Step 4 - Own everything

If we can’t beat the market, what’s left? Well, we can cross our fingers, selecting individual stocks and fund managers in hopes that we’re making the right decision.

Or we can approximate the market’s returns by owning everything. There are several benefits to this approach:

• You’ll beat approximately 85% of managed funds
• When the market goes up, you will know for sure that your investments are going up too
• You’ll be insulated from spectacular Enron-like bankruptcies

So, how does one go about owning everything?

 
Low-cost index mutual funds.

They match the market’s return, minus small annual fees (the expense ratio).

They beat the majority of actively managed funds every year.

They beat an even higher percentage of actively managed funds if you consider consecutive years.

They don’t change—you don’t have to worry about a new manager changing the way the fund invests.

They are more efficient because there are far fewer transaction costs from the manager’s trades into and out of stocks.

So owning a little of every stock will be enough to ensure success?

Hardly. Stocks are still risky, especially over the short term. Diversifying will bring a level of stability to your nest egg that would be impossible if you only invested in a handful of places.

There are four main types of diversification:

1. Holding index funds instead of individual stocks
2. Investing in multiple industries instead of a single sector (owning different types of companies instead of owning, say just internet-based companies)
3. Investing in foreign stock markets instead of only owning your nation’s stocks
4. Investing in a combination of stocks, bonds, and cash instead of putting all of your money into one type of asset

While everyone should diversify, your personal tolerance for risk will help you decide on the exact percentages of stocks, bonds, and cash. A good, common rule of thumb is to hold your age in bonds.

As you age, your bond holdings take up a bigger percentage of your nest egg and your stock holdings decrease, protecting you from a catastrophic setback at an age when you won’t be able to replace your loses.

Four Steps to Financial Success is a six-page pamphlet on building wealth, distilled into four simple, reliable steps. Continue reading online, or download the color pdf.

• An Introduction
• Step 1 - Start now
• Step 2 - Save enough
• Step 3 - Minimize expenses
• Step 4 - Own everything
• What’s next?