Achieving eventual Financial Independence requires more than diligent saving habits. Once contributed, retirement dollars must be deployed into investments that are likely to grow over time while experiencing a level of volatility acceptable to the investor.
On the low-risk extreme of investments are Money Market Funds and CDs, which earn interest at a rate that loses every year to inflation and taxes. Banks and credit unions, looking to control a larger percentage of their customers’ cash assets, offer only fixed-income products, robbing customers of the opportunity for their assets to grow with the entire financial market. Many banks offer (and fiercely solicit) fixed annuities, a topic for another Blog.
At the high-risk end of the investment, scale is extremely volatile individual stocks, which provide returns ranging from negative to outsized. Many savers hire stockbrokers, who too often claim that they can outperform the market with well-researched stock picks. While some brokers may achieve this result occasionally, over time they are much more likely to underperform the market, as trading costs continually erode account values.
Neither is acceptable for most savers and investors.
Savers who become investors understand (or will learn) that the key to long-term success lies in diversification among Asset Classes, as well as assets within those Asset Classes. Basic Asset Classes include Domestic Stocks, Domestic Bonds, Foreign Stocks, Foreign Bonds, Real Estate, Cash and Equivalents, and Alternatives, such as Commodities. Successful portfolios will include significant numbers of assets from many of the basic Asset Classes.
In the course of our day jobs as Certified Financial Plannersâ, we field questions from a wide variety of savers. From the range of questions we field, we know that Americans have long been burdened with a lack of financial education from our public education system. Thankfully, that is changing, led by Florida public schools.
When investing in equities, how much diversification is enough to protect an investor, while accumulating a reasonable rate of compound growth? This question has been studied for generations, with no specific conclusion. One recent study concluded that 30 stocks was sufficient, while the same study showed that an individual could only reasonably track 15 at once. Sounds to me like they were drumming up business for stockbrokers.
In today’s investment world, it is possible to hold very large numbers of stocks, using Exchange-Traded Funds, or ETFs, which we will discuss in next week’s Blog Post.
Van Wie Financial is fee-only. For a reason.