Sure, you know you should have some (if not most) of your long-term savings in the stock market. You've heard that ordinary investors have turned thousands into millions, and you want your shot at those kinds of returns.
Yet the risk of the market scares you, and you're unsure how to get started. You want to know exactly what actions you should take to finally get your investing house in order. Don't worry, there are plenty of folks in your situation. The low-risk "Index Plus a Few" strategy may be the answer, and I'll explain how you can implement it in just a few days.
Former Fool writer Matt Richey expounded on the "Index Plus a Few" five years ago, dubbing it the "IPF" strategy. In a nutshell, this elegant and simple plan gives investors a very good shot at market-beating returns over the years.
It all starts with allocating the majority of your portfolio -- 70% to 90%, say -- to an S&P 500 or total-market index. You can do this two ways. The first way is to buy into an index fund, such as the Vanguard S&P 500 index or a similar total-market fund.
But perhaps an easier way is through an exchange-traded fund, or ETF. These can be bought and sold, just like stocks, through your online discount broker. The two ETFs we're interested in here are S&P 500 Unit Depositary Receipts -- better known as "Spiders," and Vanguard Total Stock Market Index Shares. One tracks the S&P 500, the other the total market. Either, or both, will work just fine.
Investors with the bulk of their portfolio in any combination of these instruments are already off to a great start and stand a good chance of outperforming the majority of managed mutual funds over the years. If this is you, and this is as far as you want to dip your toe into the equity markets, that's fine by us. But if you want to shoot for higher returns, while adding just a bit more risk, read on.
.Plus a Few
And now for the part of the equation we're counting on to help us beat the market averages over time. And we're talking about only a very few stocks that will fill out the remaining 10% to 30% of our ports -- stocks that will provide that extra boost we're seeking. Consider the following table, which highlights returns over the last 15 years:
|Jan. 1990*||May 2005||Return on Investment|
Uncovering a winner or two like these throughout our investing careers will add the few percentage points we're seeking. And what will a few percentage points mean over the long term? Glad you asked. Someone investing $2,500 per year and earning the historical market average of 10% annually will have accumulated $157,506 after 20 years. But adding just two percentage points to that market average boosts the total to $201,747. Larger dollar amounts and longer time periods make the difference even more dramatic.
But how do you find these stocks? Two ways: on your own or with others' help. Either way is fine. Perhaps the Peter Lynch philosophy of investigating the products and services you use will work for you, as it did for Lynch when he bypassed big-name hotel giants such as Hilton
At the same time, I know that plenty of you would like help finding "the few," and I'm more than comfortable guiding you to Hidden Gems, where Tom Gardner and his guest analysts have rolled up 29% average returns since the product's inception in July 2003. That stacks up very well to the comparable S&P 500 return of 6%. I also think that investing in a few smaller businesses is a nice complement to the indexes, which are dominated by larger companies.
Start right now
If you're interested in this strategy, you'll want to get into an index first. The larger the percentage of your portfolio that you allocate to an index, the less risk you'll take on. Cautious investors may even want to start with 95% in the index, leaving 5% for individual stocks. Younger and more experienced investors can shift the allocation to take on more risk in exchange for potentially more reward.
For some idea of the amount of risk you'll be taking on, consider a worst-case scenario: If your few stocks all went bankrupt, how much would you lose? A 90%-10% strategy with a $25,000 portfolio would lose $2,500. That's comparatively small, but you will either have to make up that amount in extra contributions or lose the compounding power on that $2,500 over the years.
The next step, of course, is finding your few stocks. If you're going on your own, there's a wealth of information out there that you can dive into -- most of it right here at Fool.com. If you like the idea of a newsletter with two recommendations each month, you can give Hidden Gems a try, for free, for 30 days.
No matter how you decide to do it, the most important thing is to simply get started.
Rex Moorehelps Tom Gardner pan for gold at Hidden Gems. He owns shares of La Quinta, but no other companies mentioned in this column. The Motley Fool is investors writing for investors.