Zen and the Art of Portfolio Maintenance

Pssst. I've got an investment secret for you. In fact, I can say with some certainty that it is the best tip you'll ever encounter. It's so powerful that it will enable you to sleep easily at night and serenely go about your business while everyone's freaking out. Amid the chatter of Armageddon in the Square Mile and on Wall Street, you'll know that you've done the very best thing for your portfolio.

I can sum up this strategy in just three words: TUNE IT OUT.

Tune out the talking heads on TV who purport to know what the market is going to do. Tune out the broker peddling the supposedly bulletproof securities du jour. Tune out the man on the radio who makes a pretty convincing case that you should buy gold and run for the hills.

TUNE IT OUT.

The fact is, no successful investment strategy revolves around trying to guess the market's direction, so I wish everyone would just stop acting like that's a productive activity. Now, maybe there's some guy running a hedge fund somewhere who has been able to call the highs and lows in this or that market with some regularity in the past, but I'd question his ability to do so in the future, and chances are the onerous fees he's charging will get the better of his returns in the long run.

Now, I know that I can't convince the legions of pundits and brokers of the merits of not producing the noise. After all, their livelihoods depend on getting you to trade and buy stuff based on the daily news flow. But if I can convince you, Mr. or Ms. Small Investor, to tune it out, I'll be satisfied. Simply follow these three steps. As you do so, take note of the fact that NOT ONE of them involves formulating a view of the future direction of the market.

Step 1: Find your true north.
The bedrock of any sound investment strategy is creating a stock/bond mix that makes sense for you based mainly on your age, your years until retirement, and your risk tolerance. Once you've come up with that, you batten down the hatches and make adjustments only if market action moves your allocation way out of whack with your targets; you'll also want to make your allocation more conservative as you get older.

True enough, most asset-allocation frameworks extrapolate the past risk/return profiles of various asset classes into the future--for example, past data indicating that stocks historically outperform bonds (but with a bigger propensity for losses) leads most asset-allocation plans to favour stocks early in an investor's life. There's clearly no guarantee that asset classes will behave the same way in the future as they have in the past, but historical risk/return profiles are the best and most logical guide we have. To help harness some expertise in this area, you can start by looking to the asset allocations of target-date funds such as those offered by Fidelity to get your portfolio's asset allocation in the right ballpark. Simply find the fund that is closest to the year in which you hope to retire, then compare its asset allocation to your own portfolio. These funds are also a great option for long-term saving in their own right if you don't want the hassle of sorting things out for yourself.

Step 2: Select your investment approach.
For individual investors, there are three viable strategies for selecting the securities that will underpin your asset allocation. Notice that not one requires that you spend much, if any, time thinking about what the broad economy or market will do. Also bear in mind that you don't have to "choose sides"; you can do just fine by combining these approaches in your portfolio. I've ranked them from the least labour-intensive to the most labour-intensive.

Index: The premise here is that you own the whole market or a market sector, then sit back and let other market participants do what they're going to do. Indexing can be a low-cost and tax-efficient strategy, and those characteristics have helped tracker funds stay competitive with, or beat, most active stock- and bond-pickers over time. Moreover, index tracking is the ultimate in low-maintenance, so if you'd rather spend your time on things other than investing, it's the right approach for you.

Delegate to an active stock- or bond-picker: If you're not satisfied with the value proposition of indexing--which is that you'll match the market's return, less expenses--you can buy a fund run by a manager who picks securities for you. In so doing, you'll gain a shot at besting the market over time, but you also run the risk of seriously underperforming it. Morningstar's growing library of fund analyst research can help you sort the good from the bad, as can our screening tool.

Buy individual stocks: This is probably one step further than most individuals want to go given the time and dedication required to effectively research individual equities, but it can be done if you're so inclined. In reality, most stock-pickers probably do pay at least passing attention to what's going on in the broad market and economy. But most successful ones really skimp on that activity and instead focus on what they can truly analyse: namely, an individual company's business prospects and whether it's trading cheaply or dearly relative to what those business prospects are worth. That's the approach employed by Morningstar's stock analyst team.

Step 3: Save more than you think you'll need.
This step is so obvious that no one bothers to talk about it, but it's actually a far more important lever in determining whether you reach your financial goals than is your investment approach. If you know that you've lived within your means and consistently put some money aside for the future, you won't have to rely on your portfolio to do the heavy lifting by generating outsized returns, and you're less likely to be spooked when the market isn't cooperating. Knowing that you've done your fair share to shape your future is ultimately the most satisfying and calming thought of all.