The Most Important Question I Get Asked About Investing
It’s one of the most common questions I get from new subscribers over at High-Yield Investing.
If you’re being honest, you’ve probably asked yourself this at some point, too…
The question is simply this…
Where do I start?
It’s a legitimate question. Even seasoned investors with years of experience can find the growing array of investment options bewildering. Stocks, bonds, mutual funds, annuities. Just within the exchange-traded fund (ETF) universe alone, there are 6,970 listed entries. And they come in every flavor under the sun.
Funds that utilize quantitative algorithms to mimic active management. Funds that short stocks to profit from selloffs. Funds that bet on cryptocurrencies. Funds built around specific themes, such as more money being spent on pet food and veterinary care.
And more are being launched every day.
Faced with such a dizzying menu, it’s easy to become overwhelmed. Afraid of making the wrong choice, many investors become paralyzed and just don’t do anything at all.
You might not realize it, but the biggest determinant of long-term returns isn’t the individual performance of the stocks and/or funds you select. It isn’t market timing either.
The most important decision involves the overall mix and proportion of various asset classes that constitute your portfolio.
Tips For Allocation
If you were building a house, you’d start with an architectural blueprint and determine the square footage and style first — picking out the kitchen cabinets or choosing paint colors would come later.
The same is true with investing. First things first, decide what percentage to invest in stocks versus bonds, large-cap versus small-cap, growth versus value, domestic versus foreign. Your asset allocation strategy should be customized for your unique objectives and risk tolerance.
A moderate-risk allocation for investors in their 50s might look something like this:
– 30% Investment Grade Bonds
– 25% Large-Cap Blend
– 10% High-Yield Bonds
– 10% Floating Rate/TIPS/Inflation-Protected Bonds
– 10% Global Stocks
– 10% Real Estate/Commodities
– 5% Small/Mid-Cap Value
This is not a one-size-fits-all model. Younger readers, for example, will generally have a more growth-focused mix, whereas retirees will be more concerned with capital preservation. Fortunately, there are quite a few free online asset allocation tools out there. Just answer a few basic questions, and you are on your way.
Of course, the goal of High-Yield Investing is to present a wide range of investment ideas to help you fill in the blanks — from municipal bonds to preferred stocks to technology funds.
The Next Step
The next big decision is this: should you reinvest dividends or take the cash? Unless you need to draw income from your portfolio, I would strongly consider reinvesting all dividends and interest. Only by reinvesting can you experience the miraculous wealth-building power of compound interest.
After all, those dividends buy additional shares, which generate dividends of their own, which then purchase more shares, which spit out more dividends… and so on. To quote Ben Franklin “Money makes money. And the money that money makes, makes money.”
Let me give you a real-world example.
When StreetAuthority launched the former Daily Paycheck newsletter in 2009, the first recommendation was 190 shares of Reaves Utility Income (NYSE: UTG) at $19.20 per share, a stake worth $3,638. Over the next decade, we collected more than 120 monthly distributions, all of which were reinvested into more shares.
By May 2020, we were sitting on 492 shares worth more than $19,000. Today, these shares would produce over $1,000 in annual dividends – a yield on cost of nearly 30% on our initial outlay. And that income will purchase another 30 shares next year at current prices.
No wonder Albert Einstein referred to compound interest as the “8th wonder of the world”.
My most recent recommendation over at High-Yield Investing is an ideal way to harness its power. After all, the higher the rate, the faster your money compounds.
To illustrate the potential, consider a $100,000 portfolio earning 8% annually. That investment will generate $8,000 in annual income or $160,000 in total over the next 20 years. Add those earnings to your initial principal, and you get a tidy sum of $260,000.
But if you reinvest that money each year, this nest egg would grow to $480,000 over the same time frame earning the same rate. That’s an extra $200,000+ in your pocket – just for reinvesting your dividends. And that’s assuming zero growth in the dividend payments over two decades.
My latest recommendation just might even outperform that hypothetical scenario, especially considering it yields close to 10%.