The Three Fundamental Principles of Investing
Asset allocation, approximate the market average, and save enough.
Bill Schultheis builds his entire investment philosophy around three principles that are fully within an investor's control: asset allocation, approximating the stock market average, and saving. The central argument is that these three levers are the only ones that matter, and that everything else Wall Street promotes -- stock picking, market timing, fund switching -- is noise that actively harms returns.
Asset allocation means dividing your money among stocks, bonds, and cash in proportions that match your investment time horizon. Approximating the stock market average means using index funds so your stock investments perform in line with the broad market rather than trailing it (as 79-90% of managed mutual funds do over extended periods). Saving means calculating how much you need to set aside monthly and actually doing it.
The framework's power lies in its simplicity and the compounding evidence behind it. By focusing on what you can control and ignoring what you cannot, you eliminate the emotional decision-making that leads most investors to buy high and sell low. The result is a portfolio that requires minimal maintenance, costs far less in fees and taxes, and statistically outperforms the vast majority of professionally managed alternatives.
- Focus exclusively on the investment factors within your control: asset allocation, market-average returns, and savings rate.
- The more you leave your portfolio alone and get on with life, the better both you and your portfolio will be.
- Trying to beat the stock market average virtually guarantees ending up below it.
- Less than 10% of millionaires consider themselves active traders; 42% make less than one transaction per year.
- Simplifying your investment decisions frees creative energy for the parts of life that enrich you most.
- Determine Your Investment Time HorizonCalculate the number of years until you need to draw on your investments, typically retirement age. This single number drives every subsequent allocation decision. A twenty-five-year-old has a vastly different optimal allocation than a sixty-four-year-old retiree.Pro tipUse age 65 as a default yardstick, but adjust if you have specific goals like early retirement or college funding on a different timeline.WarningDo not confuse your emotional time horizon (reacting to this week's market news) with your actual time horizon (decades away). Tape a long-term stock market chart to your closet door if needed.
- Allocate Assets Among Stocks, Bonds, and CashBased on your time horizon, divide your portfolio into the right proportions. Younger investors (20-45) should hold 80-100% stocks. Those nearing retirement (60+) should shift 30-70% into bonds and cash. There is no perfect answer -- the goal is to broadly represent where you are relative to your time horizon.Pro tipEven the most conservative retiree portfolio should include some stock allocation to protect against inflation, which is the silent risk most investors ignore.WarningDo not let Wall Street's talk of fear and greed push you into short-term allocation changes. Set your allocation and rebalance annually, nothing more.
- Approximate the Stock Market Average with Index FundsInvest in unmanaged stock index funds that own a piece of all publicly traded companies in a given market index. This ensures your stock investments match the market's collective return rather than trailing it, as the vast majority of managed funds do over time.Pro tipChoose index funds with expense ratios of 0.25% or less. There is no reason to pay more for what is essentially the same product.WarningPast performance of managed mutual funds is no indication of future performance -- this is so well-established that fund companies are legally required to tell you.
- Calculate and Implement Your Savings GoalUse a retirement worksheet to determine how much you need to save monthly. Spend ten minutes calculating the gap between your current savings rate and your target. Even a rough approximation is vastly better than the 57% of investors who have done no calculation at all.Pro tipStart saving in a tax-deferred account (IRA or 401k) to maximize compounding. If your employer matches contributions, capture that match first -- it is free money.WarningDo not let Wall Street's inflated retirement figures paralyze you into inaction. Starting imperfectly today is far better than waiting for a perfect plan.
- Rebalance Annually and Ignore Everything ElseAt the end of each year, review your allocation percentages. If market movements have shifted them significantly from your targets, rebalance by selling from the overweight asset class and buying the underweight one. Then ignore your portfolio until next year.Pro tipIn tax-deferred accounts, rebalancing is free of capital gains consequences. In taxable accounts, direct new contributions to the underweight asset class instead of selling.WarningIt is emotionally difficult to move money away from the asset class that performed best, but failing to rebalance leaves you overexposed to the next downturn.
The state of Washington indexes 100% of its domestic stock market pension money. California indexes 85%, New York 75%, Connecticut 84%. These are sophisticated investors managing billions with fiduciary responsibility, and they overwhelmingly choose indexing over active management.
In February 1994, a top mutual fund magazine published its best eight domestic stock funds to own. Four years later, every single one of the eight had underperformed the stock market average, and collectively they trailed by 25% annually.
A friend who restores parks in San Francisco had spent years switching from fund to fund searching for the best one. After being walked through the indexing concept multiple times, she finally asked: 'Why would anyone consider anything but indexing?' She freed herself from Wall Street clutter to focus on her true passion.
Schultheis developed this framework after thirteen years working with retail and institutional accounts at Salomon Smith Barney in Seattle. He noticed that the people who were most successful with their investments were those who spent the least time worrying about them. Saturday morning conversations at a Seattle coffeehouse with friends revealed that most people wanted successful portfolios but had no desire to spend energy on Wall Street. The three principles emerged as the distillation of what actually matters versus what the financial industry pretends matters.