Jonathan Clements of the Wall Street Journal writes a good article that everyone should take a look at and thing about how it applies specifically to their own lives. His advice has solid grounding, but the execution of the advice could be a potential pitfall for some people.
The Popular Advice
As Mr. Clements notes, “Those in their 20s are encouraged to invest heavily in stocks, because they have decades until retirement and thus plenty of time to ride out market declines. This is good advice -- in theory.”
Mr. Clements Advice
- Be more cautious
- Start off with 60% stocks, 40% bonds then move your stock allocation up if you want to
- Be well diversified
My Short Input
Mr. Clements article is too much shock and awe and is far too cautious and conservative.
Be more cautious.
This part I fully agree with. This is you’re retirement. You cannot count on Social Security and no one has pension plans anymore (well… yeah no one – not really anyway). You need to save for yourself and therefore you need to be as careful as you WANT to be.
That being said, when you’re starting out you want to be able to gradually learn what you want, what you like, and how you like things.
This means a number of things. Here we go:
Stocks and Bonds. Really quickly… when stocks tend to do well, bonds don’t do well. Conversely when stocks tend to do poorly, bonds tend to do well. This is really, really simplified, but overall mostly true. This is why people diversify between stocks and bonds. Stocks are more risky, but with higher risk usually comes higher returns. When you have lots of time to ride through fluctuations, you can take these risks. The general rule of thumb is (100%-your_age) = %in_stocks. If you’re 20 you should look for 20% bonds and 80% stocks. Again this is a general rule of thumb. You may choose to be more or less conservative. But I would think (90%-your_age) = %in_stocks is a great place to start off if you don’t know what you want to do.
If you so want you can go after TARGET FUNDS or RETIREMENT DATE FUNDS which automatically change the investment in the fund moving towards more bonds and income the closer you get to the fund target date. Just to note the FIDELITY FREEDOM 2050 fund has about 92% in stocks and 8% in bonds to give you some idea.
This is great because you don’t have to think and you minimize expenses with only one fund. However there are risks. The fund may be more or less aggressive than you like. Your fund manager may not be that good (you’re not diversified in the respect all your eggs are in one managers basket). Depending where you hold the fund there may be tax consequences. The fees may be above your liking.
Markets You can invest in funds focusing on large, well established companies (large-cap or blue-chip), middle sized companies (mid-cap), or most risky the small businesses (small-cap). You can invest in companies that tend to use their dividends to reinvest into company growth (growth funds) or you can invest in companies that pay you the dividends (value or income funds). You can invest in companies in specific markets (air transport, energy, software, telecommunications, biotech). You can invest in specific locations (US only, foreign only, emerging markets, specific countries).
My recommendation would be to try to find an INDEX TRACKING TOTAL MARKET FUND. Do this because:
· You only need a few funds to be well diversified (minimize fees)
· Index tracking does not require active management and fees are nearly 3-4 times lower
· You’re well diversified over the entire market
· It’s a great place to start and you have more control over what you choose
If you can’t meet the minimum fund requirements consider an index tracking total market ETF which is like a hybrid between a stock and a mutual fund.
He is right in that you should be smart about your investments and ease your way into these new waters. He is right in avoiding growth overall because this is a more risky investment. He is also right in avoiding loading up on value/income as well. You want a good blend of things to start out with. Total market gets you that. Some growth, some income. Some large, some small. Some biotech, some energy, some transportation. You may want to further diversify between US Total Market and Foreign Total Market, however.
I feel he is, however, far too conservative in his recommendation of 40% bonds. If you find yourself perturbed by the market, then try a set it and forget it Target Fund and let them do the worrying. You really have no need to be so conservative until you’re in your late 30s. 40% bonds will rob you of potential growth and really cut down on the potential compounding of your life savings… unless he knows of a HUGE recession no one else does… I think he’s just being overly conservative.
Other Warnings: DON’T, DON’T EVER, NEVER TIME THE MARKET
Unless you’re some sort of time-traveling genius, don’t bother. You stand to risk far more than you will ever gain. The S&P 500 tends to out gain most all actively traded mutual funds in the long term.
Other Warnings: BE IN IT FOR THE LONG HAUL
Don’t panic or day-trade. Again you stand to lose far more than you will ever gain… unless you have some inside information which isn’t a good idea (ask Martha Stewart why). Ride out the fluctuations.
Other Warnings: DO WHAT YOU WANT
Do not let the tax consequences or losses prevent you from getting out. If you really think there are better funds to be in (be intelligent not emotional here) then take the loss and make your portfolio SMARTER. Warning: only do this to make it smarter. Far too many people panic and jump when it would be much better to stay on the boat. See THE STOCK MARKET IS A HUGE AIRPLANE.