While it’s not always obvious from the conventional wisdom around investing, the keys to investment success are (1) asset allocation and (2) low fees. Paradoxically, keeping your investment program simple is the best way to maximize your performance.
- Determine your “investment horizon.” In other words, when do you need the money? Think of a “now or never” continuum. “Now” is having immediate access to your money whenever a need arises. “Never” is the establishment of an endowment where you will only spend a small percentage (e.g., 5%) annually without ever touching the principal. It’s likely you will fall somewhere along the continuum.
- Your investment horizon will dictate your asset allocation. Simply stated, asset allocation refers to the relative proportions of equity (i.e., stock) and fixed income (i.e., bond) investments. Under normal market conditions, stocks will be more volatile than bonds. If you’re on the end of the continuum where you need immediate access to your money, volatility is not your friend. To avoid losing your principal, you should favor CDs or short-term bond investments. If your horizon is long-term, volatility isn’t a concern. Therefore, you should favor more stocks, because they will provide greater growth potential.
- Select low cost investments, which means index funds. Academic research has proven time and time again that stock picking is more often than not a fruitless and ineffective exercise. As Burton Malkiel opined in his 1973 book, A Random Walk Down Wall Street, blindfolded monkeys throwing darts at the pages of the Wall Street Journal can select winning investments as well as professionals. For this reason, you should favor a passive rather than an active style of investing. In a passive style, you invest in a large basket of stocks (e.g., the S&P500) and capture the returns of a broad market while benefiting from much lower investment fees.
Investment management companies that specialize in low-cost index funds offer simple-yet-elegant options for this. For example, Vanguard offers “single fund solutions” that provide a balanced asset allocation at an extremely low cost. Their LifeStrategy Growth fund has an allocation of 80% equity and 20% fixed income. Alternatively, their LifeStrategy Moderate Growth fund has an allocation of 60% equity and 40% fixed income. Splitting your investments 50/50 between these two funds provides a 70/30% asset allocation.
If you want the best portfolio returns over the long term, this is the way to do it. If you already have an established investment management relationship that is not this simple, I strongly urge you to consider making a change. This simple strategy will serve your organization well even if your portfolio grows to $100 million and beyond. Why not give it a try?
Dan Weiss, founder and President of Counterpart CFO, leads a team of flexible, part-time CFOs specializing in nonprofits. To read more from Dan, follow him on LinkedIn or subscribe to his blog at www.counterpartCFO.com.