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Friday, 7 December 2007

Three Ways to Boost Your Investment Returns

ByMike Woelflein, Special to TheStreet.com

If you read Part One and Part Two of our series on boosting your income, you may be making and hanging on to more money.

The next step is growing the money you've got.

Kicking up your returns by a percentage point or two can brighten your financial outlook, big-time. For example, let's say you invest $500 per month in a 401(k), with a 3% employer match. If your investments generate a 7% average annual return, you'll have $882,049 in 30 years. Juice your returns to 9%, and you'll end up with $1,285,785 -- an increase of more than $400,000.

The extra money could make an enormous difference in your retirement income. A $1.29 million nest egg would allow $51,000 in inflation-adjusted annual withdrawals, assuming you take financial advisers' standard advice and withdraw 4% of your retirement savings each year. (Myriad studies have found that a 4% maximum withdrawal rate gives retirement savings the best chance of lasting at least 30 years.)

By comparison, the $882,000 portfolio would allow annual withdrawals of just $35,000. (You can run your own calculations here.)

"You often hear how a dollar saved today can make a big difference tomorrow," says Rick Shapiro, a managing member of Investment and Financial Counselors in West Hartford, Conn. "That's true for every dollar your portfolio earns, too."

Here's how to maximize your investment returns:

Cut Expenses

Every dollar spent managing your money is a dollar missed, not just from today's balance but from tomorrow's growth -- so cutting costs can have a major impact on your returns.

Say you invest $20,000 in an actively managed, no-load stock fund that earns the stock-market average of 11% per year for 10 years. A 1.5% expense ratio would force you to forgo nearly $8,000 in fees and lost earnings, leaving your investment worth $48,823 after a decade. Lower your expense ratio to 0.25% -- for example, by investing through an index fund -- and your costs would shrink to about $1,400, boosting the value of your investment in 10 years to $55,385.

The Securities and Exchange Commission has a calculator that enables you to compare funds and see how their expense ratios might affect your portfolio over time.

Spice Up Your Portfolio

In general, the more risk you're willing to take, the higher your returns will be over the long run. Goosing your stock allocation even a bit might help you amass a good deal more money over time.

Vanguard has charted 10 different asset allocation models for the period from 1926 through 2006. Here's some of what the company found:

With More Risk, More Reward

Average returns for the period 1926-2006

Asset allocation Average annual return Best Year Worst Year
50% stocks, 50% bonds 8.50% 32.30% -22.50%
60% stocks, 40% bonds 8.90% 36.70% -26.60%
70% stocks, 30% bonds 9.40% 41.10% -30.7
80% stocks, 20% bonds 9.80% 45.4 -34.9
100% stocks 10.50% 54.20% -43.10%
Source: Vanguard

The point isn't that a 100% stock portfolio is for everyone. Indeed, the all-stock portfolio lost 43.1% during its worst year (compared with a loss of just 8.1% for an all-bond portfolio's worst year) -- a collapse most investors in or approaching retirement couldn't afford.

But the more time you have until you need your money, they more time you have to recover from potential losses. History shows that the stock market moves inexorably upward: The S&P 500 has never lost ground over any 20-year period since at least 1926. So if you have decades before you'll need to draw on your savings, short-term downturns shouldn't disrupt your finances one whit -- meaning you can afford to ride them out in pursuit of greater long-term gains. As you approach the time when you'll need to withdraw your funds, you can shift the money you'll need into bonds and cash.

Diversify

Meanwhile, you can increase risk-adjusted returns by holding stocks of various sizes, industries and nationalities, and bonds with a variety of term lengths and credit qualities. Those different types of investments tend to move in different patterns --one might surge while another plunges -- helping you smooth out your portfolio's short-term fluctuations while pursuing long-term growth.

"If you want more return, you're going to have take more risk," Shapiro says. "But you can manage that risk with a fully diversified portfolio. In the long term, nothing is going to keep up with a fully diversified portfolio."


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