Playing the odds

You only get one shot, do not miss your chance to blow
This opportunity comes once in a lifetime, yo

– Eminem “Lose Yourself”

Face it.  Eminem is right.  We all have one shot at this investment game.  One chance to get it right, one lifetime of investing to save, grow and protect wealth to achieve our goals. It’s a little scary and definitely intimidating. And the thought instills panic that leads people to do the wrong thing fairly often.  But you can harness this concept to make much better decisions for your future investment portfolio.  We may only get one lifetime, but we can make huge steps to tilt the odds to our favor compared to the average investor.

1) Fees

Yes, I talk about it all the time.  Because it matters. If you wanted to pick a single statistical factor to determine which investment product might perform best in the future, pick the cheap one. From Morningstar in 2010:

“If there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision.  In every single time period and data point tested, low-cost funds beat high-cost funds.”

So stack the deck and invest in low-cost funds or ETFs.  Don’t pay ridiculous fund charges, commissions, sales loads, surrender fees, and high asset-based fees. A low-cost index fund isn’t “average,” it’s better than that.

2) Taxes

If it is within your control, control it.  Be smart about making tax-efficient investments.  Use low-turnover broad-market funds as the core of your portfolio.  When possible shelter tax-inefficient investments such as taxable bonds, TIPS and REITs in tax-deferred accounts. Take long-term capital gains and not short-term gains. Harvest your tax losses and create tax deferral.  Be smart about making charitable gifts, using appreciated assets whenever you can.  Take distributions from tax-free accounts for income when your taxable income is high and tax-deferred accounts when you might be in a lower tax bracket.  Fund a 529 plan for college expenses even if it’s for a short period of time.

3) Evidence, not speculation

A mutual fund’s past track record is not evidence of skill.  In fact it is nearly impossible to separate luck from skill in an active strategy for the time horizon of most managers’ careers. Getting a hot stock tip that turned out to be correct isn’t evidence of brilliance.  Know how to tell the difference between skill and luck (when you can). Don’t invest based on your “hunch” or whatever picture of the future you believe in.  Instead rely on reasonable, accepted long term investment evidence: stocks outperform bonds over long periods of time.  Cheap (value) stocks outperform expensive (growth) stocks, but come with more risk.  Same goes for small vs. large stocks. The body of historical evidence demonstrates that markets ebb and flow, and investment strategies do as well. A strategy, market or asset class that “works” today may not “work” next year, and everything goes through cycles. Be prepared.

4) Be patient

Everything else on this list is pretty simple and straightforward, but if you can’t be a patient investor, none of it matters. If you build a portfolio for long term success, and tilt the odds in your favor by controlling what you can, it only takes one impatient irrational act to wreck it.  It is much easy to fail as an investor than it is to succeed.


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