I looked into this awhile back and quickly came to the conclusion, based on the several books I read, that it's silly to try to beat the market long term. "The Intelligent Investor" is the one that laid it out clearly to me. The main point is: the performance of narrow investments (specific stocks) can't be reliably predicted, but the market as a whole tends to grow over time. Therefore, invest in the market as a whole. (== S&P index fund)

Index funds are the way to go. They are a passive instrument, so you cannot (should not) be actively trading them. When you put money in an index fund, you essentially buy shares of that fund (along with several others). There is a fee attached to every trade, and that fee is consumed by all share holders equally. So most index funds will penalize you for trading those shares actively.

The way I look at it, an index fund (like S&P index fund) is merely a layer of abstraction over trading stocks. But instead of putting all your money in one stock, the index fund divies up your money across many different companies and sectors in the same ratio as the target index. This protects you from major fluctuations in the market, so in the long term you essentially grow at the same rate as the index. On the flip side, if one of those companies sees astronomical growth, you won't see the same growth.

[All: This is my understanding of index funds, so if I am wrong, please, do correct me]

There are several good books in the market if you want to go down this route, including the aforementioned "The Intelligent Investor" [must read] and "A random walk down wall street"

Another book that I surprisingly found to be very good was "Mutual funds for dummies" [http://tinyurl.com/5ulpvw][The other book "Personal finance for dummies" by the same author is a good book too. There is another one [http://tinyurl.com/5wso5z] that is short and sweet to read.

Good luck!

I would avoid buying a single index fund though. I go with small cap growth funds 50% US, 25% Europe, 25% Asia and rebalance them every 6 months.

PS: Outside of a Roth IRA / 401k rebalancing stocks has some negative tax consequences so it's better to change what your buying than sell off existing stock.

I am also a passive investor trying to capture full market returns. However, just investing in stocks exposes one to too much risk with no more return than if you spread your money across many asset classes that move in different directions at any given time.

The Benefits of Low Correlation is a good summary: http://www.indexuniverse.com/component/content/article/6/322...

And here is a summary of the summary: http://articles.moneycentral.msn.com/RetirementandWills/Reti...

And here is the highlight of the summary of the summary:

His two-asset portfolio -- 50-50 U.S. large- and small-cap stocks -- produced an annualized internal rate of return of 10.74%. But it lost a deadly 30.8% in its worst year. His seven-asset portfolio -- equal portions of U.S. large- and small-cap stocks, international stocks, U.S. intermediate fixed-income investments, cash, REITs and commodities -- provided an 11.25% return. But the worst-year loss was only 10.2%.

Thanks for the good links.

I was just wondering, what does the worst one year loss matter if you are investing over 30 years? The annualized rates given were positive, and the better one happened to have a smaller worst year number, but it shouldn't really matter. If a fund returns 13% annualized but had one year where it lost 90% of value (hypothetical here), I'd still choose it for the 13%.

I can see how this would matter if you are actively drawing on the funds... then a high volatility portfolio could be stressful and possibly dangerous, but if you are looking at a 30 year timeline, it doesn't matter.

It matters for two reasons. First, it gives some people (including myself) peace of mind that without it might otherwise prevent investment in some of these vehicles. Second, you will probably draw down (or switch into less volatile investments) eventually, and so it ups the probability that when you do you so all will be OK.

Of course, it also yields higher returns on average, so it is a win-win really.

Philip Greenspun (of Ars Digita fame) wrote a great guide on the subject: http://philip.greenspun.com/materialism/money

He recommends index funds too, and explains the choice.

The benefits of diversification are vastly overstated. Especially over long time periods, the benefits of buying e.g. your 5 best ideas rather than your 10 best ideas vastly outweigh the benefits of having less volatility. If you have time to do the research, do this: find companies that are either the low-cost provider, the most-loved brand, or have special government-protected status in their industry. Examples would be Coca-Cola, Wal Mart, Kraft, etc. Possibly, rule out companies whose managers make irresponsible financial decisions (like over-leveraging at a bank, or buying back stock at high prices like Coca-Cola). When these stocks are cheaper than the broader market, buy them. If one of them rises enough that, after capital gains taxes, you're getting more annual earnings per dollar invested in another company of similar or better business characteristics, sell the expensive one and buy the cheap one.

Basically, your goal should be to have a portfolio you don't have to follow, of companies that will tend to grow their earnings faster than their capital and thus throw off free cash for shareholders. If you can get these at a fair price, your net worth should grow nicely.

However, this is difficult to articulate and extremely hard advice to follow. Perhaps it would be better to put most of your money in an index fund, and do this with the rest of your money long enough to see if it works for you. Sadly, this kind of strategy should be judged over a longer time period (like five years). So, index fund or take your chances.

Do you follow this strategy yourself? If so, what is your portfolio right now?

I do follow this strategy, but I also invest in weird little situations that don't fit into it (e.g. a small, post-bankrupt manufacturing company with a hugely overfunded pension, managed by a billionaire trader). I don't like to discuss specifics of what I invest in now. However, stuff I bought in the past includes NDAQ and IBA; huge mistakes include buying MOVI and MGAM (I sold for more or less unrelated reasons), and not-buying DAKT (I sold after a good earnings report -- it's up 150% since then) and not-buying AAPL (I was researching it, then they announced their first million songs sold through iTunes, the stock went up about 15%, and I said "Nahhh" and decided to wait for it to calm down. That was when it was at, uh, $9. Ouch).

I'm sure this is frustratingly vague.

If you start to pay attention to business -- not in the sense of reading the WSJ, but just looking at how consumers behave -- you'll eventually detect some companies that are either a) able to ask for a higher price than anybody else, or b) able to make acceptable stuff more cheaply than anybody else. About 99% of businesses are second-best or less at one of these things, and those businesses are fundamentally unable to grow without investing equivalent capital. The other 1% can usually have above-average growth without having to reinvest all of their earnings, or have steady earnings that are high compared to invested capital but that can't be easily grown. An example of the former would be a software company or a drug company -- it costs a lot to create a product, but the cost of selling it to a million people is not that much more than the cost of selling it to ten thousand. An example of the latter would be the gravel and sand business -- nobody is going to import ten tons of the stuff from overseas, or even across state lines, so it's basically a business made of hundreds of tiny local monopolies. Some of these are exceedingly well-managed; they pay dividends when their stock is high, and buy it back when their stock is low.

I follow that strategy with a portion of my funds, the majority is in a diversified index fund.

My top 3 picks a few months ago when I last looked at the market were GOOG, AAPL, TD.

Generally unless you're a genius in the field (ie, Warren Buffet, Peter Lynch etc) you will not beat the market, so what you have to do is join it. Take your money and spread it widely across sectors, indecies and geographical regions - if you spread it well enough, your money will grow at the rate of the global economy which is realistically the most you can hope for.

The second thing is to separate your investments from your speculations. Your investments targeted for long-term growth should be handled as above - spread them widely and sit on them for a long time. Your speculations should be money you can easily afford to lose and you should do with them whatever you instincts tell you. This can be things like buying stock in a particular company or commodity, trading currencies etc.

Finally, you need an excellent book: http://en.wikipedia.org/wiki/A_Random_Walk_Down_Wall_Street

You can expect your money to grow at more than the rate of global economic growth if you own equities rather than fixed-income, unless you are arguing that investors are indifferent to risk (which can't be true if they use leverage).

Two recommendations for reading: A Random Walk Down Wall Street (mentioned in another post, long, detailed, and entertaining), and The Coffeehouse Investor (short and funny). Both lay out the principles behind the theory of efficient markets, and make a great case for it.

In a nutshell: buy the cheapest unmanaged index funds you can find. Come up with an allocation you're comfortable with (e.g., 50% large cap, 20% mid-cap, 20% small-cap, 10% international equity). Reallocate once a year so that your investments still follow the same rough percentages; that way you won't have more risk exposure to any particular asset class just because it happened to have done well or poorly in any given year. That's it. You will not outperform the market by picking your own investments or playing hedging games with derivatives, and, over the medium-to-long term, neither will any fund manager. Since you're in this for the long term, have fun in life and don't bother checking your balances except when you get your quarterly statements.

Are those the asset allocation % you use? Also, what about commodities, real estate, infrastructure, and other asset classes?

Here is what I do - I keep 2 months' worth of income in a high-yield saving account (a la ING) This amounts to about 5 months of living expenses for me, so it is a good safety net. - I stash away a small majority (say, 60%) of my long-term savings into index funds and relatively safe, stable stocks - Since I am fairly young (27), I invest a sizeable chunk (but still a minority; say, 40%) of my savings into riskier stocks with a potential to be a home-run down the road. I only invest into companies and technologies that interest or excite me. This makes research a pleasure rather than a chore.

The ratios will tip towards the conservative side as I get older.

Traditionally, investing in a Small Cap Value eft or index fund would have earned you about 2% more than the market on average. It's the only asset class that has consistently beat the market over the last 100 years. I know several smart people in finance who use this long-term strategy.

Had you been doing this over the last three years, however, the results would not have been pretty.

I can think of two very important principles to keep in mind:

-Diversification: Commodities, property, and bonds often do well when stocks fall. Economic shocks can happen that are localized to a single country or region. It makes sense to put your eggs in several different baskets, both by asset type and by geography.

-Long-term inexorable trends: The world's population is getting older. Well-run but less-developed economies will tend to grow faster than well-established ones. Invest in "iceberg" trends, those that are slow-moving, easy to predict, and hard to stop. I recommend medical ETFs and emerging market ETFs

Of course, throw in some traditional investments while you're at it. Don't get cocky or daring and don't let short term variations spook you. Trading too much can knock a significant percentage off of your returns.

Some great answers here, and mine is not going to be an answer to you specifically, but might open some minds nonetheless.

I try to invest in "myself." Rather than supporting those producing, innovating, and providing value to the economy, I try to be a producer, innovator, and value provider myself.

This attitude works well in your 20s, at least, but might not seem so alluring when closer to retirement.

It is not uncommon, however, to see or hear about situations where someone has started a business with a reasonably small amount of money (<$50k) and even if they're not worth mega-millions, their business can grow to the point where it provides the owner with a high income and can effectively manage itself (if you get the right people). This technique makes you a producer rather than an investor in the long run.

A small proportion in cash (enough to survive for a year or two if I want to stop being employed). The rest in equity index funds, spread between UK, US, Europe, Japan/Pacific. Some of those equities are in retirement funds for the tax advantages, and for the discipline of not being able to spend them any time soon.

That seems reasonable for me now, as someone who's young and employed. My future earnings ("human capital") are likely to be bigger than my current financial assets (because I'm young) and fairly steady and bond-like. As I get older, or if I become self-employed, I would move more of my financial wealth into safer assets (eg long-dated index-linked bonds).

The comments so far are espousing passive investment strategy and good asset allocation, which I agree with, but I was looking for something a little more concrete.

So in effort to engender some discussion with hard %s, the following is where I am right now (excluding equity in primary residence). The accuracy (beyond decimal point) is certainly irrelevant, but it came right off a spreadsheet and I left it in because it sums to 100.

US Large Cap: 21.87%

US Mid Cap: 8.35%

US Small Cap: 3.03%

Commodities: 8.47%

Real Estate: 6.26%

International Equities: 7.55%

Emerging Market Equities: 4.63%

Cash: 12.71%

Bonds: 27.13%

The Bonds are in a 10 year ladder. The Cash is in FDIC insured money market accounts. All the rest is in index vehicles.

I'm very interested in any feedback and also what your numbers are.

Depends on the stocks. Unlike many modern investors, I'm extremely uncomfortable with the idea of trading something as an asset class rather than as part ownership of a business. You end up doing things like investing in oil companies and investing directly in commodities, which is redundant -- the oil companies are basically a portfolio of call options on oil, where the strike price is the cost of extraction.

Think about it: if you told Andrew Carnegie you were putting "21.87%" of your money into "US Large Cap," he'd laugh his ass off. He'd ask why you knew, to four figures, what kind of stocks you were investing in, but didn't bother to talk about what they made, who ran them, or how much money they earned. He'd ask why you would prefer buying $100 million of cash flow for $2 billion rather than $1 billion, as an allocation based on market cap would have you do. Carnegie is a great example, because for a while he was purely an investor -- he had a diversified portfolio of stocks in companies whose management he knew personally, and he paid careful attention to their business performance and the dividends they paid, not their market price.

Don't do anything Carnegie, Morgan, or Rockefeller wouldn't recognize as an investment, and you should be okay.

I said specifically The accuracy (beyond decimal point) is certainly irrelevant, but it came right off a spreadsheet and I left it in because it sums to 100.

As for indexes vs individual stocks, I don't want to spend that much time worrying about (or tweaking) my investment portfolio.

So, for you, it depends on the stocks. But if you work backwards, where does that come out on an asset class basis? Are you buying no international equities? No commodities? No REITs? What are the actual %s?

That looks insanely conservative. I would basically drop Large Cap, Cash, and bond from any long term investment strategy. I would bump Emerging Mark's and US Small cap stocks to 25% each and spread the rest over Mid Cap, Commodities, Real Estate, and International Equities.

Does your advice depend on how much money you are investing, i.e. 100K vs 1M vs 10M?

In my case, the bonds and cash are mainly for capital preservation. I set aside an amount for that, and invested the rest in the various asset classes.

Not for long term investing, but if you are living off of your savings then having some stocks and bonds to avoid pulling more money out of the market when it's down is useful.

The investment paradox is all about leverage. If you have 10+ million then who cares if spending 40 hours a month could give you a 1% better ROI you don't really need the money or the stress. If you have under 1/2 million then a 1% better ROI probably not worth the time it takes to get that extra return. (.01 * 500k) is only 5k which is probably not worth all that much of your time. At in the 1-3 million range your close enough to just retiring that your risk's are probably not worth it.

Note: I am getting around 12.5% ROI/year over the last 5 years and I spend about 8 hours a year looking at my investments why bother with more than that? Well sometimes you want to play with the market which can be fun. EX: After VISA’s IPO they are up 40% how cool is that. Just don't bet the farm and you will probably make some money.

If it was 1928 year now, would this portfolio have survived Great Depression? Almost all positions are paper actives. What do happen with the paper actives in case of huge world economical slowdown and depression? I prefer something more reliable than paper (gold, land, real estate, cash flow from the business)

I believe it should, but am interested in your speculation as to how you think it would hold up. About half of it is not in equities (cash, bonds, commodities, real estate). And I did not include actual land holdings in the %s (including our personal residence), which brings it up to a majority. Also, some of the equities are international, and we are in a much more global environment now as compared to 1928. Over 40% of large cap earnings are from abroad.

Are you saying that you hold 100% of your assets in gold and land?

"Cash flow from the business" was specifically excluded from the question, i.e. income does not enter into it.

One point about the index funds (besides from being very hard to beat the market even working full time on it) is that the huge fees compounding on hedge and mutual funds also take away most of your gains. 2% compounded over 30 years wipes out a lot of the alpha.

This podcast is an excellent intro to index funds and how fees decimate returns (also a fantastic entrepreneurial story): http://www.venturevoice.com/2006/02/vv_show_28_john_bogle_of...

For most of my retirement money, I follow the "Lazy Portfolio" method. Some examples and results are tracked here:

http://www.marketwatch.com/news/story/lazy-portfolios-annual...

Basically, you buy indexes across asset classes so you have diversification within each asset class as well as asset diversification.

It's easy, cheap, and works. It's just not "sexy"

I highly recommend the Agora Financial Group and their various newsletters.

Back when I had a little money to play with, I was following a couple of them (Penny Investor and another), and was able to gain 40% in a year (someone else was doing the actual work for me). But that's just anecdotal evidence.

I also like their whole philosophy; they've had several NYT #1 bestsellers, 'cause it's both commonsensical and also exceedingly contrarian at the same time. (Addison Wiggins and Bill Bonner.)

I subscribe to a few newsletters put out by the Motley Fool with the general targets being smaller, lesser known, less covered companies that have great long-term prospects currently priced at a discount to their computed intrinsic value. My target allocation is 100% equities. What you need more than anything else is the willingness and discipline to apply your investment strategy when the market is acting irrationally.

I have read on a previous comment in another story about "shorting bonds and longing stocks" but this was given as an example of a bad idea. Why is it so? If in the long term stocks outperform bonds wouldn't this actually be a good strategy for a long-term investor? Obviously the risks would be higher, but since it is over the long term it shouldn't matter, right?

If you go back to that thread, it concludes that there is indeed a place for equities in a balanced portfolio. Your point is exactly the one I was trying to make!

Invest 100% of your money in small-cap/value funds. They do best in the long run.

Invest 100% of your money in BRICs (Brazil, Russia, India, China). They have large, youthful populations with better prospects than America, Europe, or China.

I'm afraid that I don't know of any small-cap/value, BRIC funds. If anyone knows of any, I'd appreciate a pointer. Thanks.

Earlier this week, I put a lot of my money into two ETF's, EWZ (Brazil), and FXI (China). They have great technical setups if you are believe in that as well. Good time to buy.

I know its cheesy, but I really would rather invest in myself (Education, Business suit etc)

The question assumes you have money set aside in a thirty year time horizon with the goal of long term growth. Or are you saying that you put all your retirement money into your startups?

Also, for the purposes of the question, assume you have enough money where education expenditures don't impact this portion.

What do you do with the money you're not spending?

He bets it on himself.

I posted this yesterday: "The best investment advice you'll never get"

http://news.ycombinator.com/item?id=178443

go to vanguard and invest your money in several different, diverse, low-cost funds. index funds are great, but you can't buy only index funds and be diverse. buy some REITs, some bonds, etc..

spread the money out, no more than 20% in any single fund unless the fund itself is diverse.

sit on it for a long time.

thats it.

What %s do you suggest in particular across the various asset classes?

well, this is how i invest, specifically. i'm young and more aggressive:

35% domestic 500 index

15% foreign developed markets

20% foreign developing markets

10% REITs

10% intermediate-term bonds

10% inflation-protected bonds

vanguard index fund or fidelity spartan fund (which actually is a money loser for fidelity, but they keep the fees at .1% as a loss-leader to bring in the chumps for the managed mutual funds)

no-load, low-fee index funds, basically.

Berkshire Hathaway.

I wonder what's gonna happen when Buffet retires.

If things go downhill, it'd happen slowly. The management team at Berkshire is good and Warren had his pick of replacements. Plus they hold so many companies and are pretty hands-off with each of them.

I'm just wondering if there is going to be a big drop the second the news is announced, even if it is unwarranted.

Check out http://seekingalpha.com/article/66982-berkshire-hathaway-app...