Improve Your Investing With 1 Simple Tip
Experienced investors know a lot of secrets -- many of which they've learned the hard way -- about smarter investing. But there's a tip that even many longtime investors don't know. If you follow it, it could revolutionize the way you manage your investments -- and improve your overall returns. Best of all, it can make investing a lot more fun.
The carbon-copy approach
Believe me, I know how busy modern life can be. For many, spending a bunch of time on your investments is near the bottom of your priority list. Asset allocation strategies, where you decide how much money you want to invest in particular types of investments and then allocate your available money across them, are a godsend for time-crunched investors trying to put their money to work as efficiently as possible.
But in an effort to find simplicity, investors all too often adopt a cookie-cutter model for their investing. Not only will they follow an asset-allocation strategy, they'll follow it in every single account they have. That may seem like a simple approach, but in reality, it can lock you into a fixed mindset that makes you miss out on some unique opportunities when they arise.
Ignoring your biggest asset
Why's it a bad idea to carbon-copy your asset allocation in every account you have? Because different types of accounts have different pros and cons. If you don't tailor your investments to fit each account type, you won't take maximum advantage of the benefits different accounts offer.
The most prevalent example I've seen is in retirement accounts. IRAs and 401(k)s have huge advantages over regular investment accounts. Unlike with most accounts, any income you earn in retirement accounts doesn't get taxed when it's paid. That's a huge resource that can make a huge difference to both your tax bill and the amount of time and money you have to spend doing your taxes.
But if you simply use the same asset allocation in your retirement account that you use elsewhere, you aren't making use of its full potential. Sure, you'll get some benefit from your retirement account, but it won't be as big as it could be.
The one-portfolio approach
The key to addressing this problem is simple: In the end, everything you own is one portfolio. No matter how many different brokers you use, how many stocks or funds you own, and how many types of tax-favored accounts you may have, you can achieve the goals of asset allocation by adding everything up and considering it a big single mass of investments.
Realizing that can be the most liberating thing for your investment strategy. For instance, many investors want to own mortgage REITs Annaly Capital (NYS: NLY) and Chimera Investment (NYS: CIM) because their dividend yields present what could be a unique short-term opportunity to cash in on the Federal Reserve's interest rate policy. But spread your mortgage-REIT holdings around taxable accounts, and you'll lose up to 35% of that income in taxes -- plus you'll expose any gains you eventually claim to further taxation. Concentrate mortgage REITs in your retirement accounts, however, and you'll save on taxes.
Foreign dividend stocks can work the opposite way. Right now, European telecoms France Telecom (NYS: FTE) and Telefonica (NYS: TEF) both pay attractive yields, with the sovereign debt crisis and the potential for a long recession on the Continent hurting their future prospects. But if you own them in a retirement account, then you can't recover any foreign taxes that may be withheld from their dividend payments. In contrast, in a taxable account, many can take advantage of foreign tax credits that will effectively credit that money back.
Make your life simpler
Perhaps most importantly, not having to worry whether every single account you have looks exactly the same can reduce your stress level. With investing as challenging as it is, lower stress is a good thing -- and if the freedom to have different investments in different places also earns you some extra returns in the process, that's just a bonus.
Asset allocation is a great approach, but to make the most of it, you still have to find some smart long-term investments. We've got three great stock ideas in The Motley Fool's latest special report on retirement. In addition to those three picks, we also give you some easy-to-follow guidance for setting you a great overall investing strategy. It's free, but read it today while it's still available.
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance. You can follow him on Twitterhere.
At the time this article was published Fool contributor Dan Caplinger loves to keep things simple, but he likes extra money even more. He doesn't own shares of the companies mentioned in this article. The Motley Fool owns shares of Chimera Investment, Telefonica, and Annaly Capital. Motley Fool newsletter services have recommended buying shares of Annaly Capital and France Telecom. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is the simplest thing you could ever imagine.
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