Monday, August 4, 2014

First Things First ... Owning Stocks for the Long Haul ... Avoid Bonds and Target-Date Funds

Chad posted earlier about the comparative attractiveness and wisdom of owning stock index funds versus investing in a portfolio of diversified individual stocks. See "Down the Rabbit Hole."

While both methodologies are sound approaches, the most important thing for individuals is to save and invest in stocks for the long haul, whether in a low cost index fund or a diversified portfolio of securities.

And perhaps the next most important thing is not to overly invest, or perhaps not even invest at all, in bonds, the so-called 'safe' way to invest. That's because today bonds are not a safe play at all, as interest rates are at historic lows and have nowhere to go but up over the next decade or two. And when interest rates rise, bonds decline in value.

And that warning about staying away from low interest paying bonds applies as well to owning  target-date funds as well. In fact, target-date funds overly invest in bonds. At least that's my view.

Why auto-pilot investing isn't all it's cracked up to be is subtitled 'New research on target date funds has investing world in a tizzy:'

"One of the most appealing concepts in investing can be summed up as “auto-pilot,” the idea that you let someone else do the navigating and guide you to your destination.

But some prominent new research suggests that investors who have put their most important long-term assets on auto-pilot may wind up off-course.

The operative word here is “may,” but the situation is worth examining because it suggests that investors using target-date retirement funds should be careful about making selections, rather than simply accepting a one-size-fits-all course of action.

To see why, let’s look at the research that has the target-date fund world squawking.

Rob Arnott, chairman of Research Affiliates, recently published research that examined all 40-year time spans dating back to 1871, finding that retirement investors would be better off turning conventional wisdom on its ear and investing a higher percentage of assets into stocks as they age.

The standard target-date plan becomes more conservative as an investor ages, typically getting down to keeping just 20% of assets in stocks over time. Arnott suggested flipping that strategy, and investing more in stocks as an investor ages; the results, he suggested , would be more than 20% more in the retirement chest as a result. . . .                                              

The second piece of data that could change the way people view target-date funds comes from Morningstar Inc., which recently released its 2014 research paper on target-date issues. The findings directly contradict studies suggesting that any sort of market-timing approach — any tactic that deviates from the standard glide path — results in lesser results....                                      

What no one is going to say here — not even Arnott — is “This is the one right way to do things.”                                        

That’s problematic for consumers who have come to believe that a target-date fund is a solution to all of their decision-making problems. . . . 

What’s more, for all of the work showing which paths would work best, the plain truth is that no fund — target-date, balance, target-risk, tactical allocation, whatever — is sufficient for someone who hasn’t saved enough. The only way to make sure any fund can build an ample nest egg is to set aside enough dollars so that a range of returns from whatever path the fund follows results in satisfactory savings."                                        

Summing Up

Owning stocks for the long haul, whether in an equity index fund or as part of a diversified portfolio of individual securities, is the best route to achieving financial security.

But to do that, beginning to set aside sufficient amounts of money early in our careers and thereafter positioning ourselves to benefit from the 'magic' of compound interest (rule of 72) is essential.

Next comes adopting a habit of saving regularly and investing those savings in stocks for the long haul, whether in low cost index funds or a basket of individual securities.

Finally comes patience, stick-to-it-iveness, and knowing that dollar cost averaging will yield a high value result down the road. And that's when it matters most --- down the road --- not today.

Patience is a virtue in long term investing because in the short term, stock prices will be volatile and fluctuate up and down, sometimes wildly.

But over the long haul, stock prices will increase and almost certainly outpace inflation over time. Other investments probably won't.

That's my take.

Thanks. Bob.               

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