off handsomely. Here's a down-n-dirty summary of what I've learned:
1. Start Today
Start as early as possible to take advantage of the astounding power of compounding growth. By reinvesting the gains you receive from the money you invest, you can double your money in less than eight years assuming a 10% average annual return.
Take a look at the following example, then try this calculator to see how much postponing your savings plan could cost:
Starting amount: $0
Savings plan: Save $10,000 per year for 30 years
Rate of return 10.00%
Ending balance = $1,809,434
Starting amount: $0
Savings plan: Postpone saving for 10 years then save $10,000 per year for 20 years
Rate of return: 10.00%
Ending balance = $630,025
Cost of waiting = $1,179,409
2. Put Your Investments on Auto-Pilot
Instruct your bank to automatically transfer at least 10-20% of your gross income to your investment accounts each month. If you don't think you can afford to do this then you can't afford your lifestyle. Get creative and cut expenses elsewhere and pay yourself first.
3. Maximize Retirement Account Contributions
How taxes are applied to an investment can make a big difference in the long run. There are tax advantages to retirement accounts which is why you should maximize your contributions to these accounts first, then add to your taxable accounts. Additionally, some employers match your contributions which equals free money.
This calculator compares a normal taxable investment to two common tax advantaged situations: An investment where taxes are deferred until withdrawals are made, and an investment where taxes are paid on money that goes into the account but all withdrawals are tax free.
4. Do It Yourself
Invest $10,000 each year and use a broker to place your order and you might pay $575 per year in sales commissions. Alternatively, learn to place investment orders yourself and your commission savings, compounding 10% annually, would be an extra $104,042 in your pocket after 30 years.
I use TD Ameritrade, an online trading brokerage, and spend $0 to $49.99 per trade in commissions. Compare their prices with a few competitors.
5. Diversify and Build a Balanced Portfolio
Speculative investments are like eggs-- when they fall, they make a mess. Don't place your bet on a single stock or sector. Spread your risk into a variety of market caps and styles as well as domestic, foreign and emerging markets. Proper diversification helps your portfolio weather any ups and downs the market can take. Asset allocation accounts for 94% of the variation in portfolio returns, while market timing and stock selection account for only 6% (Gary Brinson, Randolph Hood and Gilbert Beebower). Review and rebalance your portfolio annually to maintain your desired allocation percentages.
The Asset Allocator calculator is designed to help you create a balanced portfolio of investments. Your age, ability to tolerate risk, and several other factors are used to calculate a desirable mix of stocks, bonds and cash.
I'll share what my portfolio looks like in a future post, so please check back soon.
6. Be Mindful of Fees
Invest in a low-cost equity portfolio using no-load mutual funds, Exchange Traded Funds (ETFs) and index funds. Even a small difference in the fees you pay on your investments add up over time.
Use this calculator to see how different fees can impact your investment selections.
7. Don’t Try To Predict The Future
Rises and falls in the stock market are normal, frequent and not a reason to sell quality investments. On average, a 10% drop in the stock market has happened once a year during the past 100 years (Ned Davis Research). Don’t try to time the market by predicting the effect that current events might have on the market. You're likely to buy high and sell low which will cost you a bunch of money. Stay invested. Even professional market timers get it wrong most of the time.
8. Cover Your Ass(ets)
Protect your growing wealth with adequate insurance. The number one cause of bankruptcy is major medical expenses. In addition to health insurance, consider coverage for disability, life (use term rather than whole life), auto, homeowner/renter, business, and personal liability. Buy policies with the highest deductible you are comfortable with and invest your premium savings.
9. Understand Your Assets and Liabilities
Most people consider the home they live in as an asset but the truth is, it’s a liability. You're spending money (mortgage payments, repairs and maintenance, insurance, property taxes, etc) on property that isn't producing income. Stop thinking of your home as a savings account. In fact, consider living in a smaller home to free up extra money to invest. Put your money into investment property that produces a positive cash flow or into stocks and bonds.
We sold our home four years ago to invest the equity accumulated. Alarmed at the irrational exuberance in the real estate market, we then chose to rent a home to live in as the bubble grew and popped. Renting instead of buying our home saves us money and, by keeping money invested in equities rather than in the roof over our heads, affords us the opportunity to retire early. Don't believe the sales-pressure hype that homeownership is your best investment. I'll discuss this concept in more detail soon.
10. Crack Open Some Good Books
What I've offered today is a summary. I've shared my opinions and experiences. But don't just take my word; ask questions, read quality books, practice investing as you wean off of your high-commission broker.
Readers, what is your best investment rule-of-thumb? Do you use a broker or financial advisor? Have you been successful investing on your own?
Relevant and Recommended Reading:
View my favorite investment books at the Millionaire Mommy Next Door Store. Profits are offered as micro-loans (via kiva.org) to sponsor small businesses operated by the world's working poor-- empowering them to lift themselves out of poverty.
110 Personal Finance Calculators: Fast Answers For Your Financial Questions (my previous post)
5 Things The Marshmallow Test Can Teach You About Money (my previous post)
Start on your first $1 million at age 16 (article at MSN Money)
Did you miss a step? Want to learn my recipe for success, happiness and a million dollars? Start here: Baby Steps to Financial Freedom.