Easy and Profitable Rules for Investing With Mutual Funds
Best Ways to Invest Are the Easiest
Believe it or not, the most profitable investment styles and strategies are not complex. The most successful investors have similar habits and philosophies about investing.
All of the top qualities of successful long-term investors are embodied in these easy and profitable habits for investing in mutual funds.
Keep a Long-Term Perspective
You've probably heard advice about "investing for the long term" or that patience is one of the greatest virtues of successful investing. You heard correctly!
When researching and analyzing investments, especially mutual funds, it is best to look at long-term performance, which can be considered a period of 10 or more years. However, "long-term" is often loosely used in reference to periods that are not short-term, such as one year or less. This is because one-year periods do not reveal enough information about a mutual fund's performance or a fund manager's ability to manage an investment portfolio through a full market cycle, which includes recessionary periods as well as growth and it includes a bull market and bear market. A full market cycle is usually three to five years. This is why it is important to analyze performance for the three-year, five-year, and 10-year returns of a mutual fund. You want to know how the fund did through both the ups and the downs of the market.
Use a Buy and Hold Strategy
A wise perspective with investing is that "time in the market almost always beats timing the market." What this means in that long-term strategies often beat short-term ones.
This is why long-term investors often use a buy-and-hold strategy, which buying investment securities and holding them for long periods of time because the investor believes that long-term returns can be reasonable despite the volatility characteristic of short-term periods. This strategy is in opposition to absolute market timing, which typically has an investor buying and selling over shorter periods with the intention of buying at low prices and selling at high prices.
Furthermore, the buy-and-hold investor will argue that holding for longer periods requires less frequent trading than other strategies. Therefore trading costs are minimized, which will increase the overall net return of the investment portfolio.
Invest Regularly By Dollar-Cost Averaging Into Your Mutual Funds
Sometimes called a systematic investment plan, dollar-cost averaging (DCA) is an investment strategy that implements the regular and periodic purchasing of investment shares. The strategic value of DCA is to reduce the overall cost per share of the investment(s). Additionally, most DCA strategies are established with an automatic purchasing schedule. An example includes the regular purchase of mutual funds in a 401(k) plan. This automation removes the potential of the investor to make poor decisions based upon emotional reactions to market fluctuations.
Consider a simple example of DCA where an investor buys an equal dollar amount of investment once per month for three months. The share price fluctuates significantly from $10 in month one, then down to $9 in month two, then up to $10.50 in month three. The average purchase price per share is $9.83 [(10+9+10.5)/3]. If the investor had bought shares in a lump sum in month one or month three, she would have fewer shares (and lower total dollar value). However, the DCA allowed her to buy more shares as the price dropped and to participate in gains as the price moved higher.
Equally as important, the automatic nature of the investor's DCA removed the emotional tendency to buy at higher prices and sell at lower prices, which is the opposite of a sound investment strategy.
Build a Lazy Portfolio of Index Funds
A lazy portfolio is a collection of investments that requires very little maintenance. It is considered a passive investing strategy, which makes lazy portfolios best suited for long-term investors with time horizons of more than 10 years. Lazy portfolios can be considered an aspect of a buy and hold investing strategy, which works well for most investors because it reduces the chances of making poor decisions based on self-defeating emotions, such as fear, greed, and complacency, in response to unexpected, short-term market fluctuations.
The best lazy portfolios can achieve above-average returns while taking a below-average risk because of some key features of this simple, "set it and forget it" strategy.
Here is an example of a lazy portfolio, which can be built with just three funds from Vanguard Investments:
40% Total Stock Market Index
30% Total International Stock Index
30% Total Bond Market Index
Rebalance Your Portfolio
Rebalancing a portfolio of mutual funds is simply the act of returning one's current investment allocations back to the original investment allocations. Therefore rebalancing will require buying and/or selling shares of some or all of your mutual funds to bring the allocation percentages back into balance. In different words, rebalancing is an important maintenance aspect of building a portfolio of mutual funds, just as an oil change or tune-up is to the ongoing maintenance of your car.
The idea of rebalancing is quite simple but the timing and frequency of rebalancing can add some strategy into the process. In fact, many investors make rebalancing more complex than it needs to be. Financial planners and money managers often argue over how often an investor should rebalance. Should it be monthly, quarterly, yearly, or something different? Before answering this question, let's consider the basics of rebalancing.
To rebalance, you simply make the appropriate trades to return your mutual funds back to their target allocations. For example, if you use the lazy portfolio allocations above, you would periodically make the appropriate buy and sell trades to return the allocations back to 40% Total Stock, 30% Total International Stock, 30% Total Bond Market.