I’ve previously written that low-cost, passively managed mutual funds out-perform high-fee, actively managed funds over the long-term. So the first step in selecting the right investments is avoiding high-fee products. But there’s much more to it.
The real key to attractive returns with acceptable risk is in how you combine these funds — getting the proportions right.
Here’s a simple example. Over the past 10 years, a low-cost fund tracking the US stock market went up, on average, 3.9% per year. But a 50/50 combination of two funds – the US stock market fund and a fund tracking all non-US stocks – did better: 5.4% per year. If we add in funds tracking other important sectors – emerging markets, bonds and real estate – the return over the past ten years would have been over 7% annually. Over 10 years, you would have doubled your money, compared to only a 50% increase with US stocks. And by diversifying, you would have reduced your risk. The past is no guarantee of the future. However, history teaches us that, on average, a diversified portfolio will generate attractive long-term returns with lower risk.
“Asset allocation” – the process of deciding which types of investments to select, and what weighting each should have — is far more important than picking individual stocks or funds. A value-added adviser will spend their time determining the right mix, and matching that to a client’s risk tolerance and financial goals. How much to put into international? Emerging markets? Commodities? Real estate? Short, intermediate and long-term bonds? Over time, the adviser will continue to monitor those weightings as a client’s situation, and the world, changes.
In investing, it’s all in the mix.