Time is the most powerful tool available to the passive investor. It is the one portfolio growth tool that cannot be replicated or falsified.
Investing for the long term (ideally ten years or more) ensures that you will not be affected by short term market fluctuations and the natural economic cycles of the market. Investing for the long term over time ensures your investments can ride the waves of these cycles and allow you to rebalance/ optimize your portfolio based on these cycles.
Time is also necessary for compounding to take effect to grow your portfolio.
Compounding is the process of generating earnings on an asset’s reinvested earnings. Albert Einstein called compound interest “the greatest mathematical discovery of all time”.
To work, it requires two things: the re-investment of earnings and time. The more time you give your investments, the more you are able to accelerate the income potential of your original investment, which takes the pressure off of you.
Read more about compounding here.
Grow Your Investment Capital & Reinvest Earnings
Be sure to grow your investment capital regularly and reinvest your earnings throughout your investing life.
As highlighted above, reinvesting your earnings from your investments will allow compounding to take effect over time.
A disciplined approach to growing your investment capital overtime will grow your portfolio exponentially over time.
You can do this by injecting large sums of money on an ad hoc basis. Naturally, this is dependent on your active earning power and regularity of your income.
If your income is commission-based or you receive yearly bonuses, you can inject lump sum amounts into your portfolio.
Alternatively or concurrently, you can invest smaller amounts regularly (every month) using a dollar cost averaging approach to investing. This involves investing a fixed sum of money at regular intervals, whether the market is up or down. Over time, this approach works well as you avoid timing the market.
You can read more about Dollar Cost Averaging here.
Various stock brokers, banks or fund companies offer regular savings plans or monthly investment plans where you can invest as little as $100 a month to buy a stock, mutual fund or ETF.
Keep Costs Low
One key to optimize the growth of your passive investment portfolio is to ensure you keep your transaction costs low. These fees may include brokerage commissions, sales charge, loading fees, management and platform fees.
There are several ways to minimize your costs as a passive investor.
1) Only trade when you need to. The less trades you make, the less fees you will incur. As a passive investor, you should be employing a “buy and hold” strategy with some necessary rebalancing infrequently (albeit a regular basis. That is; once a year or longer)
2) Execute the trades yourself with your stock broker’s online trading platform instead of going through your human stock broker. This will cost less per trade.
3) As a passive investor, a bulk of your portfolio will consists of low cost mutual funds (unit trusts) or ETFs. Try to look for funds or ETFs that have no front-load sales charge and low annual management fees.
Fees are charged as a percentage. Generally, anything below 0.2% is considered low and anything above 1% is considered high.
If you are buying mutual funds (unit trusts), look for a distributor that charges a low or no platform fees.
While the difference in percentage in fees may seem small, the small amounts do add up significantly over time. Just as compounding works in your favour when you reinvest your earnings, fees also compound over time.
Here is an example, assuming your investment amount averages $50,000:
If a fund company charges 0.125% per quarter for ongoing platform fees, you will pay $1,250 over 5 years and $2500 over 10 years.
If a bank charges a front-load charge (sales charge) or 3% and ongoing platform fees of 1% per annum, you will pay $4,000 over 5 years and $6500 over 10 years.
4) Avoid any complex financial instruments like Structured Deposits or Investment-linked Insurance Policies that may have high fees and a low return.
5) Avoid making investments or trades through a financial adviser or planner. On top of transaction fees, you might be paying additional commissions.