Five Factors for Successful Investing

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Matt Soladay

Matt Soladay

An investment is something you put money, time, or effort into with the hopes of generating income from it or the ability to sell it for more than you paid.  Many of us have done this with our education and training already, even before we thought about investing in the stock market.  We paid money for our education, anticipating that the resulting income from our newly acquired healthcare careers would significantly exceed the cost of obtaining it.

In a more traditional sense, investing is the act of acquiring assets that appreciate or generate income over time. If you pay for something that doesn’t generate income or appreciate in value, it is not an investment. 

Although investing can appear complicated and saving for the long-term can be intimidating, it doesn’t have to be. In fact, I believe the simpler you make it, the better off you will be. It is easy to get caught up in the many strategies and opinions revolving around investing, which leads to many people losing sight of what is most important when it comes to investing; here are the five factors that will significantly impact your investing success.

Invest Enough Money To Reach Your Goals 

If you only invest $10 per month, it doesn’t matter what you invest in; you will fail to reach your long-term financial goals.  This is why Savings Rate is so important; the bigger your financial goals, the more money you will need to invest to achieve those goals. The key is to start now and stick with your plan; maybe that is increasing your savings a percent or two each year or reserving your bonus, overtime pay, etc. But finding ways to increase and invest your savings over the long-term will have a major benefit to your financial well-being.

Time In The Market

If we could perfectly predict the performance of the market, it would make sense to time the market. But, we can’t, and neither can the experts.  In an interview with CNBC, Keith Banks, Bank of America’s vice chair and head of investment solutions, said, “it’s time in the market, not timing the market” regarding long-term investment strategies. This quote really resonated with me because stock market risk is certainly easier to tolerate over the long-term. 

Think about it, which statement are you more confident about:

  1. The stock market will be higher 30 years from now.
  2. The stock market will be higher 30 days from now.

The answer is obvious: Number 1 is much more likely.

This first chart shows the price of the S&P 500 over the period between 2/2011 to 10/2011.  And when you look a little closer, you will see a drastic change in those last 30 days. If you invested at the beginning of this graph and looked at how it was doing eight months later, it might make you nervous.

 

However, that first chart is a short-term representation of market fluctuation. As a long-term investor planning for a comfortable retirement, you will see the benefit of time in the market. The next chart shows the same S&P 500 index price but over a much longer timeline of 40 years, from 1980 to 2020.

 

Do you see that little red box?  That represents the time from the first (red) chart. But when you zoom out and look at the long-term picture, it is a powerful representation of what history has shown us.

Compound Interest

Compound Interest is the magic behind long-term wealth accumulation and occurs when your initial investment earns interest, and then your interest earns interest. To enjoy the benefit, time, and rate of return are the two main factors; let’s look at an example and assume your goal is to have one million dollars in your retirement account at the age of 60, and you are expecting an 8% return.

Chart one: You are 45 years old and start saving for retirement. To hit $1M, you will need to contribute $3,000 a month. Your total contributions are $540,000, and interest earned is $479,000.

Chart two: You are 30 years old and start saving for retirement. To hit $1M, you will need to contribute $700 a month. Your total contributions are $252,000, and interest earned is $740,000.

Wow, what a difference in both total contributions and interest earned. Example two contributed $288,000 LESS and gained $261,000 MORE in interest.

 

You can run the numbers yourself or input your own data into the compound interest calculator. The point is, compound interest has a far greater impact with the amount of time your investments are exposed to the market.

Asset Allocation

The most common asset classes that people invest in are Stocks, Bonds, Real Estate, and owning their own business.  There are risks and benefits to all asset classes, so it is important to remain well-diversified.  A well-diversified portfolio is one that spreads your risk so that you are not too vulnerable in case one portion doesn’t perform well.  

You can diversify within an Asset Class and also between Asset Classes.  Within the Asset Class of stocks, the easiest way to diversify is to purchase different funds.  A fund is a professionally managed or created investment in which the money from many different investors is pooled together to buy the types of assets specified for that fund.  For example, if you are investing in an S&P 500 fund, it would only purchase stock from the country’s 500 largest companies.  This allows you, the individual investor, to easily diversify at a lower cost than individually having to buy many different stocks all at once.  It is easy to achieve instant stock diversification.

There are several different types of Funds through which you can own many stocks all at once.  Historically, Mutual Funds were the most common, but their higher cost without superior performance has led many investors towards Index Funds and Exchange Traded Funds (ETF’s).  These are lower-cost ways of being diversified without compromising long-term investment returns.

Index Funds and ETF’s biggest advantage over traditional retail mutual funds are that they cost less; they have lower expense ratios and fees because they tend to be passively managed.  That means that you don’t have to pay extra for someone to try and ‘beat the market’ like in actively managed mutual funds. 

Fees

The single most reliable way to improve long-term investment returns is to reduce the costs associated with the investments; this includes the cost of the individual fund and any fee you are paying someone to manage your money for you.

A fund will charge the investor (you) a percentage of the money invested as a means of maintaining the fund and earning money for those that manage it.  This is expressed as the ‘Expense Ratio’ and will be easy to identify with any fund you own or consider buying.  The higher the expense ratio, the more expensive the fund is.  For example, the expense ratio of Index Funds is noticeably lower than regular actively managed mutual funds because Index Funds are ‘passively’ managed.

Financial Advisors and the like earn money by charging you fees based on a number of things.  It could be an hourly rate, a specific amount for a specific service, commission, or, more commonly, an Assets Under Management (AUM) Fee.  The AUM fee is typically a percentage of the total amount of your money they manage for you, most commonly, 1% of the entire portfolio. 

We don’t control the stock market’s performance, but we want to make sure we benefit from its growth over time.  The higher the fees and costs you pay to invest, the more that eats into your ability to reap the rewards of market growth. 

Let’s explore this with an example: if you invested the maximum amount of $19,500 per year for 30 years into your 401k or 403b and received an 8% return, you would end up with $2,300,000.

However, if you paid 1% of your portfolio towards management fees and high-cost funds during that time, then your final rate of return would go down to 7%.  The result?  Your portfolio would be $1,900,000. That’s a difference of $400,000!

If actively managed funds that charge higher fees consistently beat the market (or index) to an amount to make up for the higher fees via greater return, we wouldn’t be having this conversation.  However, according to the SPIVA U.S. Scorecard, which tracks actively managed funds performance compared to Index Funds, the majority of actively managed funds underperform the index.  As of June 2020, 67.4% of funds underperformed in the last year, and a whopping 87.23% underperformed in the last 15-years.

There is no reliable way to identify the small number of funds that will outperform, and even if they are lucky enough to do it, their outperformance will likely not persist over time.  The lesson of this story: don’t overpay for underperformance.

When it comes to paying a financial professional to help you manage your money, the services they provide must be worth the cost you are paying.  Either way, it’s important to pick the investing strategy that works best for you, makes you comfortable, and stick to it. If you invest the appropriate amount of money in a well-diversified and low-cost portfolio over a long period, you will give yourself the best chance at financial success.

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