Convenience vs. control: Investing sensibly

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  • 1. “A unique voice on money, i w r d an do i l l ail d i wn fo ds, one singularly attuned to…his generation.” t e y t nt loa a c ac er I WIll h y tic act Vis u t o l tip e sp —San FranciSco chronicle o a iv it b e r s, b re i c on ads h . us h co m ee ts TEAch You by RAmIT SEThI founder and writer of iwillteachyoutoberich.com ToBE No Guilt. No Excuses. No B.S. Just a 6-Week Program That Works
  • 2. INVESTING ISN’T ONLY FOR RICH PEOPLE More Convenience or More Control: You Choose I want investing to be as painless as possible for you, so here’s what I’m going to do: I’ll give you an easy version and a more advanced version. If you’re the kind of person who wants your money to grow with the least possible effort on your part and you don’t care about all the theory, turn to page 180. There you’ll find a step-by-step guide for picking a single investment—a lifecycle fund—and you’ll get started investing in just a few hours. But if you’re a Type A nerd like me who wants to learn how it works— and maybe even customize your own portfolio for more control—read on. I’ll walk you through the building blocks of a portfolio, and I’ll help you construct a portfolio that’s both aggressive and balanced. Investing Is Not about picking Stocks R eally, it’s not. Ask your friends what they think investing means and I bet they’ll say, “Picking stocks.” Guys, you cannot reliably pick stocks that will outperform the market over the long term. It’s way too easy to make mistakes such as being overconfident about choices or panicking when your investments drop even a little. As we saw in Chapter 6, even experts can’t guess what will happen to the stock market. Because they’ve heard it repeatedly from the many investment magazines and TV shows, people think that investing is about picking winning stocks and that anyone can be successful. They can’t. I hate to say it, but not everyone is a winner. In fact, most of these so-called financial “experts” are failures. Actually, I don’t hate saying that. I’ll say that to their faces again and again. Yeah, I’m a frail Indian man throwing verbal punches here on page 165 of a personal-finance book. This is how battles should be fought. Anyway, the little-known but true fact is that the major predictor of your portfolio’s volatility is not due, as most people think, to the 165
  • 3. I Will Teach You to Be Rich individual stocks you pick, but instead your mix of stocks and bonds. In 1986, researchers Gary Brinson, Randolph Hood, and Gilbert Beebower published a study in the Financial Analysts Journal that rocked the financial world. They demonstrated that more than 90 percent of your portfolio’s volatility is a result of your asset allocation. I know asset allocation sounds like a B.S. phrase—like mission statement and strategic alliance. But it’s not. Asset allocation is your plan for investing, the way you organize the investments in your portfolio between stocks, bonds, and cash. In other words, by diversifying your investments across different asset classes (like stocks and bonds, or, better yet, stock funds and bond funds), you could control the risk in your portfolio—and therefore control how much money, on average, you’d lose due to volatility. It turns out that the amounts you buy—whether it’s 100 percent stocks or 90 percent stocks and 10 percent bonds—make a profound difference on your returns. Later, other researchers tried to measure how closely volatility and returns were correlated, but the answer ends up being pretty complicated. Suffice it to say that asset allocation is the most significant part of your portfolio that you can control. Think about that remarkable fact: Your investment plan is more important than your actual investments. Take, for example, this book. If we apply the same principle here, it means that the way I organized this book is more important than any given word in it. That makes sense, right? Well, the same is true of investing. If you allocate your money properly—for example, not all in one stock, but spread out across different kinds of funds—you won’t have to worry about a single stock possibly cutting your portfolio’s value in half. Indeed, by diversifying your investments, you’ll make more money as an individual investor. To know how to allocate your assets, you have to know the basic options you have for investing, which is where we’re headed next. “Since you cannot successfully time the market or select individual stocks, asset allocation should be the major focus of your investment strategy, because it is the only factor affecting your investment risk and return that you can control.” —WILLIAm BERNSTEIN, The Four Pillars oF invesTing: lessons For Building a Winning PorTFolio 166
  • 4. Get the full book at Amazon.com About the book At last, for a generation that's materially ambitious yet financially clueless comes I Will Teach You To Be Rich, Ramit Sethi's 6-week personal finance program for 20-to-35-year-olds. A completely practical approach based around the four pillars of personal finance—banking, saving, budgeting, and investing—and the wealth-building ideas of personal entrepreneurship.