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Cake day: November 19th, 2023

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  • Way back when I took a short class in investing, and the bottom lines were:

    1. Diversify your investments. Nobody, not even the pros know which individual stocks, or even sectors (small cap, mid cap, large cap, international, bonds, etc) will go up over any given year.

    Individual stocks are risky, because you really don’t know what’s going on inside each company. A sure thing today may collapse tomorrow. The more different stocks you invest in, the lesser your risk.

    1a) Index funds work according to that principle of lowering risk by investing across hundreds of different stocks.

    Choose the ones that have low expense ratios, because they’re automated, and fees will eat into the fund’s earnings.

    Vanguard is famous for their index funds, but other brokerages have copied them, but those others still have higher expense ratios somehow.

    1b) Also these days, ETFs are similar, but you will be paying stock commission fees to buy and sell them, taking a hit on your initial and parting investment.

    1. Portfolio balancing once a year. Since you don’t know which sectors will go up or down in any year, balancing your portfolio is how you capture gains.

    Let’s say you have set a target of 70% large cap index, 10% international stock index, 20% bonds, and you balance your portfolio on July 1st every year.

    In a fictional example, this year, the large caps did well and now constitute 75% of your total portfolio’s value, internationals did okay and are now at 11%, and bonds relatively speaking didn’t go up as much, and are now 14% of the total value.

    That means that bonds are relatively cheap, and a relatively good buy.

    So sell the “extra” 5% of your large cap, 1% of your internationals, and put that total 6% of your portfolio into bonds, rebalancing your portfolio back to 70% large cap, 10% internationals, 20% bonds.

    Next year on July 1st, the stock market has tanked, and bonds are now 30% of your total portfolio value. That means that you should sell the extra 10% total portfolio value of bonds and re-assign them to your large cap and internationals, however that works out mathematically.

    edit: There’s no need to watch your portfolio like a hawk and rebalance every time you glance at it. Just do it once a year, but be consistent.

    etc, etc.

    1. Reduce investment risk as you get older.

    As you get older, and closer to retirement, your tolerance for losing value gets lower because you’re approaching the point where you have to start using your accumulated retirement nest egg.

    Lower your risk of the stock market, and increase your holdings of fixed income return investments, such as actual bonds (NOT bond mutual funds) that are (practically) guaranteed to pay you X amount of interest.

    But holding 0% of stocks still carries risk of inflation wiping out all of the bonds’ earnings.

    It was said that holding 10% of your portfolio in stocks is the lowest risk that works.

    There are index funds that automate this rebalancing and risk reduction for you: Multiple brokerages have “Target retirement funds” These types of funds have years in their names, stating when these funds will reach a minimal risk portfolio. Once again, shop around and find which ones have low expense ratios.