Investing: What You Can Control
- Reducing expenses
- Diversifying portfolios
- Minimize taxes
This is actually easier than it sounds. All mutual funds have to tell you what their annual expense ratio is. You should be investing in funds that charge less than 1%. The lower the expenses, the better. Why does this matter? Because these are fees that you pay. You pay them indirectly. You don’t get a bill, but rather you pay them through your investment. Look at a quick example of what a fee costs you:
You have $10,000 that you can invest. You choose Fund A, which has 1.14% expense ratio. In 10 years, you paid $2,774 in fees. Now, your friend has the same amount, $10,000 and chose to invest in Fund B, which charges 0.26% in expenses. In 10 years, he paid $658 in fees. That is a difference of $2,116. So, if both of your funds returned the same amount, in 10 years, his account would be worth $2,116 more than yours. Fees make a difference. You can control them. Pay attention to what you are being charged. You can learn more about what to look for in mutual funds by reading this post.
Making sure you have a diversified portfolio is a big deal. When I talk about diversifying, I mean that you should have your money spread out between large and small cap stocks, domestic and international, and include a mix of bonds. Case in point, in the past 10 years, had you only invested in the S&P 500 Index, you would have returned almost nothing. This means if you invested $10,000 in 2000, in 2010, you still have roughly $10,000. However, had you diversified your portfolio, you could have returned just over 6% during this same period. The old saying is true: don’t put all of your eggs in one basket.
Just like fund expenses, taxes are your enemy. You pay taxes on any dividends you receive and any capital gains. There are funds out there that focus on tax efficiency. This means they will do their best to keep your tax expense low. Seek out these funds. Additionally, you can choose to hold taxable bonds in your retirement accounts and equities in your taxable accounts.
The reason for this is because bond funds pay out monthly distributions that are taxed at your ordinary income rate. Capital gains from equity funds on the other hand, assuming the holding period is long enough, get tax at a lower, capital gain rate. Take advantage of this and structure your portfolio so that you minimize taxes.
This is easier said than done. You cannot control what happens in the market over the short term. But over the long term, you can earn 8% on your money. When looking at the market on a short term basis, there is a ton of volatility. It comes with the market. But over the long term, the trend of the market is positive.
Stay focused, stay disciplined. Stay in the market. Don’t let the media or others try to talk you out of it. You need to focus on the long term and you will meet your goals be doing this. Do whatever it takes to put blinders on when it comes to short term volatility.
By paying attention to fees, taxes and how your portfolio is structured, you will be ahead of the game. Doing these things will help you to reach your financial goals – but only if you are disciplined enough to stay invested in the stock market. Read my post on how to become a stock market millionaire for all of the details that will make you a successful investor.