Stick with stock funds
As long as you have five or more years until you need the money, stock funds will likely provide you with superior returns over any other investment. But you have to be patient.
In the short term, the market is very volatile, so don't fret when the market drops 10 percent in a week, or your account seems to be worth a lot less than it was last month. Over five, 10 or 20 years, you'll come out much further ahead by sticking with stock funds.
Get friendly with the 800-pound gorillas
When you invest in the big American companies, companies like Microsoft, Intel, Citigroup, Merck, Proctor & Gamble and General Electric, you don't have to worry much about whether they will be going out of business any time soon. What's more, these industry leaders have generated outsized returns for their shareholders over the past decades. Bigger isn't always better, of course, but "large-cap" stocks like these provide plenty of solid returns (over the long-term, of course). Invest in these stocks by buying large cap stock funds.
The world is a big place and getting smaller as we build telephone lines and Internet connections and satellites that send signals all around the world. Still, somehow, the stock markets in other countries always tend to go down when the US market is up, and vice versa. You can take advantage of this trend by including some global stocks in your portfolio along with big American stocks. You can do this by buying a fund specializing in large international stocks.
Think small, too
Every 800-pound gorilla big company once started out as a small company. If you can buy good companies when they're small, you'll benefit as they get to be big and successful companies. The trouble is, lots of small companies just get smaller and eventually go out of business. So small company stocks tend to be a little riskier than big stocks. But here's the good part -- another funny thing about small stocks, particularly small cap value -- is that they tend to do well when big stocks are doing lousy, and vice versa. So if you own big and little companies in your portfolio, over the long-term, things will more than balance out in your favor. Do this by buying small cap stock funds, both growth and value.
Consider index funds
The Standard & Poor's 500 Index is one of the best known stock market indexes, made up of 500 large American companies from all industries. An S&P 500 Index fund simply invests in those 500 stocks; the fund's advisors don't try to pick stocks that will beat the market. Index funds always match the performance of the market -- or of the sector that the index tracks-- so you never have to worry about your index fund dogging the market. As a bonus, these funds have low expenses (the fees that the fund's managers take off the top) and that increases your returns. Consider Large Growth Index and Large Value Index, too.
Sometimes people think that if one large cap fund is good, two or three are better. When you buy several funds of one type, more likely than not you'll just end up owning roughly the same set of stocks. Not only will you probably not increase your overall returns, you'll create more work for yourself by having to track additional funds. Choose one good fund of each type in your portfolio and, as long as they continue to perform well, stick with them.
Avoid long-term bond funds
Use short and intermediate term bond funds. If you have five years until you will withdraw your investment, like for retirement, then bonds might be appropriate for perhaps 10 to 20 percent of your portfolio, and increasing to perhaps 40 percent (at most) when you are at retirement age. The problem that most people have is that they think bonds are "safe" but long-term bond returns are still volatile, and will give you a lower rate of return than stocks over time. Stick with short-term bond funds for stable interest and low volatility.
Put it all together
Divide your portfolio in half. Put half in bond funds; equally short and intermediate term. Be sure to get both corporate and government bond funds. Take the remaining half of your portfolio and spread heaviest the US large cap growth and value. Sprinkle the remainder in small cap and international. Now you've got a diversified portfolio in which at least one sector will be doing OK, or better than OK, nearly all of the time.
Never, I mean never, put money into stocks that you may need in the next five years. The stock market rarely disappoints over five-year periods. But, when the stock market goes down, it goes down in a hurry! Cash is king when the market is suffering -- it is your aspirin for your headache. Always have aspirin on hand. How do you know how much cash to have on hand? Complete a personal x-ray of your entire financial situation and consult a professional financial advisor to keep your goals and investments on track.
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