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However, that depends a lot on your starting position. Is your portfolio situated along the efficient frontier? Are you taking uncompensated risk? Have you done all you can to minimize your investment fees and taxes?
There may be steps you can take to improve your returns without putting your money at further risk, and Dr. Jim Dahle outlines four easy ways in which to do so below.
As always, this post originally appeared on The White Coat Investor.
Four Ways to Boost Investment Returns Without Additional Risk
Most investors, physician or otherwise, need relatively high returns in order to achieve their financial goals. However, many experts feel the returns of bonds, stocks, and even real estate are likely to be lower in the foreseeable future than they have been historically.
Bond yields, in particular, are near 30-year lows. The stock market is nearly ten years into a bull market and good deals in real estate are becoming harder and harder to find as the economy recovers.
Higher returns are often correlated with higher risk when it comes to investing, but there are several ways to boost your investment returns without increasing risk in the short or long term.
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#1 Achieve Market Returns
Despite decades of academic literature suggesting the need to change strategies, many investors are still unknowingly engaged in a vain pursuit to beat the market over the long run by selecting individual securities and engaging in market timing, or more commonly, hiring a mutual fund manager or financial advisor to engage in these same deleterious behaviors.
Investors in the know, on the contrary, have realized that these behaviors are far more likely to result in underperforming the market than in beating it. The sophisticated solution is also the simple solution—guarantee yourself market returns by investing in low-cost index funds.
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For further reading on the three fund portfolio, check these out:
- He Has Read Over 250 Investing Books. He Recommends These Three Funds.
- From 28 Funds to 3: Simplifying to a Three Fund Portfolio
- A Vanguard Three Fund Portfolio Just Got Cheaper!
- Investing in a Three Fund Portfolio Across Numerous Accounts. Get the Spreadsheet!
- The Bogleheads Guide to the Three Fund Portfolio
#2 Decrease Fees
Another guaranteed way to boost your investment returns is to lower your investing-related fees. These include advisory fees, commissions, spreads, expense ratios, and wrap fees. It is not uncommon to see investors paying 2% or even 3% in total fees every year.
Even if an investor managed a return of 8% a year before fees, if he is paying 3% a year in fees, he will end up with 43% less money (and retirement income) after 30 years. While most investors cannot reduce their fees by 3% a year, many investors who start paying attention to their fees are able to reduce them by 1% a year or more.
Every dollar paid in investment expenses comes directly from your investment returns. Reduce the “drag” and your nest egg will grow much faster. Some easy ways to reduce fees include eliminating “churn” by engaging in fewer transactions and using the mutual funds in your 401(k) with your lowest expense ratio.
Many investors can also lower advisory fees by negotiating with their current advisor, moving to a lower cost advisor, or even learning to manage their own portfolio. While individual investors often lack the knowledge of a professional, sophisticated investment management can be surprisingly simple, and if nothing else, the investor can rest assured that he won’t rip himself off!
#3 Decrease Taxes
One of the largest expenses for many investors is the taxes due on interest, dividends, and capital gains generated by investments. By investing in a tax-efficient manner, this expense can also usually be reduced significantly.
Tax loss harvesting any investments with capital losses can further reduce the tax bill. After applying the effects of investment expenses, taxes, and inflation, many investors don’t have any return at all. There isn’t much you can do about inflation (aside from taking sufficient investing risk that you can outpace it) but an investor can exert a surprising amount of control over his fees and taxes.
#4 Diversify in High-Returning Asset Classes
Another way to boost investment returns without taking on any additional risk is to diversify into other high-returning asset classes. For example, instead of simply investing in US stocks, an investor could add an investment in international stocks and one in real estate to his portfolio.
Since each of these investments has similar, high returns over the long run, but varying returns over the short run, holding a fixed percentage of each of these assets and periodically rebalancing them reduces portfolio volatility, reducing risk and increasing returns.
The lower the correlation between the returns of the various asset classes, the more effect this diversification will have. Bear in mind that diversifying into some lower-returning asset classes, such as bonds and precious metals, may reduce risk, but is also likely to reduce long-term portfolio returns.
Very few investors have the luxury of only needing low returns to meet their goals. Achieving acceptable returns in our current low-yield environment can be made much easier by achieving market returns, reducing investment expenses, decreasing taxes, and diversifying the portfolio.
The sooner you take these steps with your portfolio, the larger your nest egg will become, allowing you more money in retirement, more time in retirement, or both.
6 thoughts on “Four Ways to Boost Investment Returns Without Additional Risk”
Yea efficient frontier! Other techniques include:
Tax loss harvesting. Last year I converted $600K of appreciated stock to cash for free because of tax loss harvesting.
Planning the most efficient way to Roth convert including funding living expense during conversion. If you plan correctly, years to decades in advance (much like planning for college) a small amount of money can compound to a large amount of living expense while Roth converting. My Roth conversion is going to cost about $650K including 4-5 years of retired living expense and 248K of taxes. Over half of that expense will be paid by compounding. My present tax bill is $62K/yr and is entirely due to Roth conversion. There is no other income to tax. I’m living on cash. My portfolio remains closed to SORR since a conversion is not a withdrawal. The 248K already belongs to the government and will only grow larger as the TIRA grows larger. My first post age 70 tax bill after conversion is estimated at $1590. It never goes above about $15K per year till age 92 which is when I ended the projection.
Gold is useful because its value tends to grow dramatically in a crash. It sometimes is negatively correlated to stocks during the crash period. Take a look at SPY compared to GLD on a yahoo finance chart in the peri 2008 period to get a vizual of the negative correlation of the two in a crash. This is very useful if you need to sell something (like gld) in a crash to buy hamburgers and no longer have a W-2. This saves you from selling your depressed stocks at the worst time. I guess you could call that diversity of options. In a truly diversified portfolio (bonds gold stocks etc) in a crash you sell what is high if you need some cash. This point is often missed by investors in the accumulation phase where the W-2 is providing the bulk of free cash flow (hamburgers) and diversity.
The final thing is re-balancing which provides a kind of “time domain” and mechanical diversity and enforces a system of selling high and buying low. Systems save fortunes.
I’m also a big fan of Roth converting about 5 years before RMD and pretty much cleaning out TIRA (read that taxable IRA money) up to the top of the 24% bracket. If you compounded yourself up some money to live on and pay for the taxes during your working life, while converting, you can convert at the lowest cost and you can let your SS grow @ 8% till age 70, minimizing future taxes and maximizing SS and you can let your portfolio continue to grow unmolested by SORR. This strategy especially pays off when a spouse dies and the remaining spouse can get kicked up 2 tax brackets by good old Uncle Sam. The projected end value of my portfolio increased by nearly 1M by doing proper sequencing. An extra 1M near the end of life buys a lot of long term care.
Damn, a lot to chew on there Gasem. Thanks for taking the time to add your thoughts! Lots of useful nuggets for me to think through.
I would also add that you need to take a long term view in investing and not be swayed by short term noise in the market. Studies have shown that even though people have done index funds and invested in the market, they can have lower returns. The reason was that they ended up selling at inopportune times when the market went down instead of riding it out and thus lost on the subsequent gains that the market has always shown in recovery.
Just missing a few of the biggest market day gains by being on the sideline after selling can have a significant impact in your portfolio return.
I am glad to see that since I have “found the light” and switched to index fund investing I pretty much am following all 4 suggestions.
I totally agree with the second point around fees. For a long time I thought the best I could do was to shop around (eg. look for a cheaper self-investment platform) and transfer my assets there.
However I have discovered that there is almost always room for a little negotiation on the fees – maybe as a condition for making the transfer.
So I now call them and try and negotiate a better deal. Sometimes it works, sometimes it doesn’t, but because of compounding, even achieving what may feel like a tiny reduction in fees (say, from 0.8% to 0.7), translates into a meaningful return in the long term.
An acquaintance of mine was told by his already expensive financial advisor, that his investment firm was thinking about raising their fees from 1.5% to something higher.
He told them he would be going to Vanguard or Fidelity if they did.
I don’t know why he stays at 1.5%.
Great post. By sticking with the major indexes, investors get to capture the market average. 80% of investors who try to beat the market earn returns below the market. Index funds, low fees, tax efficiency, and an appropriate asset allocation is the best approach for most individual investors.