How to overhaul your retirement portfolio in just 7 days

Investing — especially when you’re a novice — can seem overwhelming. But what if you could right your retirement portfolio by spending just five to 10 minutes each day learning and thinking about money?

That’s the concept behind “From Here to Financial Happiness: Enrich Your Life in Just 77 Days,” a new book from personal finance guru Jonathan Clements. While this latest title from the former Wall Street Journal columnist tackles all aspects of your financial life—from spending to estate planning—we’ve excerpted his day-by-day advice on investing.

Follow these steps, and in a little over a week, you’ll be on your way to a sound investment strategy:

Day One: Take Stock

Start with two thoughts. First, the best predictor of our future behavior is our past behavior. Second, we misremember the past.

In truth, “misremember” is too polite. We often believe our investments performed far better than they really did. We imagine that we foresaw major market developments. We might even remember bravely buying during a market decline, when we were, in fact, panicked and selling. We lie to ourselves all the time—and yet we don’t even know we’re lying.

All this makes it hard to become better investors. Want to get a handle on your real behavior? Take a look at the evidence:

  • If the firm you invest with calculates your personal rate of return, see how it compares with major market indexes. For instance, you might compare your personal return to the performance of Vanguard’s total stock and bond market index funds. Does your performance look weak? Perhaps you should stop trying to pick winning investments and instead purchase index funds that simply track the market.
  • If you were investing in late 2008 and early 2009, when global stock markets collapsed, grab your old account statements and see whether you were buying stocks or selling. If you were a seller, that suggests your risk tolerance is low—and you should probably favor a more conservative portfolio.
  • Look at how many stock and stock fund sales you made in the past year. A handful of sales could mean you needed cash or you were tweaking your portfolio to keep it in line with your target investment mix. But if there were a lot, it likely reflects frequent changes of heart about your investment strategy— a sign you aren’t sure what you are doing.

Related video: Suze Orman’s 7 rules for retirement success

Day Two: Pick a Mix

The key driver of both our portfolio’s short-term price swings and its likely long-run return is our so-called asset allocation. What’s that? It’s our basic mix of investments: stocks; bonds; cash investments like money-market funds and savings accounts; and alternative investments, such as gold, real estate, and hedge funds.

Stocks are undoubtedly risky in the short term, but they can be a portfolio’s engine of growth over the long haul, generating gains that easily outstrip inflation. Cash investments almost always prove to be low risk, but there’s a strong likelihood they’ll lose us money once inflation and taxes are factored in.

What about bonds and alternative investments? Most bonds would count as a conservative investment, kicking off a steady stream of interest without too much fluctuation in price. But some can give investors a wild ride, including high-yield junk bonds, emerging-market debt, and Treasury bonds with 20 or more years to maturity.

Similarly, alternative investments are a mixed bag. The hope is that they’ll post gains when the stock market is falling. But they don’t always deliver on that promise—and many suffer dramatic price fluctuations. That’s why investors often limit alternatives to 10% of their portfolio’s value, and some avoid the category entirely.

You should have a target asset allocation for each of your major goals. For instance, if you plan to buy a house in the next three years, you can’t afford to take a lot of risk, so your target allocation should probably be 100% cash investments. But if you’re investing for a retirement that is 30 years away, your target might be 90% stocks and 10% bonds.

Day Three: Diversify

Once you settle on your asset allocation for any particular goal, the next step is to diversify—and that means buying lots and lots of securities.

Admittedly, this isn’t so important with cash investments. If you have a money-market mutual fund, there isn’t a strong diversification argument for opening a high-yield savings account. Instead, diversification matters most with bonds, alternative investments, and stocks.

Let’s say you own shares in just one company. What if that company gets into financial trouble? There’s every chance you’ll lose much or all of your investment, no matter how well the rest of the stock market is performing. You’ll have taken a massive amount of risk—making a big bet on a single company—and yet have nothing to show for it.

To avoid that fate, you need to own lots of stocks—big and small, U.S. and foreign. Similarly, you’ll want to own lots of different bonds, and if you opt for alternative investments, you should buy many different securities. By diversifying broadly, you reduce the risk of owning any particular stock or bond, and you are far more likely to be rewarded for the risk you’re taking. In other words, if you are diversified, and the financial markets rise over time, your portfolio will almost certainly go along for the ride.

Buying so many stocks and bonds might sound daunting. In truth, it’s remarkably easy—thanks to mutual funds and exchange-traded index funds. Funds simply bundle together a bunch of different stocks, bonds, and other investments into a single package, making it easy for investors to get broad market exposure with a relatively modest investment. Take the Vanguard Total World Stock Index Fund, which owns some 8,000 stocks from every part of the global market. That’s extraordinary diversification—and yet it takes just $3,000 to open an account.

Day Four: Count Costs

Dazzled by the prospect of big gains, investors often give far too little thought to investment costs. But if we aren’t careful, we could find ourselves paying annual costs equal to 2% of our portfolio’s value, and perhaps much more. We could hit that 2% if we buy high-expense mutual funds, purchase insurance products positioned as investments, trade too much, or hire a broker or financial advisor who steers us toward higher-cost products.

Admittedly, paying 2% of our portfolio’s value each year might not sound so bad—which is why Wall Street likes to frame investment costs that way. But that 2% could be devouring a huge chunk of each year’s potential investment return. Let’s say the stock market returns 6% a year. If we pay 2% in investment costs, our net return will be 4%. That means a third of our potential return disappeared into Wall Street’s pocket.

Your task for today: Figure out what you pay to invest.

Given the importance of keeping investment costs to a minimum, this is much harder than it ought to be. With some investments, like a savings account, certificate of deposit, fixed annuity, or cash-value life insurance, there’s no stated expense ratio. That doesn’t mean these products are cheap. In particular, almost all investments that are sold by insurance companies pay high commissions to the salespeople involved and effectively levy high ongoing costs. But this, alas, isn’t clearly disclosed to investors—and it may not be disclosed at all.

Other investments—such as buying individual stocks and bonds—can appear deceptively cheap because you might pay little or nothing in commissions. But the big hit is the trading spread on individual stocks and the markup on individual bonds. Every stock and bond has two prices: the higher price at which you can currently buy and the lower price at which you can sell. The spread or markup represents the difference between those two prices, but it’s tough for everyday investors to figure out what that difference is.

Yet other investments—notably mutual funds, including those in your employer’s retirement plan—make clear what commission, if any, is levied when you buy and sell, as well as how much you pay in ongoing annual expenses. Ideally, you want to own funds that are no-load, meaning there’s no commission when you buy or sell, and which have annual expenses of less than 0.5%, equal to 50¢ a year for every $100 you have invested. The lower the expenses are, the better.

Day Five: Find Funds

Imagine you joined a bunch of weekend warriors facing off against a professional basketball team. Or you found yourself on the other side of the court from a Wimbledon champion. Or you pulled your old bike out of the garage and lined up for the start of the Tour de France. What do you think your chances of success would be? This isn’t exactly a tough question: The odds of coming out on top are probably somewhere between zero and nothing.

Investing is no different.

Reams of statistics and undeniable logic have firmly established that the vast majority of investors—both amateurs and professionals—earn results that trail the market averages. Sure, there are always a few winners, just as there’s always somebody who wins the lottery. You may even beat the stock market averages this year and perhaps the next. But your chances of outpacing the market over a lifetime of investing probably aren’t much better than your chances of beating a professional tennis player.

The upshot: Consider building a portfolio using three core index funds.

How to Build a Starter Portfolio

Try building a portfolio by combining just three index funds: a total U.S. stock market index fund, a total U.S. bond market index fund, and a total international stock index fund. These three funds are available as mutual funds from Fidelity Investments and the Vanguard Group, and as ETFs managed by BlackRock (iShares), State Street Global Advisors (SPDR ETFs), and Vanguard.Charles Schwab also offers index mutual funds and ETFs that invest in all three sectors, though its broad international fund includes only developed markets. That means you’d probably want to add a fourth fund devoted to emerging markets.

a screenshot of a cell phone

Index funds buy many or all of the securities that make up a market index in an effort to match the index’s performance. The funds almost always fall slightly short of this goal because of their investment expenses. Still, those expenses are typically low, so the shortfall is modest—and far less than that suffered by most active investors, with their much higher investment costs. Result: By aiming for average, index funds fare far better than most other investors.

Index funds come in two varieties: mutual funds and exchange-traded funds (ETFs). The mutual fund variety is bought directly from the fund companies involved, with the share price established as of the 4 p.m. ET market close. The exchange-traded variety is listed on the stock market and is available for purchase throughout the trading day. To buy shares, you need to open a brokerage account.

Day Six: Check Your Target

Yesterday we discussed combining three index funds to create a globally diversified portfolio. There’s also a second approach worth considering— and it’s even simpler. Instead of combining three index funds, you might purchase a single target-date retirement fund.

A target-date fund provides a broadly diversified portfolio in a single fund, with each fund geared toward a particular retirement date. For instance, a fund targeting 2045 would have a mix of stocks and bonds that would be appropriate for someone turning age 65 in 2045 or thereabouts.

The big advantage of target-date funds is their simplicity. Indeed, they have become a mainstay of many 401(k) plans and may even be the default investment option. But there are drawbacks. While most target-date funds don’t charge any expenses themselves, they typically invest in other funds offered by the sponsoring fund company—and these funds can be costly and will almost always be actively managed.

Three exceptions: Charles Schwab, Fidelity Investments, and the Vanguard Group all have a series of target-date retirement funds that invest in each company’s own index funds. That means the funds have low annual expenses: 0.08% a year for the Schwab funds, 0.14% for Fidelity’s offerings, and 0.13% to 0.15% for the Vanguard funds. Keep in mind that, while the stock index portion of these funds shouldn’t generate big tax bills, you will owe income taxes each year on the interest kicked off by the bonds—assuming you hold your target-date fund in a regular taxable account rather than in a retirement account. Also, keep in mind that Fidelity and Schwab have a separate series of target-date funds that invest in actively managed funds, and those funds have much higher annual expenses.

Even if you would like to own just three index funds or just one target-date fund, that probably won’t be possible. You might end up with a 401(k) plan, an individual retirement account, and a regular taxable account. Your spouse might have the same selection of accounts, plus you might also have 529 plans for the kids. In each of these accounts, you’ll need to hold at least one investment.

Moreover, your 401(k) might have neither target-date funds nor index funds. You’ll be left to muddle through, perhaps building a globally diversified portfolio with actively managed funds you aren’t that enthusiastic about. Still, look for the lower-cost options—and be sure to diversify broadly.

Day Seven: Be Prepared

Buying stocks and stock funds is easy. Staying invested is the struggle. We may be managing money for a retirement that is decades away—and which might last two or three decades beyond that—and yet most of us pay close attention to the stock market’s daily performance, especially at times of market turmoil. The danger: We get so unnerved by a market downturn that we end up selling at the worst possible time.

With any luck, you’ll grow more comfortable with the stock market over time. But these three strategies may help:

1. See the Silver Lining

If the market drops, that’ll hurt the value of your existing investments. But if you are regularly adding fresh savings to your portfolio, you’re also benefiting from the decline because your next investment will buy shares at cheaper prices. Indeed, if you’re in your twenties or thirties, the current value of your portfolio is probably modest compared with the dollars you’ll invest in the decades ahead.

2. Focus on All Your Assets

Even if a market decline knocks 20% or 30% off the value of your stock portfolio, it’s unlikely your total wealth has declined that much. After all, you might have money in bonds and bank accounts, a home that you own, your future Social Security benefits, any pension you’re entitled to, and—maybe most important—your income-earning ability, all of which remain as valuable as ever.

3. Remember That Stocks Have Fundamental Value

At times of market turmoil, shares can seem like little more than numbers on an account statement, and those numbers keep shrinking. But behind those declining stock prices are real businesses, which produce goods and services that folks buy every day. Eventually, investors will recognize the value that’s there—and they’ll bid share prices back up.

a close up of a logo© Courtesy of John Wiley & Sons Inc.

Jonathan Clements is the founder of HumbleDollar.com and the author most recently of From Here to Financial Happiness (Wiley).

Excerpted with permission of the publisher John Wiley & Sons Inc. from From Here to Financial Happiness © 2018 by Jonathan Clements. This book is available at all bookstores, online booksellers, and from the Wiley website at wiley.com.

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