I’ll share some of my thoughts and experience in investing. Note that this is based purely on my investment experience in the US. As such, the specifics describe below would not apply to individuals outside the US.
I follow a few simple rules in savings and investment:
1. Invest a majority of liquid assets in stocks. In the US, stocks historically outperformed all other asset classes, including real estate, by a wide margin. I normally invest 70% of my liquid assets in stocks. The remaining 30% are invested in bonds (US treasury and corporate bonds) and cash.
2. Let the professionals do the stock picking. I know I cannot consistently beat investment professionals who manage money for a living. Therefore, 90% of my stock market investments are in mutual funds. The remaining 10% is my play money – I trade individual stocks, particularly technology stocks, for fun. If I do well, that’s great. If I don’t, it doesn’t hurt much since most of my money is still in the hands of the professionals.
3. Diversify. I generally invest most of my mutual fund assets in three major categories: large cap (capitalization) stocks, small cap stocks, and international stocks. For large cap stocks, I would normally pick an S&P 500 index fund. The market for large cap stocks is very efficient, and it is quite difficult for a large cap mutual fund to beat the S&P 500 index over the long term, say 10 years. So if you pick an index fund, you are guaranteed to earn a better return than at least 90% of the actively managed mutual funds. For small cap funds, I would pick an actively managed one since the market for small cap stocks is not as efficient, and good money managers can outperform the indices. You can use Morningstar’s ratings to help select a good fund. For International Funds, I would invest in both mature markets like Europe, and emerging markets.
4. Take maximum advantage of tax-advantaged programs. There are numerous retirement plans (such as 401(k) and IRA) and college savings accounts (such as 529 plans and Coverdell Education Savings Account) that legally shelter earned income and/or investment income from taxation. For individuals in executive positions, there is also the option to defer almost any income, including salary, bonus, and restricted stocks granted by the company, etc. For these lucky people, this is the easiest way to accumulate assets.
5. Properly allocate different funds to different types of investment accounts to minimize taxes. For example, I would buy an actively management small cap fund in a 401(K) account since all investment income is tax deferred. The result is that I would not have to pay taxes each year on the capital gain distribution. This tax-free compounding makes a huge difference in the long term rate of return on your investment. I would buy index funds, like S&P 500 index, in the taxable accounts. There is very little churn in the index funds, and therefore you don’t have to pay much in the capital gains taxes until you sell the fund.
