As anyone who has ever bought even one stock knows, getting rich fast in the market isn’t easy. But over the long term -- a decade or longer -- if you invest in a well-diversified bundle of stocks, throw in a smattering of well-priced bonds and save regularly, you will almost certainly see your money grow. That’s why we consider the tried-and-true approach to investing to be relatively low risk. Remember the Rule of 72: Divide 72 by the return from your portfolio to get the number of years it will take for your money to double.
By contrast, the high-risk approach we describe -- buying a small number of aggressive stocks in hopes that some or all of them will become runaway winners -- carries with it a real possibility of large losses as well as outsize gains. Or you could combine the strategies to reach a comfortable middle ground.
High risk: Hold a few aggressive stocks.
With this approach, you invest in a small number of stocks that you hope can double, triple or even quadruple in relatively short order. Risky? Absolutely. You might even call this a shoot-the-lights-out strategy.
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Nobody knows for certain which stocks will surge and which will sink. But if you are hoping to achieve big gains, you’ll need to look beyond large, steady-Eddie types of companies. Small companies that are poised for rapid expansion and firms that serve emerging markets, which are growing more rapidly than developed nations, make for fertile hunting ground for potential winners.
For example, you could invest 10% of your portfolio in each of the following companies, all of which have strong growth prospects (prices are as of March 8): Exelixis (symbol EXEL, $5), a small biotechnology firm developing drugs to treat thyroid and prostate cancers; Myriad Genetics (MYGN, $25), which develops gene-based tests to determine whether patients are at increased risk for certain cancers; C&J Energy Services (CJES, $23), a provider of services for the hydraulic fracturing industry; Ormat Technologies (ORA, $21), which harvests geothermal energy; Entegris (ENTG, $10), a provider of services and products to protect against contamination in the semiconductor-making business; Millennial Media (MM, $8), which partners with mobile-application makers to deliver advertisements on phones and tablets; NationStar Mortgage Holdings (NSM, $39), a mortgage servicer that has benefited from turmoil in the banking sector; Encore Capital Group (ECPG, $31), a fast-growing debt-collection company; Baidu (BIDU, $89), the top Internet search engine in China; and New Oriental Education & Technology Group (EDU, $16), the largest private education provider in China. If you follow this route, you’ll need to monitor these companies carefully to determine whether to hold them or replace them with better opportunities.
Lower risk: The tried-and-true approach.
Diversifying, minding your investment costs, buying and holding—these are the humdrum concerns that make up the basics of smart investing. Taken individually, or evaluated over the short term, they may not seem to add much to your returns. But taken together and followed over a lifetime, the basic rules of smart investing are powerful. So let’s review them.
Diversifying means spreading your money among many individual stocks and bonds, and across many sectors and asset classes. It helps to lower your risk because it prevents a stumble by one or two investments from wrecking your portfolio. Since 1926, U.S. stocks have returned 10% annualized. A portfolio that was 50% in U.S. stocks and 50% in bonds and rebalanced monthly returned a respectable 8.3% annually, and did so with far less volatility.
You can’t control whether markets go up or down, but you can control costs. Favoring low-cost mutual funds and exchange-traded funds, and trading judiciously to hold down brokerage commissions, are foolproof paths toward a higher account balance. For example, cutting your expenses by 0.5 percentage point per year should add precisely that amount to your returns.
With buy-and-hold investing, place the emphasis on hold. Sticking with well-diversified stock funds through down markets is difficult, but it’s an important ingredient for investing success. After all, trying to time the market’s moves means you not only have to be right about when to get out, you also have to pick the right time to get back in. During the 2007–09 bear market, plenty of investors got out of stocks before the market bottomed. But many also sat out the subsequent recovery and missed out on huge gains. From the market’s low through March 8, Standard & Poor’s 500-stock index returned 150%, or 25.7% annualized.
So what does a low-risk portfolio look like? Assuming you’re investing for retirement, take your current age, subtract ten and consider that the percentage of your portfolio that should be invested in bonds. Invest the rest in stocks. Tweak as necessary to make the portfolio reflect your personal tolerance for risk and volatility.
The biggest chunk of your stock portfolio should be in large U.S. firms. But you should also hold stakes in smaller companies and in foreign stocks. For example, suppose you’re 50 years old and saving for retirement, meaning you should hold 40% in bonds and 60% in stocks. You might have 25% of your portfolio in large U.S. companies, 15% in small and midsize U.S. firms, 10% in developed-markets foreign stocks and 10% in emerging-markets stocks. For more-specific ideas, consult the model portfolios on page 31, which we have constructed with funds from the Kiplinger 25, the list of our favorite no-load funds.