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5. Steps for Investing Success

Most people who achieve financial independence through investing, rely on a set of core principles. Here are the ones I use. They have stood the test of time, and tragedy. They don't require clairvoyance, luck, or genius. Instead, they are built on simplicity and statistics. They can work for you too:

  • Allocation: Know your asset allocation — the single most important factor in your long-term investing success. In particular, know your percentages of cash, bonds, real estate, U.S. stocks, and international stocks. For asset allocation purposes, manage all investment assets, retirement and non-retirement, yours and your spouse's, but not home equity, as one big portfolio.
  • Bonds: Choose a bond allocation between 20%-80%. That's the single most important choice in asset allocation. The old rule of thumb, a good starting point and still touted by John Bogle, founder of Vanguard, is to "keep your age in bonds." So, if you're 40, you'd have 40% in bonds; if you're 60, you'd have 60% in bonds.
  • Funds: Buy mutual funds or exchange-traded funds (ETFs), rather than individual stocks. Most investors do not have the time or expertise to choose among individual securities for an adequately diversified portfolio, and then monitor them. Prefer very low cost index mutual funds or ETFs.
  • Familiarity: Don't hold investments you don't understand. Know your investments like family members, or employees. Expect a long-term relationship. Understand their strengths and weaknesses, and don't ask every one to be good at every thing. Don't judge them by whether they are up or down in the short term, but by whether they behave predictably, and complement each other's performance, in the long term.
  • Simplicity: Hold as few positions, in as few accounts, as possible. Each one of your holdings requires some overhead and management from you. The fewer moving parts, the better. It's possible to construct a well-diversified portfolio for the long term with just three or four holdings: a U.S. stock fund, an international stock fund, a bond fund, and possibly a real estate fund.

Action Items

  • Compute your current asset allocation, or have somebody do it for you.
  • Decide on your bond allocation.
  • Choose and migrate to low-expense mutual funds and ETFs.
  • Prune out and consolidate complicated, unfamiliar, or small holdings.
  • Commit to your remaining holdings for the long term, and learn everything you can about them.

NEXT: Diversification Thru Allocation