Here are five ways an active approach can help even hands-off, index-fund investors squeeze more gains out of their portfolios.
With the S&P 500 ($INX) surging over 30 percent last year, many more people are attracted to passive index fund investing. But even among those who skip the active trading approach, it's possible for investors to be actively involved in implementing a passive investment strategy.
I consider myself a passive investor, but I also actively invest my time to eke out just a bit higher return. Here are a few actions to follow if you want to do the same:
You would think sitting on your hands and doing nothing would be easy, but staying the course is perhaps the hardest thing to do in investing. Your rationale to decrease your stock allocation during a bear market may be solid and reasonable, but the worst time to sell stocks is after their valuations go down.
When the markets turn south, the media will suggest an incredible number of reasons it's the end of the world. Go out of your way to tune out the noise. Turn off your TV if you have to, because it's that important.
Consistently adding money to your portfolio is the key to building wealth. Assuming you wrote down your well-thought-out investment strategy, you need to commit to it by continually putting money away -- even when your investments are not doing well. Investing in poorly performing asset classes might even turn out to be the buying opportunity of your lifetime.
On the other hand, good times tend to tempt many people to spend just a bit more. You might notice your neighbors buying flashy new cars when stocks are flying high. Also, make an effort to stick to your savings plan when your investments are performing well. You only live once, and that's exactly why you need to take care of your future.
The return on an investment isn't the only number that determines how much money you will make from it. You also need to factor in how much tax you will pay on each investment, because different investments are taxed at different rates. It's often a good idea to hold investments with higher tax rates inside your retirement accounts and low-tax investments in taxable accounts to minimize the overall tax rate on your portfolio. Spend some time thinking about the taxes you are likely to pay on each investment, and consider taking action to lower your tax rate.
Asset prices fluctuate, so there are bound to be times when current values are below what you've paid to own a particular asset. Always look to see if it's appropriate to sell an investment at a loss and recognize the capital lost in order to reduce taxes. Just make sure not to trigger the wash sale rule: Avoid buying a substantially identical investment within 30 days of selling it.
Don’t sell investments without thinking through the tax consequences of each action. It’s your after-tax return that will ultimately decide how much spending power you will have in retirement.
Those who take the time to manage their passive investments will reap huge rewards over time. Think about it this way: Putting in a bit of time now to fine-tune your investment strategy could allow you more time off from the 9-to-5 grind later in life, so get into the habit to doing what's right for your investment portfolio.
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