Impact Your Investment Return with 3 Simple Strategies
Positive investment returns are harder to come by with the sluggish economy and lackluster stock market. Here are a few simple strategies to juice up your investment performance while you wait for the market to recover.
Diversify: The old adage of not putting all of your eggs in one basket is very important to protect your portfolio. What many investors don’t realize is that diversification usually will provide you with a higher return as well.
Numerous studies have shown the advantages of diversification over a long period of time will not only reduce portfolio risk, but also greatly improve returns. Owning various asset classes that move independently of each other (some may zig while others zag) can also stem panic when the market inevitably declines aggressively.
Rebalance: Rebalancing your investment portfolio at least once a year allows you to maximize the benefits of diversification. Rebalancing means selling some of what has done well and buying some of what has done poorly. This strategy gives you the ability — and the mandate — to buy low and sell high, even if you're not comfortable doing so at times.
Here's a simple example of diversifying your portfolio to 50% stocks and 50% bonds. However, suppose that the stock market had a terrible year and fell by 20%. At the same time, bonds rose 20%. The decreasing value of your stocks and increasing value of your bonds would create roughly a 40% stock and 60% bond allocation.
Rebalancing at the end of the year means selling off 10% of your bonds after they have increased in value and purchasing an additional 10% stocks while they are cheap. This brings the portfolio back to its original allocation of 50% stocks and 50% bonds. You were able to buy low and sell high.
Rebalance your portfolio 1-2 times per year for maximum effectiveness. Rebalancing alone can add 1-2% of additional return year after year.
Try dollar cost averaging: This means simply consistently contributing the same dollar amount each month or year to your investment portfolio. Dollar cost averaging your money into your investments allows you to purchase more shares when the prices fall which can dramatically juice up your returns.
Assume you had $1,000 each month to purchase mutual fund shares. The mutual fund you are purchasing is $100 per share. This allows you to purchase 10 shares (ignoring fees and expenses). Next month, the shares dropped to $50 per share and you bought another $1,000 worth or 20 shares. Then, in month 3 the shares rose to $75 per share and you purchased 13.33 shares.
After three months, despite the fact that the price has dropped 25% from where you started, you have invested $3,000 but have 43.33 shares valued at $75 each for a total of $3,250. Your investment has provided you with a little more than 8% return in only 3 months despite the fact that the investment itself is down 25% from where you started. That is the benefit of dollar cost averaging.