Last week we focused on a topic you voted for in our Facebook group, The Basement. Often you are deciding between two different options and can’t decide…so what do you do? Here’s our outline:
- FIRST: What’s the time frame? If one investment doesn’t fit, eliminate it. How do you know what investments fit each timeframe? Here’s a handy reference link. Generally, the more volatile an investment type is, the longer amount of time you want to give it. If you’re 1-3 years away, stick with cash. Bonds are safest for 4-7 years. Stocks and real estate are best for 8+ years (and ideally, 10 or more years).
- If BOTH fit when you need the money, move down the funnel.
- SECOND: Which investment is less volatile? If both meet the “when are you going to need the money?” test, then move on to which investment follows a smoother path along the route. That way, if you end up needing the money early, you aren’t worried about whether it’s down or not. How do you measure volatility? We like a measure called standard deviation. Here’s a short introduction to how it works. If you use this link you’ll see the standard deviation on a mutual fund through one of our favorite sites to find this information, Morningstar (it may require you to create a free account to see the page, but it’s well worth joining–however, you probably do NOT need the premium features unless you’re a pro). Standard deviation is halfway down the page on the right side.
- Still can’t decide? Move down to the next filter.
- THIRD: Which investment offers the higher average return over long periods? Now that we’ve mitigated our chances of losing money, it’s time to begin looking at making money. Assuming that your investment choices are diversified, you’ll want to look at a chart like this one to see how this type of investment performs historically over long periods of time. You can also use Morningstar to look at the long term track record on your investment. DO NOT choose the investment with the highest short term return! While newbies think this is a “hot” investment that you SHOULD invest in, pros know that investments hot now are often soft performers in the following period.
- Both have similar returns? Move down to the next filter.
- FINALLY: Choose the investment that is less expensive. Notice how most people begin with expenses but we END there? We’re looking first to avoid losing money and to have funds reliably where you want/when you want. Then we want higher returns, after fees (who cares how much they take if your returns are high?). THEN we focus on fees. You’ll find fee information also at Morningstar, under this tab (notice that this link still goes to Fidelity Contrafund, but now is the “Expenses” tab).
- AND after that? Mom says that if you STILL can’t decide, flip a coin. 92% right and fast beats 100% right and slow.