You can build wealth by saving for the future and investing over a long term. The earlier you start, the easier it is for your money to work for you through compounding.
Building wealth is essential to accomplish a variety of goals, from sending your kids to college to retiring in style. Wealth is what you accumulate; not what you spend. Most Americans are not wealthy. and few have accumulated significant assets and wealth.
How long could the average household survive without a steady income.
Every successful saving and investing journey starts with a set of clear and concise goals, whether they’re as big as retirement or as small as wanting to save for new tires for your vehicle. It’s important to determine and write down what are your savings, investing and wealth building goals.
Rather than trying to guess what’s going to happen, focus on what you can control. Each financial goal calls for a positive step you can take no matter what the market or the economy is doing.
The Wealth-Building Process can help you keep many of these financial goals and investing process on track. It is designed to give you clarity on what you are investing for and what steps you need to take to reach and fulfill those goals.
The key is to stick to your financial plan and recalibrate the investing process throughout the year. One way to do so is to set up reminders that prompt you to go back and review your goals. Positive change often requires a willingness to put yourself back on track whenever you drift away from the plan.
With that in mind, here are financial and investing tactics for investors:
1. Only follow strategies you can stick with no matter how good or bad market conditions are. All too often, investors misperceive the optimal strategy as being the one with the highest return (and often the one with the highest recent returns). This is a big mistake; if you can’t stick to the strategy, then it’s not optimal for you. Better long-term results come to those investors who can stick with a good long-term strategy in all market environments rather than chasing the hot strategy only to abandon it when market conditions change.
One way to tell if your strategy is optimal is to look at the portfolio actions you took this past year. Make sure that you are not taking on more risk than you can actually tolerate. Alternatively, you may need to develop more clearly defined rules about when you will make changes to your portfolio.
2. Focus on your process, not on your goals. Mr. Market couldn’t care less about how much you need to fund retirement, pay for a child’s college education or fulfill a different financial goal you may have. He does as he pleases. The only thing you can control is your process for allocating your portfolio, choosing investments to buy and determining when it’s time to sell. Focus on getting the process right for these three things and you will get the best possible return relative to the returns of the financial markets and your personal tolerance for risk.
3. Write down the reasons you are buying an investment. One of the most fundamental rules of investing is to sell a security when the reasons you bought it no longer apply. Review your current holdings and ask yourself the exact reasons you bought them. Recommend you maintain notes, so you don’t have to rely on your memory to cite the exact characteristics of a stock or a fund that attracted you to the investment.
4. Write down the reasons you would sell the investments you own. Just as you should write down the reasons you bought an investment, jot down the reasons you would sell an investment, ideally before you buy it. Economic conditions and business attributes change over time, so even long-term holdings may overstay their welcome. A preset list of criteria for selling a stock, bond or fund can be particularly helpful in identifying when a negative trend has emerged.
5. Have a set schedule for reviewing your portfolio holdings. If you own individual securities, consider reviewing the headlines and other relevant criteria weekly. (Daily can work, if doing so won’t cause you to trade too frequently.) If you own mutual funds, exchange-traded funds (ETFs) or bonds, monitor them quarterly or monthly.
6. Rebalance your portfolio back to your allocation targets. Check your portfolio allocations and adjust them if they are off target. For example, if your strategy calls for holding 40% large-cap stocks, 30% small-cap stocks and 30% bonds, but your portfolio is now composed of 45% large-cap stocks, 35% small-cap stocks and 20% bonds, adjust it. Move 5% of your portfolio out of large-cap stocks, move 5% out of small-cap stocks and put the money into bonds to bring your allocation back to 40%/30%/30%. How often should you rebalance? Vanguard suggests rebalancing annually or semiannually when your allocations are off target by five percentage points or more.
7. Review your investment expenses. Every dollar you spend on fees is an extra dollar you need to earn in investment performance just to break even. Higher expenses can be justified if you receive enough value for them. An example would be a financial adviser who keeps you on track to reach your financial goals. Review your expenses annually.
8. Automate when possible. A good way to avoid unintentional and behavioral errors is to automate certain investment actions. Contributions to savings, retirement and brokerage accounts can be directly taken from your paycheck or from your checking account. (If the latter, have the money pulled on the same day you get paid or the following business day.) Most mutual funds will automatically invest the contributions for you. Required minimum distributions (RMDs) can be automated to avoid missing deadlines and provide a monthly stream of income. You can also have bills set up to be paid automatically to avoid incurring late fees.
9. Create and use a checklist. An easy way to ensure you are following all of your investing rules is to have a checklist. It will both take the emotions out of your decisions and ensure you’re not overlooking something important.
10. Write and maintain emergency instructions on how to manage your portfolio. Typically, one person in a household pays the bills and manages the portfolio. If that person is you and something suddenly happened to you, how easy would it be for your spouse or one of your children to step in and take care of your financial affairs? For many families, the answer is ‘not easily’ given the probable level of stress in addition to their lack of familiarity with your accounts. A written plan better equips them to manage your finances in the manner you would like them to. It’s also a good idea to contact all of your financial institutions and give them a trusted contact they can reach out to, if needed.
Even Warren Buffett sees the value of this resolution. In his 2013 Berkshire Hathaway shareholder letter, he wrote, “What I advise here is essentially identical to certain instructions I’ve laid out in my will. One bequest provides that cash will be delivered to a trustee for my wife’s benefit … My advice to the trustee could not be more simple: Put 10% of the cash in short-term government bonds and 90% in a very low-cost S&P 500 index fund.” Considering the probability of Mrs. Buffett having learned a thing or two about investing over the years, it speaks volumes that Warren Buffett still sees the importance of including simple and easy-to-follow instructions in his estate documents.
11. Share your insights about investing with your family. If you’re reading this, you likely have some passion for, or at least interest in, investing. Share it with your family members by having a conversation with them. Talk about how you invest, what you’ve learned and even the mistakes you’ve made. It’s a great way to pass along a legacy to those younger than you and to maintain a strong bond with those older than you. You might even learn something new by doing so. Our Wealth-Building Process can provide a great framework for facilitating these types of conversations.
If a family member isn’t ready to talk, don’t push them. Rather, write down what you want to say, give the letter to them and tell them you’ll be ready to talk when they are. For those of you who are older and are seeking topics that your younger relatives (e.g., millennials) might be interested in, consider our discount broker guide, which includes a comparison of the traditional online brokers versus the newer micro-investing apps.
12. Check your beneficiary designations. It is critical that all of your beneficiary designations are current and correctly listed. Even if nothing has changed over the past year, ensure that the designations on all of your accounts are correct. Also, make sure your beneficiaries know the accounts and policies they are listed on. Finally, be certain that those you would depend on to take over your financial affairs have access to the documents they need in the event of an emergency. We think this step is so important that we included a checklist for it in our Wealth-Building Process toolkit.
While you are in the process of checking your beneficiaries, contact all of the financial institutions you have an account or policy with to ensure your contact information is correct.
13. Be disciplined, not dogmatic. When you come across information that contradicts your views, do not automatically assume it is wrong. The information may highlight risks you have not previously considered or that you have downplayed in the past. At the same time, don’t be quick to change your investing style just because you hear of a strategy or an approach that is different than yours. Part of investing success comes from being open to new ideas while maintaining the ability to stick with a rational strategy based on historical facts. When in doubt, remember resolution #1, only follow strategies you can stick with no matter how good or bad market conditions are.
14. Never panic. Whenever stocks incur a correction (a decline of 10%–20%) or fall into bear market territory (a drop of 20% or more), the temptation to sell becomes more intense. Our brains are programmed to disdain losses as well as to react first and think later.
This focus on the short term causes us to ignore the lessons of history. Market history shows a pattern of rewards for those who endure the bouts of short-term volatility. We saw this last year. The coronavirus bear market was sharp, and the drop was quick. Those who were steadfast—or used it as an opportunity to add to their equity positions—were rewarded with new record highs being set late in the year and so far this year.
Drops happen regularly and so do recoveries. If you sell in the midst of a correction or a bear market, you will lock in your losses. If you don’t immediately buy when the market rebounds—and people who panic during bad market conditions wait too long to get back in—you will also miss out on big gains, compounding the damage to your portfolio. Bluntly put, panicking results in a large and lasting forfeiture of wealth.
15. Don’t make a big mistake. Things are going to go haywire. A stock you bought will suddenly plunge in value. A mutual fund strategy will hit the skids. A bond issuer will receive a big credit downgrade. The market will drop at the most inopportune time.
If you are properly diversified, don’t make big bets on uncertain outcomes (including how President-elect Biden’s administration and the Democrats’ control of Congress will impact the financial markets), avoid constantly chasing the hot investment or hot strategy and set up obstacles to prevent your emotions from driving your investment decisions, you will have better long-term results than a large number of investors.
16. Take advantage of being an individual investor. Perhaps the greatest benefit of being an individual investor is the flexibility you are afforded. As AAII founder James Cloonan wrote: “The individual investor has a distinct advantage over the institution in terms of flexibility. They can move more quickly, have a wider range of opportunities and can tailor their program more effectively. They have only themselves to answer to.”
Not only are we as individual investors not restricted by market capitalization or investment style, but we also never have to report quarterly or annual performance. This means we can invest in a completely different manner than institutional investors can. Take advantage of this flexibility, because doing so gives you more opportunity to achieve your financial goals.
17. Treat investing as a business. The primary reason you are investing is to create or preserve wealth, and no one cares more about your personal financial situation than you do. So be proactive. Do your research before buying a security or fund, ask questions of your adviser and be prepared to sell any investment at any given time if your reasons for selling so dictate.
18. Alter your passwords and use anti-virus software. There continues to be news stories about hacks. The best way you can protect yourself is to vary your passwords and use security software. A password manager is helpful for this. Anti-virus software and firewalls can keep viruses off of your computer and help thwart hackers.
19. Protect your identity. Identity theft can cause significant problems. Freezing your credit, monitoring your credit reports (Consumer Reports recommends AnnualCreditReport) and paying your taxes as early as possible can help prevent you from becoming a victim. Promptly challenge any suspicious charges on your credit card or telephone bills. If you get an unsolicited call asking for personal information, such as your Social Security number, or from someone claiming to be an IRS agent, hang up. (Better yet, don’t answer the phone unless you are certain you know who is calling.) It’s also a good idea to cover the keypad when typing your passcode into an ATM. Never click on a link in an email purporting to be from a financial institution (a bank, a brokerage firm, an insurance company, etc.). Instead, type the company’s website address directly into your browser.
The Economic Growth, Regulatory Relief, and Consumer Protection Act of 2018 required credit bureaus to allow consumers to freeze their credit reports at no cost. The following links will go directly to the relevant pages on each credit bureau’s website:
- Equifax: www.equifax.com/personal/credit-report-services
- Experian: www.experian.com/freeze/center.html
- TransUnion: www.transunion.com/credit-freeze
20. To help others, invest in yourself first. Investing based on your values, donating to charity, devoting your time to causes you are passionate about and giving to family and friends are all noble actions and goals. To do so now and in the future requires taking care of yourself. Keep yourself on a path to being financially sound through regular saving and controlled spending. Good sleep habits, exercise and following a healthy diet (eat your vegetables!) are also important—as are continuing to wear a face mask and practicing social distancing. The better shape you keep yourself in from a physical, mental and financial standpoint, the more you’ll be able to give back to society.
For those of you seeking to follow an ESG strategy, be it due to environmental, social or governance issues, make sure you stay on a path to achieve financial freedom. The same applies to other values-based investing, such as following religious beliefs. While it is possible to do well by doing good, every restriction you place on what you’ll invest in reduces the universe of potential investments you will have to choose from.
21. Be a mindful investor. Slow down and carefully consider each investment choice before making a decision. Ensure that the transaction you are about to enter makes sense given your investing time horizon, which may be 30 years or longer, and that it makes sense given your buy and sell rules. A common trap that investors fall into is to let short-term events impact decisions that should be long-term in nature. If you think through your decision process, you may well find yourself making fewer, but smarter, investment decisions.
22. Take a deep breath. Often, the best investing action is to simply take a deep breath and gather your composure. Short-term volatility can fray anyone’s nerves, but successful investors don’t let emotions drive their trading decisions. It’s okay to be scared; it’s not okay to make decisions that could impact your portfolio’s long-term performance based on short-term market moves. If you find yourself becoming nervous, tune out the investment media until you get back into a calm state of mind and then focus on resolutions #1, #2, #3 and #4 (found in last week’s Investor Update). Success comes from being disciplined enough to focus on your strategy and goals and not on what others think you should do.
“I found the road to wealth when I decided that part of all I earned was mine to keep. And so will you.” The Richest Man in Babylon
Finally, remember that you have a life outside of the financial markets. Investing is merely a means to an end. Put the majority of your energy into activities you truly enjoy, including spending time with family and friends.
References:
Financial life plan focuses on the emotional side of financial planning. It considers people’s anxiety, habits, behaviors and other emotions (e.g., fear and greed) tied to investing money and accumulating wealth. People struggling with retirement and other finances really need a plan that helps them manage their attitudes, habits, behaviors, goals and resources.