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Investing 101: Six Factors That Determine Your Investment Portfolio Value
by Alexander Green, Advisory Panelist
Thursday, August 20, 2009: Issue #1071
Imagine trying to tackle algebra, geometry, or calculus without understanding basic mathematics.
Clearly, you wouldn’t get far.
Yet it’s not uncommon to run into investors who are knee deep in option trading, currencies, short selling, or sophisticated arbitrage strategies without mastering – or even understanding – basic investment principles.
Even seasoned hands can benefit from a refresher course from time to time.
So today we’re going to revisit Investing 101 and talk about the six factors that will determine the future value of your investment portfolio, whether it’s worth $10,000 or $10 million.
Six Factors That Determine Your Portfolio’s Future Value
Those six factors are:
- The amount of money you save. To put it bluntly you have to start by maximizing your income, minimizing your outgoing and paying yourself first. Why? Because expenses always rise to meet the income available. As soon as you get a raise or a higher paying job, you’ll find that you need a new car, a bigger house, better furniture and a new set of Callaway irons. But you have to draw the line somewhere. You can’t save a pittance and expect your portfolio to perform miracles each year.
- The length of time your money compounds. The sooner you start investing the better. And the longer you leave it alone the better. If you start too late – or raid your portfolio to redo the kitchen or take the kids to Disney – you’re going to have a lot of catching up to do down the road. The old chestnut is true: Don’t touch your capital. It’s like eating your seed corn.
- Your asset allocation. Studies consistently show that how you divide your portfolio among non-correlated assets – stocks, bonds, real estate investment trusts, precious metals, etc. – determines 90% of your portfolio’s long-term return. (The rest is due to security selection.) If you’re too conservative – or too aggressive to stick with your program – you simply won’t meet your goals.
- Your assets’ annual return. This, of course, is the great unknown. Not even Warren Buffett or Ben Bernanke can say what their portfolio will return each year. But the better your security selection and asset allocation decisions, the higher your annual compounded returns.
- What you pay in expenses. Don’t be oblivious to what all those financial intermediaries are charging you. You can sacrifice far too much in commissions, bid/ask spreads, wrap fees, management expenses and other costs. All things being equal, the lower your expenses the higher your net returns.
- How much you pay in taxes. Too many investors are oblivious to the tax ramifications of their investment moves. When possible, put your high-yielding investments in your tax-deferred accounts and your tax-efficient funds and individual stocks in your non-retirement accounts. (I call this your asset location strategy.) Hold positions 12 months or more to qualify for the lower long-term capital gains tax rate. Offset your capital gains with capital losses if possible.
Only one of these six factors is beyond your control: your assets’ annual compounded return. That means it only makes sense to focus on the other five.
Investing 101: Don’t Worry About The Markets…
So instead of worrying about what the market will do between now and year end – something you can’t possibly know and has nothing to do with what your portfolio will be worth five or 10 years from now – focus on:
- Saving more,
- Leaving it alone longer,
- Getting your asset allocation right,
- Lowering your expenses
- And keeping a close eye on taxes.
Get these big questions right and you’ll find the details will take care of themselves.
Better still, in your golden years, your portfolio will take care of you.
Good investing,
Alex
P.S. I tackle all these factors – and much more – in my book The Gone Fishin’ Portfolio: Get Wise, Get Wealthy… and Get On With Your Life. And we’re giving the book away free to new Oxford Club members.
- The Gone Fishin’ Portfolio: Get Wise, Get Wealthy… & Get On With Your Life
- Tax-Managing Your Investment Portfolio: There’s Still Time to Cut Your Taxes
- Municipal Bonds: A True Once-in-a-Lifetime Opportunity
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3 Responses to “Investing 101: Six Factors That Determine Your Investment Portfolio Value”
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Alexander Green is the Investment Director of The Oxford Club. A Wall Street veteran, he has over 20 years experience as a research analyst, investment advisor, financial writer and portfolio manager.
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August 20th, 2009 at 7:22 am
These points are made in “Gone Fishin’ Portfolio” which I’m reading now. However, I was disappointed that no distinction was made between Roth IRAs and other sheltered accounts. I’ve been trying to decide what to put in my Roth vs my regular IRA, and would appreciate anyone else’s ideas.
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August 23rd, 2009 at 5:51 pm
Very informative and educational article. Anyone can learn from this one. Thanks for the good work.
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August 23rd, 2009 at 6:29 pm
Dear Marlys, You probably know by now, but in case you don’t: Put as much pretax income as allowed into your regular IRA. After that, put as much taxable income as allowed ($5000 or $6000 over 50) into a Roth IRA. The regular IRA is taxable when you withdraw, the Roth IRA is not taxable when withdrawn after 5 years. Good luck, REW
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