It’s important to keep in mind a few principles when assembling and growing your retirement portfolio. There are countless investment vehicles out there to entice just about every personality you can think of. The sharp and steeled investor however will focus on fundamentals, balancing acceptable risk for maximum return through the lens of the broad market and economic cycle.
In the long term it can be said that the securities that give the highest return are also the securities that are the highest risk. Some people will roll the dice on an investment as if they’re in a casino, which is something you would probably stay away from for a retirement portfolio. In many of those cases the return isn’t even very high. This is gambling not investing and there is a better way.
For as long as there have been markets there have been people trying to understand them (and gain advantage from them). Analysts, academics and researchers have been studying the dynamics of markets in order to understand the risk/reward relationship of a bundle of securities in a portfolio. TECHNICAL ALERT: All investors should understand and compare the risk of a security in relation to a market index or bell weather. Beta* and R-squared** are two tools (models) that can help you make the comparison.
Long Term Vision
Ben Graham, Warren Buffetts mentor once said “In the short run, the market is a voting machine, but in the long run, it is a weighing machine.” Short term volatility can be quite high in the equities market but over the long-term, emotion and speculation become moderated and the actual value of a stock is reflected. The S&P 500 has averaged a return of 8.5% during the years 1950 to 2010 and this includes a year with over a 50% positive return and a year with nearly a 45% loss. Time and discipline payoff!
The Right Mix
The proper balance of investments in a portfolio is the number one determinant of divergence in returns , not individual stock picking or timing. So what makes up a proper balance? This is determined by an investors acceptance of risk but in general a younger person starting a retirement fund could be invested 90-100% in stocks. As you age that number would drop and be replaced with less risky fixed income securities. At age 55 your mix may be at 70/30 but by the time you’re 70 years old that ratio should be reversed at 30% equities and 70% fixed income.
When tax time rolls around it becomes very clear that the return on your portfolio isn’t equivalent to the actual “take home”. Whether you are just starting the building phase or you are well into the maintenance phase of your retirement accounts you should always consider the tax effect of your investments. The tax code does however provide sufficient opportunities to reduce your tax burden both during the building and withdrawal phase. Check with your accountant or tax professional to maximize the savings.
* Beta is a measure of a stock’s volatility in relation to the market. The market beta is measured at 1.0. If a stock swings higher (more volatile) than the marker than its beta will be above 1.0 and if it swings less than market it will be below 1.0.
** R-squared values range from 0 to 1 and are commonly stated as percentages from 0% to 100%. An R-squared of 100% means that all movements of a security are completely explained by movements in the index that it is compared to.