MY SONS’ BASKETBALL coach, George, has a favorite expression: He talks about “working through the uglies.” When you’re developing a new skill, he says, you shouldn’t expect to be perfect the first time or even the second. But if you keep working at it, over time there will be progress, “from ugly to not-so-bad to decent to good and then, eventually, to great.” The message is clear: You can’t rush it, you can’t skip steps and you have to start with the basics.
If you’re building an investment portfolio, I’d think about it the same way. At first, don’t worry about making it perfect. Instead, recognize that it’s a process and focus only on the most fundamental questions. Later, you can fret about the details—which particular stock or bond or fund to purchase—but don’t let those details distract you when you’re starting out.
Admittedly, this can be difficult. Investors have always struggled with the “brother-in-law problem”—the friends and relatives who always seem to be bragging about their latest grand-slam stock pick. For folks like this, the route to success consists of exactly one step: finding the next Apple, Alphabet (a.k.a. Google) or Netflix. Each time you see them, they can’t wait to tell you that you ought to be doing the same as them. It can be hard to ignore these folks.
Even within the relatively quiet world of index funds, distractions now exist. Recently, for example, Fidelity Investments made headlines when it announced a new line of index funds that are completely free. Is this a good thing? In theory, yes. But if you’re already invested in another low-cost index fund, choosing one over the other is like splitting hairs. It’s as much of a distraction as your brother-in-law and his purportedly no-lose stock picks.
How do you sidestep these kinds of distractions? Before purchasing an investment, I would ask four questions:
What am I trying to accomplish? Are you saving toward a goal, such as retirement, or have you already amassed your nest egg and now you’re focused on turning it into income? It seems like an obvious question, but the answer will dictate how you allocate your funds among the major investment categories: stocks, bonds, real estate and cash.
According to academic research, your allocation among the major asset classes is the most important investment decision you can make. I would think hard about your mix of stocks and more conservative investments, I would understand the potential downside of the allocation you choose, and I would revisit it whenever there’s a change in your financial situation.
Am I effectively diversified? The key word here is effectively. Remember that investments that are similar in nature tend to move together. Apple and Google, for example, will move in tandem far more than Apple and Hershey or Harley-Davidson. When you build an investment portfolio, it isn’t just the number of investments you own that matters. Rather, it’s the number of different types of investments that will make the biggest difference.
Are my investments tax-efficient? There’s no such thing as a universally “good” investment. There are only investments that are good for you. If you are evaluating an investment, especially on the bond side, be sure that it aligns with your tax status.
Can all of my investments be described as sensible choices? Wall Street loves building complex investment products. But in my view, complexity is your enemy. Whenever financial salespeople try to sell you something—whether it’s a stock, bond, fund, insurance policy or annuity—ask lots of questions. Ask them to explain it to you in plain English. Ask them to explain why they think it’s right for you. Ask them what alternatives they considered and how they chose the particular product they’re recommending. Ask them to spell out all the fees. And finally, ask these salespeople if they own the same thing for themselves.
Adam M. Grossman’s previous articles include Eight Heroes, Separated at Birth and Non Prophet. Adam is the founder of Mayport Wealth Management, a fixed-fee financial planning firm in Boston. He’s an advocate of evidence-based investing and is on a mission to lower the cost of investment advice for consumers. Follow Adam on Twitter @AdamMGrossman.