ETF Portfolio: Things That Don’t Matter When Selecting a Portfolio Strategy - dummies

ETF Portfolio: Things That Don’t Matter When Selecting a Portfolio Strategy

By Russell Wild

Before you invest your money in individual stocks or bonds, exchange traded funds (ETFs) or mutual funds, you should ask yourself these questions: How much return do I need to see? And how much volatility can I stomach?

So few things in the world of investments are sure bets, but this one is: The amount of risk you take or don’t take will have a great bearing on your long-term return. You simply are not going to get rich investing in bank CDs. On the other hand, you aren’t going to lose your nest egg in a single week, either.

Here are just a few things that really shouldn’t enter into your thinking, even though they play into many people’s portfolio decisions:

  • The portfolio of your best friend, which has done great guns.

  • Your personal feelings on the current administration, where the Fed stands on the prime interest rate, and which way hemlines on women’s dresses are moving his fall.

  • The article you clipped out of Lotsa Dough magazine that tells you that you can earn 50 percent a year by investing in . . . whatever.

Listen: Your best friend may be in a completely different economic place than you are. His well-polished ETF portfolio, laid out by a first-rate financial planner, may be just perfect for him and all wrong for you.

As far as the state of the nation and where the Dow is headed, you simply don’t know. The talking heads on TV pretend to know, but they don’t know squat. Nor does the author of that article in the glossy magazine that tells you how you can get rich quickly in the markets. The secrets to financial success cannot be had by forking over $4.50 for a magazine.

The stock market over the course of the past century has returned an average of about 10 percent annually (7 percent or so after inflation). Bonds have returned about half as much. A well-diversified portfolio, by historical standards, has returned something in between stocks and bonds — maybe 7 to 8 percent (4 to 5 percent after inflation).

Don’t take inordinate risk with any sizeable chunk of your portfolio in the hope that you are going to earn 50 percent a year after inflation — or even before inflation. It won’t happen.

On the other hand, don’t pooh-pooh a 7 to 8 percent return. Compound interest is a truly miraculous thing. Invest $20,000 today, add $2,000 each year, and within 20 years, with “only” a 7.5 percent return, you’ll have $171,566. (If inflation is running in the 3 percent ballpark, that $171,566 will be worth about $110,000 in today’s dollars.)