The world’s stock market index and the S&P 500 have gained roughly 5% during the past three months, to April 18, 2012.
Depending on your age, and your response to the gain, I can tell whether or not you’re an astute investor:
If you’re employed, below the age of 50, and you’re happy to see the markets rise, then you probably don’t understand how investing works. And that’s a shame. Investors are collectors. And while you’re collecting assets, you shouldn’t celebrate when those assets rise in price while you’re stockpiling them.
If you’re like most people who celebrate rising prices, you’ll buy when you’re happy and shift your money when you’re sadly disappointed. Writing for Barron’s, Martin Conrad wrote in The Money Paradox that the average investor made just 1.9% per year from 1988-2008, while the average actively managed mutual fund made 8.4% annually. If you’ve read my book, Millionaire Teacher, you’ll know that an indexed strategy is far better than investing in actively managed mutual funds, but that isn’t the point of my argument here.
An investor’s behaviour is far more crucial than decisions based on what funds or stocks they buy.
While the world’s stock markets were sinking in 2011, I bought nothing but stock indexes with my monthly savings. I even sold $50,000 of bonds to add to my stock component, on October 20th.
I’m not a gambler.
In fact, I might be one of the wimpiest investors you know. I keep a low cost account of just three ETFs representing the Canadian short term bond index, the first world international stock index and the total U.S. stock market index (XSB, VEA and VTI respectively).
The low cost index or ETF you select isn’t all that important. Reams of investors fruitlessly debate the merits of one index over another. And I often get questioned as to why I own, for example, the short term Canadian government bond ETF (XSB), rather than the total bond index (XBB) or some other promising fixed income instrument. My response? It doesn’t matter.
Your behaviour is far more important.
Create a diversified account of stock and bond indexes. Rebalance it with new purchases (buying the lagging market) or through a manual rebalancing once a year. Over your lifetime, you’ll likely outperform everyone you know. I promise.
The rising stock market over the past few months has dropped my bond allocation considerably, as a percentage of my total portfolio. Today, I have roughly 33% of my portfolio in bonds because my stock ETFs (which I loaded up on when they were low) have now risen in price.
Am I worried that my bond allocation is below my 40% target?
Not really. I’ll just keep adding my savings to my bond index, which I’ve been doing for months.
I suppose I’ll have to get off my duff to sell about $100K of stock market indexes if the stock markets rise further. At some point, I’ll need to get back to my 40% bond, 60% stock allocation. But I’m not too worried about that. I think the best investors are low key Buddhas, rather than highly tuned market watchers.
Does the hard core mathematician (who rebalances with accurate precision) beat the lazy guy like me who occasionally lets his portfolio drift? I don’t think so.
I like my approach.
It’s stress free, easy and has probably beaten the returns of everyone I personally know, over the past decade.
If you can be dispassionate, keep your costs low, and not get too carried away about your specific indexes of choice, you’ll do just as well as me over the next decade.
I can guarantee that.