The majority of “investors” aren’t investing. It’s likely you’re one of them. Oh, you think you’re investing because you’re doing what Wall Street brokers and CNBC have been encouraging for decades: speculation.
Before I show you the best way to invest, let’s consider a couple of concepts that have been masquerading as investments:
Individual stocks. Picking a few potentially hot stocks is no different from gambling. You are guessing how a business might perform in the future. How many bought Apple when it was on the brink of bankruptcy and rode it up as it became the world’s most valuable firm? How many owned General Motors, once one of the world’s most valuable companies, and then watched it fall into bankruptcy?
Timing the market. Do you really believe that someone knows the future? Do you? Even assuming someone does possess uncannily accurate predictive powers, why would they share their market-beating knowledge with you? Timing is simply gambling. Some win. More lose.
Real estate systems. There is a finite supply of houses and thousands of graduates of “flipping” classes seeking that rare “diamond in the rough” bargain. Ever wonder why there are so many “get rich investing in real estate” classes? Because the only ones consistently getting rich are those who “teach” them for thousands of dollars per class.
Gold and other precious metals. An investment needs to have the potential to grow or produce income. Gold doesn’t grow, nor does it pay interest. It just sits there as an accepted store of wealth. Remember two things about metals: They are not finite, as a massive new supply could disrupt prices. They have never, over any decades-long period, offered anyone increased purchasing power.
A real investment must offer a reasonable expectation of internal growth; an income stream (like lending); or a reasonable expectation of long-term safety, otherwise it’s gambling.
An investment that meets the first criteria is the ownership of a business. A business has the potential to multiply the growth of capital.
Bonds fall into the second group. An investor receives income when she lends her money to others.
However, owning a single stock, or even a few, imparts great risk. You can lose all of your investment. There are even some bonds that proffer the potential of total loss.
A process of elimination and some simple science lead us to a single best way to invest: Own a massively diversified portfolio of stocks and bonds based on both your needs and tolerance for risk (which, in this case, is expressed as volatility).
Your portfolio should include as many publicly traded stocks as possible, divided between U.S. and international stocks because global markets don’t always move in lockstep. When U.S. markets were hot in the 1990s, international markets failed to perform as well. When U.S. markets lagged during the infamous lost decade, between 2000 and 2010, international equities provided decent gains.
Because stock markets can be extremely volatile, real investors need some portion of their money in bonds. Forget corporate bonds; they share similar risks with stocks. Bonds should be of high quality and low volatility. Short- to intermediate-term U.S. government securities best fit the bill. Your stock-to-bond ratio should be based on your risk profile.
What makes this globally diversified portfolio the “best” way to invest? Historically, it has provided decent returns and tolerable volatility with practically no risk of total, permanent loss. A total loss could only occur as the result of a calamity that destroyed the entire world’s economy. Should that happen, are you likely to care much about your investment portfolio?
Don McDonald has been an educator and advocate for individual investors since 1988 and hosted a national radio show on Business Radio Network for over 20 years. He and his friend and partner, Tom Cock, founded the fee-only investment advisory firm Vestory in 2009. McDonald also co-hosts Talking Real Money on KOMO Newsradio.