Do you want to invest better? Who doesn’t? Today, September 25, is Invest Better Day, a day of investor education dreamed up by the jester-hatted money mavens at the Motley Fool.
Any conversation about investments tends to get bogged down by excruciating details, jargon, and ideology. “My portfolio is outperforming your portfolio” is the petty grownup version of “my dad can beat up your dad.”
Fortunately, most of what it takes to invest better has nothing to do with choosing the right mutual fund. I’ve put together my top five investment tips, and only one of them involves choosing the right kind of fund (and it’s plenty vague).
This is good news and bad: choosing a mutual fund is easy. You can do it online in five minutes. But investing better is more about managing human psychology and less about managing money — it’s also about avoiding big mistakes, not about choosing the single best investment.
Enough backstory. Let’s get to the list.
What’s the most important factor that determines how much money you’ll retire with?
It’s not which investments you choose — it’s how much you’ve saved along the way. A recent study by Putnam Investments confirmed this, and the math is simple: save pennies, and no amount of great stock-picking will let you retire with a boat.
Save a high percentage of your salary (especially in your highest-earning years), and you can make plenty of investment mistakes and still come out okay.
Avoid high-interest debt
As Burton Malkiel and Charles Ellis put it in my favorite investing book, Elements of Investing, “There are few, if any, absolute rules in saving and investing, but here’s ours: never, never, never take on credit card debt.”
Credit cards, installment loans, lines of credit, unsubsidized student loans: all of these are the opposite of investing. When you invest, you turn your money over to someone else and hope they’ll do something smart with it and hand back more money later.
When you borrow at a high rate, someone else is doing the same with you, minus the “smart” part. Other than getting a 401(k) match, it doesn’t make sense to save for retirement while carrying an 18% credit card balance.
Everyone is so tired of being told to get a 401(k) match that I’m not even putting it on the list. Fewer people, however, understand the massive tax savings you get from using tax-advantaged accounts like the 401(k), traditional or Roth IRA, health savings account, or 529 college savings plan.
Every time you put a dollar in one of these accounts, it’s like getting a match from Uncle Sam. Unless you’re saving for a specific near-term goal or an emergency fund, saving in a taxable account while you still have space available in a tax-advantaged account means paying unnecessary taxes. Yuck.
How do you achieve the high savings rate from tip #1? Only one way: automation. Unless you’re self-employed, your federal taxes come out of your paycheck automatically.
Why does the IRS require you to pay taxes this way? Because if people were required to set aside taxes on their own and pay once a year, most of us would spend it before April.
Indeed, the self-employed get into this mess all the time.
Take advantage of what the IRS knows and automate your own savings as much as possible: set up automatic paycheck deduction or an automatic checking account transfer (or both) to your retirement account.
Pay less, get more
Mutual funds charge you a fee for investing your money, but the fee is invisible: it comes out of your returns before you ever see it. The fee is called an “expense ratio” and it’s expressed as a percentage, usually between 0.1% and 2%.
If a fund charges 1%, that means you pay 1% of whatever money you have in the fund every year. That sounds like a small fee but it’s not. The world’s biggest and most diversified mutual funds and ETFs charge less than .2%. Low expenses are an excellent predictor of better returns.
This goes for your 401(k), too. In addition to the expense ratio for each fund, your 401(k) may pile on other management expenses.
New rules this year require 401(k)s to disclose all fees. Read your statement, and if you’re paying more than a small fraction of 1%, call your benefits office, team up with your fellow employees, make protest signs — whatever you need to do. It’s your money.
So there you are: five ways to invest better, and none of them involve picking stocks, reading annual reports, or any other form of nerding out.