“Sometimes your best investments are the ones you don’t make.” – W.H. Auden

Let’s assume you get the 10% raise (at least) that you resolved to get yesterday. And let’s say, just to keep the numbers round, that it amounts to $10,000.

Here’s what you should do with it.

1. Set aside the portion of the $10,000 that the government wants — $2,500 to $4,000. That leaves you with $6,000 to $7,500 net after taxes.

2. Allocate 10% of your net after taxes ($600 to $750) to reward yourself with a bonus for getting the raise — perhaps with the purchase of something you’ve been wanting for a long time.

3. Invest the rest in stocks and bonds.

Let’s talk now about that — about investing in stocks and bonds.

As you probably know, I have spent a lot of time in the investment-advisory business. Not on the financial planning or brokerage side, but as a consultant to investment book and newsletter publishers. I’ve also created, marketed, directed, and spoken at more than 100 investment seminars and conferences.

All that experience has taught me one important lesson: You can’t make money by looking for 10-to-1 returns. If you want to get wealthy as an investor, you have to have more reasonable expectations.

Speculative investing is gambling, and, as someone smart once told me, there are only two kinds of gamblers: losers and liars.

If you are inclined toward this kind of investing, make yourself a New Year’s promise that you won’t do it anymore. Keep in mind that you are going to become wealthy the smart way by following four paths:

1. increasing your income year after year (We talked about that yesterday.)

2. getting a good (but reliable) return on your passive investments

3. enjoying the relatively safe leverage you can get from local real estate, and

4. creating for yourself a second income

Since you can expect to get high returns from real estate and the growth of your own business, you don’t need to take crazy risks with your stock-and-bond portfolio. Rather, you should be conservative there — and that will give you the peace of mind you’ll need to focus on the other three paths to wealth.

Here is what I recommend for your stocks and bonds this year:

* Fixed-return Instruments:

There are all sorts of options in this area. You can look elsewhere for particular advice about what is best. I invest in top-quality municipal bonds, and I’m happy to get the market rate. Since I’m in the maximum tax bracket, 4-1/2% is equivalent to about 7% — which will double my money in 10 years. That’s more than enough for me.

I recommend you put at least half your savings in bonds — even if you are very young. I am now about 85% in bonds and I can’t imagine ever having more than 25% of my money in stocks.

I know that’s conservative, but, as I said above, I don’t need to take risks in this area — the area I know least about and have the least control over — so why should I?

* Stocks:

I have trouble predicting the profits of companies that I own — businesses that I know as well as I know my children — so how can I presume to know the future share price of someone else’s business?

That said, I believe in the stock market. Over the long haul, history tells us that we can expect to make about 9% or 10% on our money if our stock investments perform, on the average, as well as the market as a whole.

You can achieve that goal — 9% or 10% — by finding a good adviser or a good stock-investing system and sticking with it.

You might even do a little better than that.

Of the dozens of investment advisers I have worked with, there is only a handful I’d recommend to you. Not because the others weren’t smart (some were brilliant) or honest (some to a fault) or knowledgeable (some were positively erudite), but because sooner or later — and usually when things were “going against them” — they abandoned their sensible investing programs and jumped on whatever trend happened to be hot.

People (Mark Hulbert, among others) who study investment advisers will tell you that very few gurus beat the market over time. Any individual stock picker may get hot for a while, but very few post above-market returns over a long period of time.

Those who are consistently successful share one trait: They stick to their stock-picking system even when the market seems to turn against them. (Warren Buffet refused to abandon his fundamentalist approach to buying stocks even when the media — enraptured by the Internet gurus — were questioning his sanity. Now, he is once again being regaled as a financial genius.)

I look for three other traits in a stock picker or a stock-picking system:

1. I like to buy value. I believe that — over the long run — stock prices will, by and large, reflect earnings. Therefore, I like advisers and advisory systems that keep P/E ratios in mind.

2. I prefer companies that have profit schemes I can understand. You can’t know enough about another person’s business to predict its outcome, but if you can at least understand how he plans to sell his product — and if you have some similar experience in your own business life that you can compare that selling scheme to — you have a better chance of avoiding flakes, fakes, and fast faders. (The reason I bought very few Internet stocks is that I could never make sense of their marketing plans. For the most part, they violated everything I’d learned about selling.)

3. I favor trailing stop-losses. Although I do have some stocks in my portfolio composed of very substantial, very solid companies — stocks that I intend to hold on to for the long term — I believe from what I’ve read that to get a higher-than-average yield from the market, you have to pick stocks that have lower caps and are more likely to grow. And since this approach involves more risk, you need to mitigate that risk by setting and keeping trailing stop-losses.

To further reduce my risks with stocks, I break my ongoing stock investing into two parts. Half of it goes into additional very big, very reliable companies that I plan to hold on to for at least 10 years.

The other half goes into stocks selected according to the criteria mentioned above, following the advice of a stock picker I trust. When I hear a recommendation that captures my imagination — and meets the standards I’ve embraced — I’m happy to make an investment. But it’s never more than 1% of my invested net wealth.

This last rule is important, so I’ll elaborate.

Say you are worth $2 million, half of which is tied up in your home and business. Your invested wealth — the money that you have in stocks, bonds, real estate, and the bank — amounts to $1 million. One percent of that is $10,000. That’s the limit I’m recommending for this financial situation.

I’ll recommend investment advisers to you when (a) they have a hot hand and/or (b) they have written something that I think makes a lot of sense.

When I do, feel free to invest in their recommendations. But keep the investment small and your portfolio balanced. And cut your losses if a recommendation turns out badly. Do that, and neither you nor I will have to worry about you.

Let’s review your new resolutions as they pertain to stocks and bonds.

1. Give up the idea of getting huge returns on your investment portfolio. Be happy with the market average on stocks (9% to 10%) or a bit better than that by following a good adviser in a consistent way.

2. Rearrange your portfolio so that at least half of it (and probably much more) is in bonds or other fixed-return instruments.

3. Never invest more than 1% of your investable wealth in any one stock. (And this goes equally for any recommendations you get directly or indirectly through ETR.)

4. When investing in individual stocks, recognize that you don’t always have the right idea — and the same is true of your adviser(s). Use a trailing stop-loss at 25% and use it consistently.

If you invest like this, you will experience the occasional loss — but it will never be so much or so often that you’ll have to worry about it.

As the years go by, you’ll get wealthier and wealthier. Not by a huge amount — that kind of growth will come only from your primary business — but by a percentage big enough to make you happy and comfortable when it comes time to slow down and rely more on your passive income.

[Ed. Note.  Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Palm Beach Letter. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.]

Mark Morgan Ford

Mark Morgan Ford was the creator of Early To Rise. In 2011, Mark retired from ETR and now writes the Wealth Builders Club. His advice, in our opinion, continues to get better and better with every essay, particularly in the controversial ones we have shared today. We encourage you to read everything you can that has been written by Mark.

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