3 Simple Steps on the Road to Wealth
Jun 18th 2012 10:56PM
Updated Jun 18th 2012 11:02PM
On the road to investing success, a simple strategy of choosing your vehicle, your road map, and your preference for driving allows you to arrive at the destination of your financial goals. As we start our journey on the road to wealth, let's address the question: With so many investing ideas, how can you find the right ones?
Prepare for the trip ahead
Your investing style hinges on two things: your risk tolerance and your need for the money. Asset allocation plays a big role, too, but let's not gets ahead of ourselves.
Risk tolerance is like driving. Do you gun it in the fast lane, drive with the pedal to the metal, and weave in and out of traffic to quickly get where you're going? Or are you content to pick a lane and stick with it, drive the speed limit, and know you'll arrive at your destination eventually? If you're the former, you're more comfortable with risk; if you're the latter, you're less comfortable.
Your need for the money also factors into your investing style. If you are in your 20s or 30s and saving for retirement, then you have decades to invest; you can recover from stumbles in the market and still meet your long-term financial goals. If you are nearing -- or in -- retirement, missteps can devastate your portfolio and force you to delay or revise your financial dreams. You might want to avoid getting on the freeway at all.
So where do you fit? Pick where you think, and take a look at this handy chart.
Pick one below and one to the right
I have decades to save
I need my money soon
|I gun it in the fast lane||Indy 500 race car||BMW|
|I drive slow and steady||Volvo||Golf cart|
If you have decades to save and aren't afraid of risk, then you can floor it -- call yourself an "Indy 500 race car" investor. If you have decades to save but prefer to take a more measured risk-approach, pick the "Volvo" investor.
Similarly, if you need your money soon and are OK with risk, you are a "BMW" investor -- not quite as all-out as an Indy car, but still speedy. But if you need your money soon and shy away from risk, then think of yourself putting around the course and pick the "golf cart" box.
Remember which one you are. We'll get back to that in a bit.
Have car, need direction
Studies show that while making smart stock picks can make a difference over time, higher-level portfolio decisions overwhelmingly dominate investment results. For instance, one study showed that 90% of variability in portfolio returns is derived from asset allocation. That means only 10% comes from actual security selection - the stocks, bonds, mutual funds, and exchange-traded funds (ETFs) themselves.
So let's take which "vehicle" you are, and combine the concept of asset allocation.
Type of Investments
|Growth (small-cap and mid-cap)||30%||25%||20%||15%|
|Income-generating growth (large-cap)||30%||25%||25%||20%|
Source: Approximate allocations derived from the Motley Fool Rule Your Retirement newsletter service.
Think of this as a "road map" to help you develop your own investing strategy. The more growth-oriented portfolios offer more potential for return but come with more volatility, so the value of your investments will change more often than a portfolio that is less growth-oriented. The key to picking your road map is striking the right balance of the risks you're willing to take to achieve potential returns. If you'd like more help developing your road map, here's a great resource.
So you've chosen your ride and dusted off that atlas. One more quick self-check and we're out on the open road.
If you prefer to set the car in cruise control and consider yourself a hands-off, "do-it-for-me" investor, then consider mutual funds or ETFs. They provide broad diversification and require little of you. That way you can spend your time gardening, fixing up old bikes, or whatever you fancy.
Some ETFs to consider include iShares S&P 400 Mid Cap ETF (NYS: IJH) for your growth percentage, Vanguard Large Cap ETF (NYS: VV) for your income-generating growth slice, and Vanguard Emerging Markets Stock ETF (NYS: VWO) for your international piece. These ETFs are all low-cost, have a seven-year-plus track record, and boast four stars from Morningstar. Consider Vanguard Total Bond Market ETF for your bond percentage.
If you prefer a manual transmission and are a hands-on, "do-it-yourself" investor, consider individual securities, like stocks and bonds. Apple is a fantastic growth stock to assess. Not only has the company managed explosive growth over the past decade, but it has also done so in a fiscally responsible manner while remaining a constant innovator. And CEO Tim Cook has emerged as an adept successor to the late Steve Jobs.
McDonald's (NYS: MCD) and Procter & Gamble (NYS: PG) are solid income-generating growth stocks. They pay great dividends that lend stability to a portfolio when -- not if -- the stretch of road is chock-full of potholes and you need to firmly grip the steering wheel at 10 and 2.
McDonald's pays a 3.2% dividend yield and has paid a dividend since 1976. P&G pays a 3.6% yield and has offered a payout for more than 120 years. McDonald's has three times the market share of its nearest competitor, and P&G is known for its unparalleled brand portfolio and insights into consumer research.
Merge on to the road to wealth
The three simple steps to creating your diversified portfolio are:
- Determine your investing style (choose your "vehicle").
- Apply asset-allocation concepts (grab your "road map").
- Figure out whether you're a hands-off or hands-on investor (pick "cruise control" or "manual transmission").
Since you're now well equipped with a trusty ride and a customized road map, you can better evaluate individual investment ideas as they come your way. And we have some great ideas for you to consider, all outlined in a free report, "The 3 Dow Stocks Dividend Investors Need." It's full of some goodies, so get your copy today.
At the time this article was published Fool contributor Nicole Seghetti owns shares of Apple and Procter & Gamble. She is a Volvo. Nicole welcomes you to check out what she's keeping an eye on by following her on Twitter, @NicoleSeghetti. The Fool owns shares of Apple. Motley Fool newsletter services have recommended buying shares of Procter & Gamble, Apple, and McDonald's, and have recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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