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Investing Principles

5 Secrets to Help You Build Wealth by Investing

Whether you’re thinking of investing some extra cash or pushing your 401k or IRA to grow bigger, here are five ways to get more from your money immediately.

Articles by Betterment Editors

By the Editorial Staff
Betterment Resource Center  |  Published: May 12, 2014

Your investor returns are what matter most—it's the money in your pocket after all is said and done.

Betterment can add 2.66% in additional investor returns with our smart platform that helps you avoid pitfalls.

It’s exciting when you hear that the stock market is up about 30%, which it was for 2013 overall. It sounds like good news for the economy, for Wall Street—but did you see a 30% return on your money? Probably not.

Typically there’s a gap between what the market returns (investment returns) and what actually lands in your pocket (investor returns). But you can close some of that gap—without taking any additional risk for your investments—by moving a few levers right now.

Whether you’re thinking of investing some extra cash or pushing your 401k or IRA to grow bigger, here are five ways to get more from your money immediately.

Cut costs

Investment fees (expense ratios, management fees, trading costs, etc.) often sound insignificant because they’re listed as a few dollars (e.g. per trade) or couched in percentages, often as low as 1%. Yet reducing the semi-hidden fees and costs is one of the biggest—and easiest—ways to improve your take-home returns.

Over 30 years, if you pay 0.31% in money management versus 1% on a starting portfolio of $100,000, say, that savings of 0.69% could add about $161,000 to your nest egg, assuming an average 8% return over that time (and no other contributions). Here’s another look at the cost difference with regular saving. The graph below assumes monthly contributions of $1,000 over a 40-year period, and shows returns net-of-fees, on a total return of 8%.

Impact of Investment Fees on Retirement

Impact of investment fees on retirement

Index it

How do you lower investment costs? One way is to reduce specifically what you pay for the mutual funds and other investments in your 401k or portfolio. Actively managed funds (with a team of money managers at the helm) charge more than index funds, which mirror the performance of a certain market sector.

You might like the sound of having an active manager who’s on top of a certain mutual fund, but research published in the peer-reviewed Journal of Indexes in January 2014 demonstrated that over a 15-year period, an all index fund portfolio outperformed a portfolio of active funds 83% of the time.

The median annual shortfall of the losing active portfolios was  -1.25%. By using all index funds in your portfolio, you’re primed to capture that 1.25% advantage over the long term.

Diversify your investments

Having your eggs in many baskets is smart investing—but contrary to popular belief that’s doesn’t mean investing with multiple providers. (That typically only leads to a diversity of fees.)

Ideally, you want to be invested in a range of asset classes. This can help you reap the benefits of market upswings while mitigating the blow when there are dips.

A recent analysis by our investment team compared a typical DIY, two-fund portfolio to our global portfolio of up to 12 ETFs (depending on risk level). Over a 10-year period, the diversified portfolio outperformed the benchmark by 1.61% on a risk-adjusted basis at a 70% stock allocation.

In dollar terms, that means the same $100,000 invested between 2004 and the end of 2013 would have been worth about $15,000 more in the diversified portfolio—with no more risk. That’s money on the table.

Automate the details

Now that you’ve come this far, you can’t forget about the details.

Certain investment tasks (rebalancing, dividend reinvesting, etc.) are like housekeeping: they keep your funds neat and tidy so your portfolio does what it’s supposed to. And like housekeeping, those tasks are tedious—yet crucial. When your portfolio drifts away from your original allocation, for example, it usually means you are taking on an unwanted risk that could hurt your returns over time.

Studies have shown that regular automatic rebalancing helps you to keep 0.4% more of your returns.

But to make sure you’re getting the full benefit of basic maintenance, don’t leave those details to chance. Look for an investment manager that does this automatically and without any extra trading fees associated with completing this task.

Behave yourself

Once you’ve taken the first four steps and have yourself in a globally diversified portfolio of low-cost ETFs, the final step might be the hardest—and yet also the easiest—to complete.

It’s the choice to do nothing. Yes, you read that right. Nothing. Nada. Zilch.

A number of academic studies have shown that bad timing decisions—e.g. emotional or impulsive investment choices—cause investors to sacrifice a significant portion of their returns. That behavior gap has been estimated to cost anywhere from about 1% to 6% of an investor’s returns.

That’s why it’s important to find an investment manager who’s on your side—ideally an automated yet sophisticated system that allows you to make the best decisions, yet is also equipped with safeguards so you don’t careen off-track.

 

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