Deciding what to invest your money in can be a confusing process. There are thousands of stocks, bonds, and mutual funds to choose from. So it’s important to focus your decision making process on what you actually have control over.

What You Can’t Control

What the market does in the short term

There is no question that the stock market can be volatile over short periods of time. However, when you look at long time periods of 10-15 years or more, the market historically has done very well. 

This is why it’s important to choose investments with a long term mindset. And instead of focusing on what has performed well recently, focus on making sure you are truly diversified.

Which companies or funds outperform

The SPIVA U.S. Scorecard for 2021 shows that the overwhelming majority of actively managed funds (those that attempt to perform better than the market as a whole) underperformed their benchmarks over the last 3, 5, 10 and 20 year periods.

In this table, you can see the percentage of these funds that underperformed:

This tells us that it’s very difficult for even professional investment managers to perform better than index funds which track the market as a whole. And over the long term, it’s virtually impossible.

What You Can Control

Asset Allocation

The first step in deciding where to invest your money is to determine:

1. Your risk tolerance, or how much risk you can personally handle; and
2. Your risk capacity, which is how much risk you can afford to take based on your time horizon.

This will help you get a feel for how much of your money should be put into riskier assets (like stocks) with a greater chance of future growth. And how much should be in safer assets (like bonds).

Diversification

There are a couple different ways to think about diversification. You should diversify across different asset classes with different levels of risk, like stocks and bonds. 

But within your stock holdings, you should also be diversified across geographies (US, International, Emerging Markets) and company size (sometimes referred to as market cap). 

Diversification is a must since we can’t foresee the future in terms of what will happen in the market.

Fees

Controlling the fees you pay is one of the easiest ways to give yourself a leg up. Mutual funds and ETF’s charge a percentage of the amount you have invested to cover administrative and other expenses.

The percentage charged can vary widely depending on what type of fund you invest in. So take this into account since it has a direct impact on your investment returns.

Tax Efficiency

Funds that are actively managed tend to be less tax efficient. This means that buying and selling investments within the fund can create income that is passed down to the fund’s investors. 

You could then be on the hook for paying taxes on this income depending on the structure of the fund and where the investment is held. In general, the more tax efficient the fund, the fewer taxes you will have to pay. 

To evaluate tax efficiency, compare the turnover ratios of funds you plan to invest in. This represents the amount of buying and selling that happens within the fund.

Takeaway

Nobody truly knows what the stock market will do in the future. But you have some say in how much you pay in fees and taxes. And you can always make sure you are appropriately diversified.

Focus on what you can control when deciding how to invest your money, and make sure you are in it for the long term.

Joe Calvetti is a CPA and the founder of Still River Financial Planning, a comprehensive, fee-only financial planning firm that specializes in working with young families and professionals. Click here to learn more about how we work with clients.

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Disclaimer: The information provided above is for educational purposes only and should not be considered financial, legal, or tax advice. You should consult with a professional for advice specific to your situation.