How to Invest for the Long-Term: Keep it Simple

Well, after more than 10 years of a very strong bull market, I can’t say I am surprised at the recent decline in stocks. I understand it can be unsettling. And you may be thinking you need to sell your stocks.

Please think before you do anything. If you are investing for the long-term, the best move you can make is to ride out the bad markets. I am not telling you to set-it-and-forget-it. You should always keep an eye on your investments, and always make sure they are staying in line with your game plan. But I don’t want you up-ending your plan and getting out of stocks just because they are going through a rough period. People who did that in 2008—when things were really bad—then missed out on the strong rebound that started in early 2009. Many waited on the sidelines for years, missing some terrific gains for stocks.

Given what is going on right now with stocks, I think now is a great time to review some investing basics.

I know many of you get confused by all the investing choices you have for your retirement savings. Many workplace retirement plans have more than a dozen funds you can build a portfolio from. And when you save in a Roth IRA—and I sure hope you are!—you have hundreds of funds and ETFs you can choose from.

I am here to tell you that you can build a terrific diversified portfolio with just three funds or ETFs. Yep, three.

I want you to use index mutual funds or ETFs because with one investment you become an owner of hundreds—and sometimes thousands—of stocks or bonds. That’s a smart way to invest. When you own just a few individual stocks you put yourself at greater risk, as any problem with one holding can send your entire portfolio down a lot. And index funds and ETFs typically have very low annual costs called the expense ratio. Keeping your expenses down keeps more money in your pocket.

Your first step is to decide how much you want to invest in stocks and how much in bonds. A good rule of thumb is to subtract your age from 110; consider keeping that much in stocks. So if you are 60, you might have 50% in stocks. If you are 30, you might want to aim for 80% in stocks. (If you have a work place retirement place, check online to see if there are tools you can use to help you figure out the right portfolio mix. Many plans have asset allocation tools.) This strategy works for bull markets and bear markets. Bonds provide some cushion when stocks are having a tough time…like they are right now! And it works whether you are 25 or 75. Yes, my 75-year-old friends, I encourage you to keep some of your portfolio in stocks. Over the long-term stocks have the best chance to have gains that beat the rate of inflation. And you still need to focus on the long-term. Plenty of you will still be alive well into your 90s.

Okay, once you have your stock/bond mix set here’s what I want you to do:

STOCKS:

• 85% in an ETF or index fund that owns a wide basket of U.S. Stocks. Vanguard Total Stock Market (ticker symbol: VTI) is a great low cost option. But just search for the lowest cost “total” stock market option in your retirement plan, or offered as a no-fee option at your discount brokerage.
• 15% in an ETF or index fund that owns international stocks. The iShares Core MSCI EAFE ETF (IEFA) invests in companies based in developed markets, such as Germany, Japan and Canada.

BONDS:

If you are investing in a retirement fund where you must choose funds or ETFs, please invest in a portfolio that has “short-term” in its name, or ask what the “duration” of the fund is. Duration is a statistic that tells you the average length of the bonds in a portfolio. The longer the duration, the more a portfolio’s price will fall when rates rise. And right now we are experiencing rising rates. So you need to pay attention to duration.

All bonds are issued for a specific period of time. That can be one year, three years, or 30 years or more. I want you to focus on shorter term bond funds or ETFs. You want to hear that the duration is no more than three or four years.

Now that we are in a period where rates are rising, anything longer than three or four years is too risky in my opinion. I don’t want to make your eyes glaze with the math of how bonds work, but just know that when rates are rising, longer term bonds will lose more than shorter term bonds. Some funds to consider: Vanguard Short-Term Bond Fund (BSV) and the iShares 1-3 Year Treasury Bond ETF (SHY).

But my preferred bond strategy is to not use bonds at all. I recommend using certificates of deposit (CDs) instead. You can do this with money you invest on your own (outside of a workplace retirement plan).

With a CD your money is 100% guaranteed. Whereas a bond can lose value, a CD will not lose value. The better news is that now that interest rates are rising you can actually earn a decent yield on CDs. But not at your local bank. The best CD rates are at online banks such as Ally and Synchrony. The average yield for a 2-year CD offered at an old-school bank is 0.7%. Ally will pay you between 2.35% to 2.55% for an 18-month CD. Yep, more than 3 times more, for a shorter period. Synchrony currently offers a 2-year CD with a 2.75% yield.  A quick web search for “best CD rates” will send you to sites that compare offers from online and traditional banks.

I recommend dividing your CD money into a few buckets: maybe one-third you will invest in a 1-year CD, another third in a 2 or 3-year CD, and the remainder in a 5-year CD. This strategy, called a “ladder,” is where you have some CDs maturing at different times. When a CD matures you can roll it into a new CD.